Financial Services Class Actions

Growing Consensus in the Courts of Appeals against Alternative-Citizenship Theory of Diversity under CAFAIf a putative class of plaintiffs, all citizens of State A, sues a corporate defendant, which the law considers to be a citizen of State A and State B, in state court, may the defendant remove the case to federal court under the Class Action Fairness Act (CAFA)? Recently, the Sixth Circuit became the third court of appeals to answer “no.”

CAFA, 28 U.S.C. § 1332(d), provides for federal jurisdiction over class actions involving at least 100 class members, with $5 million or more at stake, and in which “any member of a class of plaintiffs is a citizen of a State different from any defendant.” Unlike diversity jurisdiction in most other contexts, CAFA allows minimal diversity—as long as one plaintiff maintains citizenship in a state different from one defendant’s citizenship, diversity is satisfied, regardless of where all other parties reside. Frequently, diversity under CAFA is straightforward. If one plaintiff resides in California and one defendant resides in Tennessee, the case passes muster. In contrast, a class of plaintiffs from one state facing a defendant from the same state cannot satisfy even minimal diversity.

Sometimes, however, the nature of corporate citizenship creates a hybrid situation. Under § 1332(b), a corporation is a citizen of both its state of incorporation and the state where it maintains its principal place of business. Defendants in the Sixth, Fourth, and Eleventh Circuits have argued that minimal diversity exists within the meaning of CAFA when one of these places aligns with the citizenship of a class of plaintiffs but the other does not. The intent of CAFA to expand federal jurisdiction beyond the traditional confines of complete diversity is often relied upon in support of this argument. Under this “alternative-citizenship” theory of diversity, the corporation can pick between citizenship in one state or the other to either satisfy or defeat minimal diversity under CAFA.

Unfortunately for removing defendants, the theory has failed thus far in each of the three courts of appeals to squarely address it. The reasoning in each court follows similar lines: First, they say, the text of § 1332 is clear—a corporation is a citizen of its place of incorporation and where it maintains its principal place of business, not either-or. Second, the courts have reasoned, allowing jurisdiction based on the alternative-citizenship theory would not comport with the historical purpose behind federal diversity jurisdiction—to protect an out-of-state litigant from prejudice within a court in the opposing party’s home state. The Sixth Circuit’s opinion even suggests that the alternative-citizenship theory would push the limits of Article III. If that is right, even express Congressional legislation would not make the alternative-citizenship theory effective.  And unless and until another Circuit rules differently, this issue is not likely to reach the Supreme Court for clearer resolution.

Will the Future Bring a Surge of Class Actions against Banks and Credit Card Companies?On July 10, 2017, the Consumer Financial Protection Bureau formally issued its long-anticipated final rule banning class waivers in future arbitration agreements for banks, lenders, debt counselors, credit card issuers, certain types of automobile leasing businesses, and many other financial institutions. The CFPB’s rule will take effect March 18, 2018, unless nullified by Congress in the next few weeks, or enjoined by a court in the next few months. The ban on class waivers would apply generally to pre-dispute arbitration agreements entered into after that date by many categories of financial service providers, such as banks, lenders, debt collectors and credit card companies.

The proposed rule would essentially forbid a covered financial product or service provider sued in a class action lawsuit from relying “in any way” on a pre-dispute arbitration agreement that does not explicitly allow the consumer to choose between class arbitration and class litigation, unless and until the presiding court has ruled that the case may not proceed as a class action and any interlocutory appeals of that ruling have been exhausted. The ban on reliance applies to “any aspect” of the class litigation related to a covered product or service.

The proposed rule would also require every pre-dispute arbitration agreement entered into after the effective date of the rule to include specific language acknowledging the consumer’s right to sue using the class action device and to participate in any class action filed by someone else despite the arbitration agreement. And both for individual arbitrations and for arbitrations commenced by any party to a class action after the denial of class certification, the CFPB will require companies with covered agreements to publicly file with the CFPB  various documents and data related to the arbitration proceeding, including, among other things, the claim documents and the arbitral award.

Congress has a filibuster-proof way to nullify the rule under the Congressional Review Act, 5 U.S.C. §801, et seq. While the House has already voted to nullify, it is unclear whether 51 Republican votes for nullification can be mustered in the Senate. Financial service providers who prefer individual arbitration to class litigation should be voicing that opinion to the Senate loudly and soon, because the Congressional Review Act allows only 60 legislative days for nullification, and that clock runs out in early November.

If that nullification effort fails, then efforts to nullify the rule will likely turn to the courts. Efforts to declare the CFPB unconstitutional are already pending (see, e.g., PHH Corporation v. Consumer Financial Protection Bureau839 F.3d 1, 2016 WL 5898801 (D.C. Cir. 2016); opinion vacated, rehearing en banc granted Feb. 16, 2017). And just days ago, the U.S. Chamber of Commerce, the American Bankers Association, and others filed suit in Texas federal court seeking to block the rule on the theory that the CFPB’s pre-rule arbitration study mandated by the Dodd-Frank Act was statutorily insufficient and does not support the rule actually promulgated, violating both Dodd-Frank’s limits on CFPB rulemaking regarding arbitration and the Administrative Procedures Act.

Those in the business of lending, storing, collecting or moving money should also be preparing for the effective date of the rule, just in case. First, they would need to consider whether, after the effective date, new arbitration agreements are desirable at all following the effective date of the rule. By definition, this rule would mean that such arbitration clauses will have no application to the largest and most costly cases—those brought as class actions. Worse yet, it would create implicit incentives for plaintiffs to bring as purported class actions claims that would otherwise have been brought individually, simply to avoid arbitration while utilizing the specter of class discovery as leverage for settlement. Indeed, the mandated language that now must be included in a post-effective date arbitration agreement all but invites class allegations as a means of avoiding arbitration. In the smaller individual cases in which arbitration clauses would still have potential effect, efficiencies once available through arbitration will now be undermined by a new layer of regulatory reporting and compliance costs, the requirement that litigation proceed through denial of class certification and exhaustion of interlocutory appeal, and the elimination of the confidentiality that businesses are accustomed to enjoying from arbitration.

Businesses that decide to continue using arbitration clauses anyway would need to start planning for the new regime sooner rather than later. This will involve not only drafting new pre-dispute arbitration agreements that comply with the new rule and contain the required language, but also hiring or training personnel to fulfill the new reporting obligations created by the rule and determining which product and service offerings are and are not subject to the new rule.

Most importantly, covered providers would need to prepare for an increase in class action litigation if the rule goes into effect. There is no other way to spin it—if this rule goes into effect, class action filings against covered companies will go up. This will affect litigation legal budgets, in-house legal and compliance staffing needs, and the bottom line of covered companies’ financial statements.