One of the few ways to control the enormous costs of lawsuits is under attack from federal regulators.
On Dec. 14 the U.S. Supreme Court issued the third decision in the last four years upholding private-party contracts to arbitrate rather than litigate disputes. Nevertheless, arbitration, one of the few ways to control the enormous costs of lawsuits, is increasingly under attack from the media and government officials. The latest enemy is the Consumer Financial Protection Bureau.
The CFPB announced on Oct. 7 that it was considering new rules barring contracts from substituting private arbitration for class-action litigation in agreements governing credit cards, checking accounts and other financial products.
The anti-arbitration movement bodes ill for American companies, and it promises to further constrain growth in industries already hobbled by increasing regulation by the Obama administration.
America has long been a litigious country, but the cost of lawsuits exploded after World War II. By the 1980s, for example, specious lawsuits threatened the entire vaccine industry, which was only saved by congressional action exempting manufacturers from suits. In the 1990s Dow Corning, the maker of breast implants, was bankrupted by litigation. This happened despite dozens of peer-reviewed medical studies showing the silicone in its product wasn’t responsible for “autoimmune disorders” purportedly linked to the implants.
Some lawyers got fabulously rich from this system, but American businesses and consumers paid a price. From their peak in the mid-1980s through the early part of the 20th century, litigation costsaveraged more than 2% of U.S. gross domestic product—and that’s just the direct tab, not counting foregone research and investment or the cost of defensive medicine. A 2013 study by NERA Economic Consulting for the Institute for Legal Reform, a division of the U.S. Chamber of Commerce, found that tort liability costs in the U.S. were 2.6 times higher than in the European Union.
That’s the bad news. The good news is that since 2003 the rate of growth in liability costs has fallen below that of the broader economy. Some of that decrease is due to tort reforms at the state and federal level, and some is due to prosecutions of corrupt plaintiffs’ lawyers and their hirelings. Some, however, is due to alternative dispute-resolution mechanisms like arbitration.
Federal law supports and governs the practice through the Federal Arbitration Act. To be enforceable, a clause must provide a meaningful opportunity for redress, and courts review contractual provisions for fundamental fairness. But precisely because the litigation system is so expensive, arbitration is often the preferred remedy for consumer disputes involving small sums, including those over cellphone and credit-card contracts, for which litigation of individual claims is uneconomical.
Is it fair? A 2009 study by the Searle Civil Justice Institute at the Northwestern University School of Law found that, after controlling for variations in case characteristics, consumers were more likely to prevail in arbitration than in court and that there was “no statistical difference in the amount they were awarded as a percentage of the amount sought.” A 2014 survey by the Office of the Independent Administrator of the Kaiser Foundation Health Plan, a nonprofit public-benefit corporation that has mandatory arbitration clauses in its health plans, found that 90% of parties that had gone through arbitration found the process at least as good as the court system.
The alternative mechanism for adjudicating small disputes, the class-action lawsuit, is rife with problems. Ten years ago a bipartisan congressional coalition, including then-Sen. Barack Obama, passed the Class Action Fairness Act to curb abuses such as shopping national lawsuits to plaintiff-friendly state-court jurisdictions and offering plaintiffs coupons rather than cash in settlements. That legislation helped but can’t undo the central problem: No individual plaintiff has enough money at stake to monitor the lawyers, and defendant companies have every incentive to minimize their total payouts. So plaintiffs’ lawyers structure settlements to pay most of the actual dollars awarded to themselves.
After some courts refused to enforce arbitration clauses that ruled out class-action remedies, the U.S. Supreme Court clarified in 2011 (AT&T Mobility v. Concepcion) and 2013 ( American Express v. Italian Colors Restaurant) that such clauses were indeed enforceable under the Federal Arbitration Act. Plaintiffs’ lawyers and their allies howled.
This month’s Supreme Court ruling in DirecTV v. Imburgia will not likely deter the CFPB, whose director, Richard Cordray, has a long-standing relationship with the trial bar. As Ohio’s attorney general, Mr. Cordray was tasked with hiring outside law firms to lead the state pensions’ securities class-action litigation, and out-of-state plaintiffs’ firms gave more than $800,000 to the Ohio Democratic Party during his 2008 election campaign.
Arbitration is not perfect: There are some cases in which arbitrators may have gotten it wrong—but that’s true of the court system as well. Yet thanks to arbitration and tort reforms, the costs of litigation, while still very high, are not as big a drag on the economy as they once were. If government officials overreact to isolated stories by curbing arbitration, they’ll be turning the country in the wrong direction.
This piece originally appeared in The Wall Street Journal
James R. Copland is a senior fellow at the Manhattan Institute and director of Legal Policy.