4th Circuit Invalidates Arbitration Clause in Payday Loan Agreements

Yesterday the Fourth Circuit refused to enforce the arbitration agreement in a Western Sky payday loan agreement in the case Hayes v. Delbert Services Corp.  The Court’s holding is an important reminder that despite the current anti-consumer state of the law on arbitration agreements, these clauses are not invitations to companies to imagine new and exciting ways to strip consumers of their substantive rights.

The Court’s holding on both the issue of the agreements purported waiver of rights as well as severability is instructive on the kinds of challenges that can be brought against unconscionable arbitration agreements.


Western Sky was an online lender owned by Martin Webb, a member of the Cheyenne River Sioux Tribe.  Western Sky’s offices are located on the Cheyenne River Indian Reservation in South Dakota, and from those offices they issued payday loans to consumers across the country.

Hayes, a citizen of Virginia took out a $2,600 loan, which included a $75.00 origination fee, meaning Hayes got $2,525 in his pocket.  Western Sky charged interest on the loan at an annual rate of 139.12%.  Hayes’ monthly repayment was $294.46 over four years, meaning that Hayes was set to pay $14,093.12 over the life of the loan.  Other class members had loan rates up to 233.84% per year.


Western Sky’s practice was after a loan was made to transfer the loan to allied servicing and collection firms.  Hayes’ loan was transferred to WS Funding, LLC which then named its corporate parent, CashCall, Inc. as the servicing agent.  The loan was then transferred to an entity named Consumer Loan Trust, which in turn named Delbert as the servicing agent.  While Western Sky was owned by a tribal member, Delbert claimed no tribal ownership or affiliation.

Plaintiff claimed that Delbert sent them collection notices without disclosing its identity as a debt collector or the identity of the actual creditor; in violation of the FDCPA and that it used an automatic dialing system to make several calls a week, and sometimes multiple calls a day to their home, in violation of the TCPA.  Hayes filed a putative class action in the Eastern District of Virginia against Delbert.  Hayes also sought declaratory relief that the loan agreement’s forum selection and arbitration agreement clauses were unenforceable.


While according to the 4th Circuit no one seriously disputed that the Western Sky’s loans violated a “host of state and federal lending laws”, the Defendant argued that the terms of the agreement barred the suit.

Agreement Terms:

The agreement provided in various sections:

“This Loan Agreement is subject solely to the exclusive laws and jurisdiction of the Cheyenne River Sioux Tribe, Cheyenne River Indian Reservation… you, the borrower,…consent to the sole subject matter and personal jurisdiction of the Cheyenne River Sioux Tribal Court, and that no other state or federal law or regulation shall apply to this Loan Agreement, its enforcement or interpretation.”

“Neither this Agreement nor Lender is subject to the laws of any state of the United States of America.  By executing this Agreement, you hereby expressly agree that this Agreement is executed and performed solely within the exterior boundaries of the Cheyenne River Indian Reservation, a sovereign Native American Tribal Nation.  You also expressly agree that this Agreement shall be subject to and construed in accordance only  with the provisions of the laws of the Cheyenne River Sioux Tribe, and that no United States state or federal law applies to this Agreement.”

An arbitration clause provided:

“[A]ny dispute [the borrower] ha[s] with Western Sky or anyone else under this loan agreement will be resolved by binding arbitration.”

The arbitration is to be “conducted by the Cheyenne River Sioux Tribal Nation by an authorized representative in accordance with its consumer dispute rules and the terms of this agreement.”

The arbitration clause further provided that it covers “any claim based upon marketing or solicitations to obtain the loan and the handling or servicing of [the borrower’s] account whether such Dispute is based on a tribal, federal or state constitution, statute, ordinance, regulation or common law, and including any issue concerning the validity, enforceability, or scope of this loan or the Arbitration agreement.”

The arbitration agreement further provided that the agreement “IS MADE PURSUANT TO A TRANSACTION INVOLVING THE INDIAN COMMERCE CLAUSE OF THE CONSTITUTION OF THE UNITED STATES OF AMERICA, AND SHALL BE GOVERNED BY THE LAW OF THE CHEYENNE RIVER SIOUX TRIBE.  The arbitrator will apply the laws of the Cheyenne River Sioux Tribal Nation and the terms of this Agreement.”

The agreement did provide that the borrower “shall have the right to select” the American Arbitration Association (“AAA”), Judicial Arbitration and Mediation Services (“JAMS”), or another organization to “administer the arbitration.”  The Court noted that this clause was apparently inserted into the agreement after the initial drafting because the tribal arbitration mechanism set out in the agreement “proved to be illusory.”

Holding of the District Court

The District Court held (1) the forum selection clause was unenforceable; (2) the doctrine of tribal exhaustion did not apply to the controversy; and (3) the arbitration clause was enforceable.

The Fourth Circuit reversed, holding “This arbitration agreement fails for the fundamental reason that it purports to renounce wholesale the application of any federal law to the plaintiffs’ federal claims.


Defendant argued that the prospective waiver of federal law in the arbitration agreement was enforceable.  The Court disagreed, noting “[w]ith one hand, the arbitration agreement offers an alternative dispute resolution procedure in which aggrieved persons may bring their claims, and with the other, it proceeds to take those very claims away.  The just and efficient system of arbitration intended by Congress when it passed the FAA may not play host to this sort of farce.”

The Court noted that the Supreme Court has repeatedly upheld arbitration agreements that give an authority to arbitrate federal statutory rights, and which contain waivers providing that arbitration is to proceed on an individual basis, or impose other procedural requirements on potential claimants.  The Court however, held that these provisions do not permit a “prospective waiver of a party’s right to pursue statutory remedies.”  (Citing American Express v. Italian Colors and Mitsubishi Motors Corp. v. Soler-Chrysler-Plymouth, Inc.)  The Court held that the clause at issue “almost surreptitiously waives a potential claimant’s federal rights through the guise of a choice of law clause.”  The Court held that while a party to an arbitration agreement “may of course agree to waive certain rights as part of that agreement” those waivers must pass “the applicable knowing and voluntary standard” in order to be enforced. (citing Syndor v. Conseco Fin. Servicing Corp.)  The Court held that a choice of law clause in an arbitration clause may chose a local law to govern the arbitration, they may not “underhandedly convert a choice of law clause in to a choice of no law clause –it may not flatly and categorically renounce the authority of the federal statutes to which it is and must remain subject.”


The Court further refused to sever the “errant provisions” from the remainder of the arbitration agreement.  The Court held that “the offending provisions go to the core of the arbitration agreement.  It is clear that one of the animating purposes of the arbitration agreement was to ensure that Western Sky and its allies could engage in lending and collection practices free from the strictures of federal law.”  The Court continued that “although our focus must be on the arbitration agreement, not the underlying loan agreement, it is only natural for us to interpret the agreement in light of the broader contract in which it is situated.”

In examining the agreement the Court found that “Western Sky’s arbitration agreement is little more than ‘to achieve through arbitration what Congress has expressly forbidden.'”  The Court continued “[g]ood authority counsels that severance should not be used when an agreement represents an ‘integrated scheme to contravene public policy.’” (Citing Graham Oil v. Arco Products Co.) (which in turn was citing Farnsworth on Contracts)

Conclusion of the Court

The Court closes with the hope that “in the future companies will craft arbitration agreements on the up-and-up and avoid the kind of mess that Delbert is facing here.”

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