Seventh Circuit revives class action suit over payday loans; calls arbitration clause "unconscionable" and process "a sham"

An embattled provider of online payday loans who allegedly used his standing as a member of a Sioux Indian tribe to tailor loan agreement terms to skirt state and federal law will need to defend yet more of those loans in federal court after the Seventh Circuit Court of Appeals panel determined arbitration procedures designed to give jurisdiction over the contracts to tribal courts failed to pass legal muster.

In a 42-page opinion issued Friday, more than a year after arguments were heard, the federal appeals panel reversed U.S. District Judge Charles P. Kocoras' July 2012 decision to dismiss the suit three Illinois residents brought against lender Martin A. Webb and a collection of his payday loan companies.

Judge Kenneth F. Ripple wrote the opinion, in which Judge Ilana Diamond Rovner and U.S. District Judge Sarah Evans Barker concurred. Barker, of the Southern District of Indiana, sat on the panel by designation.

The Seventh Circuit panel found Kocoras had erred in dismissing the matter based on a clause within the loan agreements stipulating disputes between the lender and borrower be settled under arbitration procedures established by tribal courts within the Cheyenne River Sioux Tribe, whose reservation is located in South Dakota.

The panel said this clause is unenforceable under federal and Illinois law as the tribal government lacks the legal rules, policies and mechanisms needed to actually arbitrate the dispute, making the arbitration provision in the agreements “unreasonable” and “unconscionable” to the borrowers.

“With respect to substantive unconscionability, the dispute-resolution mechanism set forth in the loan agreements – ‘conducted by the Cheyenne River Sioux Tribal Nation by an authorized representative in accordance with its consumer dispute rules’ – did not exist,” Ripple wrote for the panel

As such, “there simply was no prospect ‘of a meaningful and fairly conducted arbitration;’ instead this aspect of the loan agreements ‘was a sham and an illusion,’” Ripple added, citing language from a lower court ruling.

The panel's opinion stems from the suit plaintiffs Deborah Jackson, Linda Gonnella and James Binkowski, all of Illinois, brought in 2011 in Cook County Circuit Court. It was later removed to Chicago's federal court.

All three borrowed $2,525 from Western Sky Financial LLC, an online payday loan business operated by Webb as part of a family of such payday loan processing companies collectively known in court filings as the Webb Entities.

They filed a class action against Webb and his businesses, alleging the loans, which included interest rates as high as 139 percent, violated federal and state lending laws.

The suit is just one of several legal problems Webb is dealing with.

Western Sky and his other companies face a federal racketeering class action suit and he agreed to pay almost $1 million in fines as part of a settlement with the Federal Trade Commission over a regulatory action accusing them of engaging in “unfair and deceptive tactics to collect on payday loans.”

Those actions are separate from the suit brought by Jackson, Gonnella and Binkowski.

In response to the Jackson suit, Webb, who is a member of the Cheyenne River tribe, persuaded Kocoras to initially dismiss the matter based on an arbitration provision in the loan agreements, a move that handed jurisdiction over disputes to Cheyenne River tribal courts.

Following oral arguments before the Seventh Circuit in January 2013, the panel issued a limited remand to the federal court for a determination on whether the tribal courts could actually oversee such arbitration.

Kocoras determined they could not, noting a number of difficulties, including potential arbitrator bias, a lack of arbitration experience and knowledge among tribal officers and a lack of clear rules pertaining to arbitration in consumer loan disputes.

In reversing the lower court’s dismissal and remanding the matter for further proceedings, the appeals panel cited those findings and said the suit never should have been dismissed because the arbitration provision in the agreements is "illusory."

“The arbitration clause here is void not simply because of a strong possibility of arbitrator bias, but because it provides that a decision is to be made under a process that is a sham from stem to stern,” Ripple wrote for the panel.

The appeals judges also determined the tribal courts, under federal law, likely lacked jurisdiction to decide consumer finance matters involving the plaintiffs and similar matters involving citizens who are not members of the Cheyenne River tribe.

Chicago attorney Daniel A. Edelman of Edelman, Combs, Latturner & Goodwin argued on behalf of the plaintiffs before the Seventh Circuit. Washington D.C. attorney Claudia Callaway of Katten Muchin Rosenman represented the defendants.