FYI: 3rd Cir Grants Motion to Compel Arbitration in Case Where Validity of Assignment of Contract at Issue

The U.S. Court of Appeals for the Third Circuit recently confirmed that parties may contractually delegate questions of arbitrability to the arbitrator and reversed a trial court's order denying a debt buyer's motion to compel arbitration when there was a question about the validity of assignment of the underlying contract.

 

"Arbitration is a contractual obligation," the Third Circuit held. "Thus, parties to a contract may delegate questions of arbitrability to an arbitrator. If parties clearly and unmistakably make this choice, then district courts generally must send threshold questions of arbitrability to arbitration to comply with the parties' agreement."

 

A copy of opinion is available at:  Link to Opinion

 

A non-bank finance company and a borrower entered into a loan contract that included a very broad arbitration agreement including "the enforceability, or the arbitrability of any Claim pursuant to this Agreement, including but not limited to the scope of this Agreement and any defenses to enforcement of the Note or this Agreement."  The arbitration agreement also applied to any assignees or successors of the original parties.

 

Subsequent to the formation of the contract, the finance company assigned the contract to a debt buyer company, which attempted to collect the balance due from the borrower.  At issue was the fact that the loan had an interest rate of 26.91% that would ordinarily run afoul of Pennsylvania's usury law.  The finance company issued the loan under the Consumer Discount Company Act (CDCA) which creates an exception to Pennsylvania's usury limits.  The finance company was licensed by Pennsylvania's Department of Banking to issue CDCA loans, but the debt buyer was not.

 

The borrower filed a class action lawsuit against the debt buyer arguing that the attempt to collect the loan was unlawful because the debt buyer did not have the requisite CDCA license and did not seek approval of the Pennsylvania Department of Banking to purchase his loan and the loans of the putative class.

 

The debt buyer filed a motion to compel arbitration that was originally denied by the trial court in order that the parties could engage in brief discovery to determine whether the debt buyer either had the requisite license or had obtained approval from the Pennsylvania Department of Banking.  After the discovery revealed that the debt buyer did not in fact have either the license or the Department of Banking's blessing, the trial court held that the assignment from the finance company to the debt buyer was invalid and denied the debt buyer's motion to compel arbitration.

 

The Third Circuit had recently held that the question of arbitrability may be delegated to an arbitrator so long as the contract expressly provides for that delegation in MZM Constr. Co., Inc. v. New Jersey Bldg. Labs Statewide Benefit Funds, 974 F.3d 386, 392 (3d Cir. 2020).  Here, the issue was whether the challenge to the legality of an assignment of a loan that is subject to an agreement to arbitrate can also challenge the formation of the arbitration agreement itself.

 

The Third Circuit rejected the borrower's preliminary argument that the debt buyer was not a "party" that could move to compel arbitration under the Federal Arbitration Act (FAA) because the assignment to the debt buyer was invalid.  Rather, the Court held that "party" under the FAA referred to litigants and not parties to the agreement.

 

Moving on to the "threshold arbitrability question" the Third Circuit disagreed with the trial court's finding that it must answer the question of who decides whether the parties must arbitrate: the arbitrator or the court.  The Court discussed the strong federal policy in favor of resolving disputes through arbitration and ensuring that courts will honor and enforce contractual provisions related to arbitration.

 

The trial court and the dissenting Third Circuit judges wanted to make the determination of whether there is an agreement to delegate questions of arbitrability to the arbitrator, but the Third Circuit majority held that this decision is for the arbitrator. There was no dispute that the borrower and the finance company agreed that arbitrability would be determined by the arbitrator. The trial court made the determination that the assignment to the debt buyer was invalid whereas the Third Circuit reasoned that such a determination would render the delegation provision in the arbitration agreement meaningless. The Third Circuit recognized that the arbitrator could later find that the assignment was invalid but also noted that this was not definite as there was a question as to whether the CDCA applied now that the loan was charged off.

 

On the issue of delegating arbitrability to the arbitrator the Third Circuit noted that a party would have to challenge the very formation of the arbitration agreement unless the delegation clause was being separately challenged.  Here, the borrower argued that the challenge to the assignment constituted a challenge to the formation of the agreement to arbitrate but this argument was rejected by the Third Circuit as there was no dispute that the borrower entered into a valid arbitration agreement with the finance company and that the finance company subsequently assigned that agreement to the debt buyer.  Thus, the challenge was really to the validity of the assignment and not the agreement.

 

The Appellate Court further reasoned that "because the parties clearly and unmistakably intended to delegate the issue of enforceability of the contract to an arbitrator, the challenge to the enforceability of the arbitration agreement must be decided by the arbitrator and not the court."

 

Ultimately, the arbitration agreement at issue was very broad and included "any Claim . . . includ[ing] . . . the arbitrability of any Claim . . . and any defenses to enforcement of the Note or this Agreement."  The Third Circuit concluded that the arbitrator will determine these issues and that the District Court's opinion making that determination had to be reversed and thus remanded the case to the District Court with instructions to refer the matter to arbitration.

 

This case is significant for debt buyers and other assignees that have faced challenges from plaintiffs related to assignments in the face of motions to compel arbitration. So long as the contractual provision is clear and unmistakable (as it was here), courts in the Third Circuit will have to refer the question of arbitrability, including the alleged validity of the assignment, to an arbitrator.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: 2nd Cir Rejects Standing, Conflict of Interest, Service Award, and Other Objections to Class Settlement Against Student Loan Servicer

The U.S. Court of Appeals for the Second Circuit recently affirmed a trial court's certification and approval of a class settlement involving claims by student loan borrowers against their loan servicer.

 

In so ruling, the Second Circuit rejected several arguments brought by the objectors who filed this appeal, including:

 

•           Challenges to standing for named plaintiffs and settlement class members who no longer have their loans serviced by the defendant

•           Challenges to the fairness of the class settlement

•           A First Amendment challenge relating to the cy pres award included in the settlement

•           A conflict of interest argument due to the fact that a labor union was paying the plaintiffs' counsel's bills

•           Challenges to the $15,000 service awards granted to the named Plaintiffs

 

A copy of opinion is available at:  Link to Opinion

 

This appeal arose from the settlement of a putative class action lawsuit brought by individuals with active student loans ("Borrowers" or "Plaintiffs") against their student loan servicing company ("Company".)  A group of public servants with active student loans serviced by the Company contacted the Company for assistance repaying their student loans. Unsatisfied with the response from the Company, the Plaintiffs alleged that Company did not "lived up to its obligation to help vulnerable borrowers get on the best possible repayment plan and qualify for Public Service Loan Forgiveness [PLSF]."

 

The Company moved to dismiss. The trial court granted the motion, dismissing all of the Plaintiffs' claims with the exception of a claim brought under New York's General Business Law Section 349 which prohibits "deceptive acts of practices in the conduct of any business … or in the furnishing of any service" in the state.

 

The parties subsequently reached a class settlement resolution that, among other things, required the parties to seek certification of a mandatory nationwide settlement class in which the settlement class members agreed to release all claims in exchange for non-monetary relief. The settlement class members retained the right to file individual lawsuits for monetary relief on a non-class basis including "Aggregate Actions of five or more individuals."

 

In exchange, the Company agreed to implement the following reforms:

 

(1) enhancing internal resources for call-center representatives by, among other things, "updating job aids to clarify that customer service representatives should discuss loan forgiveness including PSLF with borrowers prior to offering forbearance";

(2) updating written communications with borrowers by "creating forms that can be sent via email to borrowers who request additional information about PSLF";

(3) improving its website and chat communications with borrowers by "requiring customer service representatives to look for keywords or phrases that indicate borrowers' possible eligibility for forgiveness programs"; and

(4) training customer service representatives to follow the new practices, and regularly monitoring their calls to ensure compliance.

 

The Company also agreed to contribute $2.25 million dollars in cy pres relief to establish a non-profit that would "provide education and student loan counseling to borrowers employed in public service," as well as $15,000 in service awards for the named plaintiffs.

 

The trial court found certification of the settlement class was proper and approved the settlement. At the settlement hearing, two members of the settlement class objected to the settlement on various grounds. The trial court overruled the objections and found the settlement to be "fair, adequate and reasonable."

 

The two individuals who objected to the class settlement appealed, raising numerous issues.

 

First, the appellant's objected to the fairness of the settlement under Fed. R. Civ. Pro. 23(e). To evaluate the fairness reasonableness of the settlement, the Second Circuit reviewed the nine factors set out in its prior ruling in City of Detroit v. Grinnell Corp., 495  F.2d 448 (2d Cir. 1974). The nine (9) factors are:

 

"(1) the complexity, expense and likely duration of the litigation; (2) the reaction of the class to the settlement; (3) the stage of the proceedings and  the amount of discovery completed; (4) the risks of establishing liability; (5) the risks of establishing damages; (6) the risks of maintaining the class action through the trial; (7) the ability of the defendants to withstand a greater judgment; (8) the range of reasonableness of the settlement fund in light of the best possible recovery; (9) the range of reasonableness of the settlement fund to a possible recovery in light of all the attendant risks of  litigation."

 

On appeal the Second Circuit gives the "the trial judge's views" of these factors "great weight." Grinnell, 495 F.2d at 454. The Second Circuit particularly noted the trial court's "careful" analysis of the nine factors, specifically factors seven, eight, and nine. The Second Circuit held that although the Company could have withstood a greater judgment, the settlement was within the range of reasonableness because there was a risk that there would have been no recovery at all if the case proceeded.

 

As a result, the Second Circuit found the trial court did not abuse its discretion in its application of the nine Grinnell factors in approving the settlement.

 

Appellants separately challenged a $2.5 million cy pres award included in the settlement terms. Appellants argued that the award to the non-profit entity was improper because it did not provide a "direct benefit" to the settlement class members.

 

The Second Circuit disagreed citing In re Google Inc. Street View Elec. Commc'ns Litig., 21 14 F.4th 1102, 1116 (9th Cir. 2021), under which ruling cy pres awards with a "direct and substantial nexus" to the interests of the class may be approved. The Second Circuit agreed with the trial court that the cy pres award contained a direct and substantial nexus to the interest of the class and should be approved. 

 

The appellants also brough a First Amendment challenge on the basis that the cy pres award was a state action that unlawfully compelled speech that violated of the First Amendment. The Court of Appeals also denied this constitutional challenge and ruled the cy pres award was not a state action that implicated the First Amendment. Instead, the Court of Appeals held, the trial court merely reviewed the settlement agreement in order to determine whether it was fair, reasonable, and adequate under Fed. R. Civ. Pro 23(e). Additionally, the Second Circuit noted that the settlement agreement could be enforced by the parties without implicating the First Amendment.

 

Another issue raised by the appellants on appeal was the issue of standing. Some members of the class were no longer using the Company to service their student loans.  Therefore, the appellants argued that the class did not have standing, and the trial court could not certify the settlement class or approve the settlement.

 

The Second Circuit rejected this argument because at least six of the named Plaintiffs continued to have a loan servicing relationship with the Company and the Plaintiffs' complaint plausibly alleged that all named plaintiffs could suffer continued harm by relying on the Company for information regarding the repayment of their loans.  Based on Second Circuit precedent, the Court held that "[i]n a class action, once standing is established for a named plaintiff, standing is established for the entire class."  in Amador v. Andrews 655 F.3d 89, 99 (2d Cir. 2011). Therefore, the Appellate Court rejected the standing challenge.

 

The appellants also raised the issue that there was an improper conflict of interest between Plaintiffs' counsel and the American Federation of Teachers Union ("AFT"), who was paying the legal fees of the Plaintiffs' counsel. Appellants argued that this was a conflict of interest because AFT's interest was not aligned with the members of the class. The "Second Circuit disagreed, noting that AFT's motive was "nothing but admirable", and due to AFT's efforts the class achieved a significant benefit. 

 

Lastly, the appellants raised the issue that the $15,000 service awards granted to the named Plaintiffs were prohibited. In support of this argument, appellants cited two Supreme Court of the United States rulings from the nineteenth century that prohibited service awards to named plaintiffs.  Once again, the Court of Appeals disagreed with the Appellants argument by concluding that the applicable caselaw does not per se prohibit service fee awards to named plaintiffs. See Melito v. Am. Eagle Outfitters, Inc.,(S.D.N.Y. Sep. 8, 2017).

 

After a review of all of the issues raised on appeal, the Second Circuit affirmed the judgment of the trial court. 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: 3rd Cir Excludes Home from Bankruptcy When Seller in Installment Sale Contract Obtained Possession Pre-Petition

The U.S. Court of Appeals for the Third Circuit recently held that, because the home seller in an installment sale contract received a judgment of possession before the buyer filed for bankruptcy, the home was not part of the buyer's bankruptcy estate.

 

A copy of the opinion is available at:  Link to Opinion

 

The buyer here bought a house through an installment sale contract with the seller. The buyer stopped making payments, and the seller sued. To obtain a second chance, the buyer agreed that if he breached again, the seller could get a judgment for possession and immediately evict him. Another breach would extinguish any rights that the buyer had in the house.

 

Nevertheless, the buyer stopped paying again, and the seller obtained a judgment for possession. The buyer stayed in the house and filed for Chapter 13 bankruptcy. In the bankruptcy petition, the buyer argued that Chapter 13 lets a bankrupt homebuyer "cure[]" a "default" on a mortgage during the bankruptcy process until the home "is sold at a foreclosure sale" 11 U.S.C. § 1322(c)(1). Pennsylvania treats foreclosed installment contracts like mortgages, and therefore the buyer also alleged that said cure gave him an interest in his property.

 

The bankruptcy court agreed with the buyer's theory. The judge reasoned that, because the buyer remained living at the property, he still had an interest in the property subject to the installment contract and a § 1322(c)(1) remedy. Thus, the bankruptcy judge included the buyer's home in his bankruptcy estate. 11 U.S.C. § 541(a)(1).

 

On appeal, the trial court vacated the bankruptcy court's order, reasoning that, because the judgment for possession was entered before the buyer filed for bankruptcy, no § 1322(c)(1) remedy existed and the home was not part of the bankruptcy estate. The buyer timely appealed.

 

Section 1322 of the Bankruptcy Code lets debtors cure defaults only until their homes are "sold at a foreclosure sale that is conducted in accordance with applicable nonbankruptcy law." 11 U.S.C. §1322(c)(1).

However, unlike a defaulted mortgage, a breached installment contract never ends in a foreclosure sale; the property's title stays with the seller until the contract is paid off. Thus, to determine whether a §1322(c)(1) remedy existed here, the Third Circuit needed an analogue of a foreclosure sale applicable to installment contracts.

 

The Third Circuit has adopted the gavel rule to define a "foreclosure sale." Under the gavel rule, although the legal interest passes at delivery of the deed, a property is "sold" as soon as there is a new equitable owner. In re Connors, 497 F.3d 314, 320-21 (3d Cir. 2007). That sale happens when a bidder wins an auction. So a property is "sold at a foreclosure sale" as soon as the gavel falls. Id.

 

In re Connors thus pegged the "foreclosure sale" to the transfer of equitable ownership.  The Court here determined the installment contract analogue of a foreclosure sale is when a default removes the bankrupt homebuyer's equitable title. Under Pennsylvania law, that happens when a judgment for possession is entered against the homebuyer. See In re Butko, 624 B.R. 338, 378–80 (Bankr. W.D. Pa. 2021) (analyzing a state statute akin to §1322(c)(1)).

 

Thus, the Third Circuit concluded that, when the buyer here filed for bankruptcy months after the seller had obtained a judgment for possession, the buyer had already lost his equitable interest in the house and the house was not part of his bankruptcy estate. 11 U.S.C. §541(a)(1). The analogue of a foreclosure sale had passed, and it was too late to cure. And though the buyer still lived in the home, he had no other good-faith claim to possession.

 

Accordingly, the Third Circuit agreed with the trial court's assessment that the buyer's effort to use §1322(c)(1) came too late, and the Court affirmed the trial court's ruling.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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