Not so fast.

Photographer: Dan Kitwood/Getty Images

Tribes Don't Get a Pass on Federal Law

Noah Feldman is a Bloomberg View columnist. He is a professor of constitutional and international law at Harvard University and was a clerk to U.S. Supreme Court Justice David Souter. His books include “Cool War: The Future of Global Competition” and “Divided by God: America’s Church-State Problem -- and What We Should Do About It.”
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Can a payday lender’s contract require all borrowers’ disputes be subject to an arbitration process in which decisions are exempt from federal law? In a decision announced this week with potential consequences for millions of contracts signed every day, the U.S. Court of Appeals for the 4th Circuit has said no. The decision shines a light on a particularly disreputable instance of the generally worrisome phenomenon of payday loans. Its importance, however, touches on broader issues, including the sovereignty of Indian tribes.

The facts of the case, Hayes v. Delbert, are pretty shocking -- and probably affected the outcome to some degree. James Hayes of Virginia borrowed $2,525 in 2012 from payday lender Western Sky Financial LLC, which transferred the loan to Delbert Services Corp. to service it. The four-year loan had an annual interest rate of 139.12 percent.

Yes, you read that right. Over the life of the loan, Hayes owed $14,093.12. Although triple-digit interest rates are indeed typical for many payday loans, that’s not the shocking part of the story.

The loan contract specified that the controlling law under which any dispute be resolved was the law of the Cheyenne River Sioux Tribe. Western Sky, an online lender, was owned by Martin Webb, a member of the tribe; Delbert, the servicing company, was not. The contract said that “no other state or federal law regulation shall apply to this loan agreement.”

According to the contract, any dispute connected to loan collection would have to be submitted to an arbitration conducted by the tribe or an authorized representative in accordance with the tribe’s “consumer dispute rules.” Another provision said that, at the borrower’s choice, the American Arbitration Association or Judicial Arbitration and Mediation Services could “administer the arbitration.”

On the surface, this may not seem that strange. The AAA and JAMS are two well-known and highly respected national arbitration organizations. Applying the law of the Cheyenne River Sioux Tribe, and not federal law, is much more unusual, of course. But it may seem plausible, given that Indian tribes are entitled to their own laws and legal systems, which don’t necessarily have to follow state or even federal laws.

In practice, however, the contract’s designation of the tribe's law and arbitration authority was a trick. Various courts have found that the Cheyenne River Sioux actually had no consumer arbitration process nor anyone assigned to perform arbitrations. What’s more, the tribe didn’t have any consumer dispute rules to apply.

In other words, Hayes’s contract took away his ability to sue under federal law, but it didn’t leave him any other options.

Hayes and a few others who had borrowed money under similar contracts sued Delbert over its collection practices, which they allege violated federal lending laws. A federal district court said it would enforce the part of the contract that required a dispute to be resolved by an arbitrator. It acknowledged that there was not much realistic chance of getting arbitration from a tribal body. But it said that, under the contract, Hayes could go to AAA and JAMS, which would resolve the conflict using whatever rules they figured out applied.

The 4th Circuit reversed that decision, in an opinion by the highly respected judge J. Harvie Wilkinson, who was nominated by President Ronald Reagan and was frequently mentioned as a possible Supreme Court nominee back in the days when the Republican Party had a moderate wing. Wilkinson could’ve approached the case from various angles. But he chose to focus on the provisions of the contract that stripped the applicability of federal law from the case.

The core of the court’s holding was that an arbitration agreement can’t “renounce wholesale the application of any federal law” to someone’s otherwise legitimate legal claims. This is a good doctrine -- but it’s also a tricky one. Courts regularly enforce arbitration agreements that stop people from exercising certain rights under federal law, the most significant of which is the right to bring a class-action lawsuit.

Any consumer-facing business that makes lots of contracts with lots of people wants to avoid being sued in a class action. The standard way to do that is to make all customers sign a contract that says they can't bring one. The Supreme Court has upheld such clauses. In doing so, it is recognized that such an agreement could even result in “effectively vindicating” federal rights. So long as some remedy -- even an ineffective one -- exists, the court has upheld that view.

In this light, Wilkinson’s opinion is modestly consumer-protective. It draws the line at contracts that take federal law out of the picture altogether.

Wilkinson tried to duck the deepest question in the case: Would it be all right to take federal law out of the picture altogether if Indian law applied instead? In this case, in practice, the recourse to tribal law would’ve been empty. But what if the Cheyenne River Sioux did have a robust arbitration mechanism in place or rules to guide an arbitration?

Under the decision, that shouldn’t matter: The court held that any agreement that rejects the application of federal law can’t be enforced. At the margin, this decision may actually reduce Indian tribes’ sovereignty. Whether it will help protect consumers from predatory lenders will depend on how other courts cite it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Feldman at nfeldman7@bloomberg.net

To contact the editor responsible for this story:
Brooke Sample at bsample1@bloomberg.net