Bankruptcy Trumps Arbitration in Indian Payday Loan Agreement

By Mark Wilson, Esq. on March 18, 2015 | Last updated on March 21, 2019

There's no end to the creativity payday lenders will go to extract huge interest rates out of desperate people. When states started to regulate them, payday lenders ingeniously contracted with Indian tribes, who were more than happy to share a cut of the money so that payday lenders could be exempt from state usury laws.

And thanks to binding arbitration agreements, disputes won't go to court. But what happens when a debtor challenges a payday loan's validity in a bankruptcy proceeding? The Fourth Circuit is here to find out.

Bankruptcy Uber Alles

Oteria Moses, a resident of North Carolina, borrowed $1,000 from CashCall, doing business with Western Sky Financial, with a 233.1 percent annual interest rate. That would be patently illegal under North Carolina law, but Western Sky Financial specified in its agreement that the tribal law of the Cheyenne River Sioux Tribe would apply, and that the agreement would be arbitrated there if necessary.

Moses went bankrupt, and CashCall filed a proof of claim to get its money. In bankruptcy, however, Moses sought to have the loan -- valued at almost $5,000 -- declared illegal. CashCall realized it made a big mistake: By filing the proof of claim in bankruptcy code, it consented to that court's jurisdiction, meaning it could no longer force Moses into arbitration.

CashCall tried to withdraw its proof of claim or at least compel arbitration, but the court wouldn't allow it, as the validity of the $5,000 loan was a "core" bankruptcy issue and dismissing it or compelling arbitration "would frustrate, rather than facilitate, the efficiency favored by arbitration and could potentially lead to inconsistent results."

While the Supreme Court has consistently favored enforcement of arbitration clauses wherever they appear, and even if they conflict with state law, bankruptcy is a federal matter, and enforcing arbitration clauses in this case would create a conflict with the public policy of bankruptcy law, which provides debtors with "the prompt and effectual administration and settlement of the [debtor's] estate" and a centralized forum for resolving disputes related to the bankruptcy.

Nevertheless, two judges on the panel voted to bifurcate Moses' claims. On the issue of the "core" claim, declaring the loan void, the majority said that should stay in bankruptcy court. But on the issue of damages under North Carolina's Debt Collection Act, the majority said that should go to arbitration.

Dissents and Concurrences Everywhere

Judge Paul Niemeyer dissented and concurred, writing a separate section to object to the majority's solution. While it's true that her agreement with CashCall specified that Indian tribal law would apply, Niemeyer observed that "the Cheyenne River Sioux Tribe has no laws or facilities for arbitration and that the arbitration procedure specified is a 'sham from stem to stern.'" Sending the non-core part of the claim to arbitration, he said, would result in wasted time and money.

Niemeyer also called out CashCall for its "gamesmanship." It clearly wanted to use bankruptcy court to easily collect its money, but cried foul as soon as Moses fought back and it realized bankruptcy court wasn't such a favorable forum after all.

Judges Gregory and Davis also wrote separate concurrences/dissents. Davis, in particular, disagreed with Niemeyer's characterization of the tribe's utter lack of arbitration, noting that, while it's certainly happened before, there was nothing in this factual record to support that assertion.

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