Supreme Court Strikes Down Mandatory Credit Card Arbitration

In a victory for consumers, the Supreme Court held today that credit-card holders can sometimes fight mandatory arbitration agreements, giving them a better prospect of victory in claims brought by banks and creditors.

The decision arose from a 2003 suit filed by Discover in Maryland state court, trying to recover $10,000 in past-due charges from cardholder Betty Vaden. In a class-action counterclaim, Vaden asserted that Discover's finance charges, interest, and late fees violated Maryland state law. Discover filed a motion in federal court to compel arbitration, citing a mandatory arbitration clause in Vaden's cardholder agreement. Discover argued that Vaden's state claims were preempted by federal banking laws, meaning that state and federal laws contradicted one another. In such a situation, federal law takes precedence and federal courts have jurisdiction of the claim.

The Fourth Circuit said that they would disregard the intricacies of the parties' pleadings to determine whether the underlying substantive controversy involved federal law. The court found that it did, and that, accordingly, they had jurisdiction over the matter. The Supreme Court agreed that underlying federal issues were enough to get a case into federal court, but said that Vaden's counterclaims alone weren't enough under that standard. Justice Ginsburg, writing for the majority, said that Discover's suit "was triggered by Discover's garden-variety, state-law debt-collection claim against Vaden," and thus belonged in state court.

It is a well-established rule that federal jurisdiction must be based on the initial controversy, rather than on a counterclaim or anticipated defense. Otherwise, a defendant could "forum-shop" by bringing a federal counterclaim, avoiding state court altogether. The Supreme Court affirmed this rule in its opinion, saying that "a federal court may not entertain a [claim] based on the contents, actual or hypothetical, of a counterclaim." A dissent in the Fourth Circuit's earlier decision made the same argument, asserting that "[t]here was no 'properly invoked federal question' in the underlying state case."

Boiled down, the decision means that credit card holders can't be as easily forced into mandated arbitration -- a major victory for consumers, since arbitration forums tend to overwhelmingly favor credit card companies. A study by consumer advocacy group Public Citizen found that a staggering 94 percent of credit-card arbitration cases were decided against consumers. In its findings, the group said that "binding mandatory arbitration is a rigged game in which justice is dealt from a deck stacked against consumers." The study analyzed California cases brought by credit card company MBNA, and heard by the National Arbitration Forum.

Credit card companies attempt to justify mandated arbitration by arguing that it is more efficient and less expensive than protracted litigation. They also point out that many state courts don't want to give up the suits, and fight to keep them out of arbitration.