On March 11, the U.S. Court of Appeals for the Fourth Circuit affirmed the district court’s denial of a motion to compel arbitration in two class-action lawsuits. The decision potentially has far-reaching implications for the enforceability of arbitration clauses in consumer contracts, particularly those involving unilateral modification provisions.

Case Background

The appellants are companies that market and service credit card accounts on behalf of the credit-card issuing banks. The appellees are Maryland residents who obtained credit card accounts from the banks.

The appellees filed separate class-action lawsuits in Maryland state court, alleging that the companies violated Maryland usury laws by extending credit without a license and charging high interest rates. They claimed that the companies engaged in a scheme to circumvent state usury laws.

The companies removed both cases to federal court and sought to compel arbitration based on the arbitration provisions in the cardholder agreements. The appellees opposed the motions, arguing that the agreements were illusory due to a “change-in-terms” clause that allowed the companies to “‘change any term of [the credit card] Agreement’ at its ‘sole discretion, upon such notice . . . required by law.'”

Fourth Circuit Analysis

The Fourth Circuit addressed three primary issues on appeal:

  1. Whether the Illusoriness Issue Should Be Decided by the Arbitrator or the Court: The court affirmed that the threshold issue of contract formation is for the court, not the arbitrator, to decide. Under § 4 of the Federal Arbitration Act (FAA), courts may only order arbitration if they are satisfied that the making of the agreement for arbitration is not in issue. A challenge to a contract’s formation necessarily puts the making of any arbitration provision within that contract at issue.
  2. Whether the District Court Erred by Refusing to Apply the Contract’s Choice-of-Law Clause: The Fourth Circuit agreed with the district court that it could not apply the contract’s choice-of-law provision to the contract-formation question because the choice-of-law provision presupposes the existence of a validly formed contract. Without an enforceable choice-of-law clause, the court applied Maryland law to determine whether the cardholder agreement was formed.
  3. Whether the Arbitration Agreement Was Illusory Under Maryland Law: The court concluded that the arbitration agreement was illusory under Maryland law. The change-in-terms clause allowed the companies to change any term of the agreement at its sole discretion, upon such notice as required by law. The court found this clause to be so one-sided and vague that it deprived the agreement of any meaningful reciprocity, rendering it illusory and unenforceable. However, the Fourth Circuit emphasized that its holding was limited to Maryland law. “Contract formation is a question of state common law. The courts of Maryland have chosen to protect consumers from change-in-terms clauses that allow sophisticated parties [ ] to enjoy a built-in escape hatch from their contractual obligations. Other states are entitled to adopt or reject Maryland’s approach.”

Concurrences and Dissent

Judge Wynn concurred with the majority opinion, emphasizing that the proper forum for adjudicating the formation of the cardholder agreement is a court. He clarified that the appellees specifically challenged the arbitration and delegation clauses as illusory, not the broader cardholder agreement.

Judge Niemeyer concurred in part and dissented in part. He agreed with the majority on the threshold issue of contract formation but disagreed with the conclusion that the arbitration agreement was illusory. He argued that the contractual structure, which allowed for unilateral modifications with notice and the opportunity for the cardholder to terminate the agreement, was consistent with Maryland law and industry practices. “At bottom, I conclude that the majority’s holding is inconsistent with Maryland law and undermines the universal practice of allowing credit card companies to make changes so long as they provide credit card holders with notice and the opportunity to accept or reject the changes by either continuing to use the credit card or withdrawing from the arrangement.”

Conclusion

The Fourth Circuit’s decision underscores the importance of clear and reciprocal terms in arbitration agreements. Companies must ensure that their contracts do not grant them unfettered discretion to modify terms unilaterally, as such provisions may render the agreements illusory and unenforceable. While the court was careful to limit the reach of the opinion by confining it to Maryland law, the result could be the same in any jurisdiction.