Class Action Alert
www.pepperlaw.com
August 10, 2006
NJ Supreme Court Condemns Class Action Waiver in
Consumer Loan Contract
On August 9, 2006, the New Jersey Supreme Court
issued an important decision with wide-ranging
implications for the consumer financial services industry
and other industries. In Muhammad v. County Bank of
Rehoboth Beach, Delaware, the Court invalidated a
provision in a consumer loan contract waiving any right
to class arbitration as unconscionable under New Jersey
law. Further, the Court severed the offending provision
and enforced the arbitration clause without it, which
means that the parties can be forced into class
arbitration even though they clearly agreed that there
would be no class arbitration.
The enforceability of class action and class arbitration
waivers is one of the most important issues facing
companies that use arbitration clauses in consumer
contracts. This decision follows a California Supreme
Court decision in Discover Bank v. Superior Court of
Los Angeles, 36 Cal. 4th 148 (2005), which struck
down as unconscionable a class action waiver clause in
an arbitration contract and sanctioned class arbitration
under California law. Other courts have upheld class
action and class arbitration waivers.
In Muhammad, the plaintiff college student obtained a
short term, single advance, unsecured loan in the
amount of $200 from the defendant, County Bank of
Rehoboth Beach, Delaware (County Bank). Under the
terms of the loan, the plaintiff agreed to repay the
principal plus a $60 finance charge within three weeks
of the date of the loan. The Loan Note and Disclosure
form that the plaintiff signed listed the annual rate of
interest at 608.33 percent.
In standard form documents that accompanied the loan,
the plaintiff agreed to two types of class-action waiver
prohibitions. The first prohibition, referred to by the
Court as the “class-arbitration waiver,” barred the
plaintiff from bringing any class claims in arbitration.
The second prohibition, referred to by the Court as the
“broad class-action waiver,” barred the plaintiff from
“bring[ing], join[ing] or participat[ing]” in any classaction suit in court or arbitration.
Despite agreeing to these arbitration prohibitions, the
plaintiff filed a putative class action in New Jersey state
court against County Bank and its loan servicer, alleging
that they had violated the New Jersey Consumer Fraud
Act, New Jersey’s civil usury statute and New Jersey’s
RICO statute by charging and conspiring to charge
illegal rates of interest.
The trial court granted the defendants’ motion to
compel arbitration and stayed the case pending
arbitration; the Appellate Division affirmed. The
Supreme Court reversed and held the class-arbitration
waiver unconscionable and thus unenforceable as a
matter of New Jersey state law. (The Court did not
address the broad-class action waiver.) The Court found
that the consumer contract at issue constituted a
contract of adhesion under New Jersey law because the
lender presented it on a take-it-or-leave-it basis.
Further, the Court found that the contract effectively
prevented the plaintiff from enforcing her statutory
rights and the rights of her fellow consumers and thus
violated New Jersey’s public policy. The Court also
found that the public interest in protecting consumer
rights outweighed the defendants’ right to seek to
enforce the class action-arbitration waiver.
Class Action Alert
As a remedy, the Court severed the class-arbitration
waiver and enforced the remainder of the arbitration
agreement, inferring that the parties intended for the
arbitration agreement to be enforced whether and to
what extent class-wide arbitration might be enforced
because the broad class-action waiver in two places used
the language “to the extent permitted by law.”
If you have any questions or would like more detailed
information about the impact of this case on your
operations, please contact one of the authors below.
Authors:
Dennis Casale
609.951.4199
[email protected]
The Muhammad decision not only sanctioned class
arbitration, it forced it upon parties who agreed that
there would be no class arbitration. Class arbitration
represents the worst of both worlds: all the expense of
complex, high-stakes litigation with none of the
procedural safeguards, such as the right to appeal a class
certification decision. Moreover, it places complex class
action decisions in the hands of arbitrators who, unlike
federal and state courts, have no recognized expertise in
handling class actions and limited authority to permit
discovery and require the attendance of witnesses.
Stephen Harvey
215.981.4450
[email protected]
Angelo Stio, III
609.951.4125
[email protected]
In light of the Muhammad decision, companies that do
business in New Jersey should revisit their form
arbitration agreements and consider, at the very least,
expressly providing that any class arbitration waivers
cannot be severed from the arbitration agreements as a
whole.
The material in this publication is based on laws, court decisions, administrative rulings and congressional materials, and
should not be construed as legal advice or legal opinions on specific facts.
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