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Supreme Court Of Pennsylvania Determines That Arbitration Clause Favoring Lender Is Not Presumptively Unconscionable

The Supreme Court of Pennsylvania decided on May 31, 2007 that an arbitration agreement which reserved judicial remedies in favor of a sub-prime lender was not presumptively unconscionable. A residential mortgagor instituted a lawsuit against a sub-prime lender in the U.S. District Court for the Eastern District of Pennsylvania. The mortgagor was a low-income homeowner and applied for a residential mortgage loan with a sub-prime lender. The mortgage application required that the parties enter into a written agreement for arbitration of any disputes. However, the sub-prime lender excepted certain disputes from arbitration and reserved the right to pursue judicial remedies. These included foreclosure proceedings, self-help remedies (e.g. repossession), and several other legal remedies (e.g. attachment, garnishment, assignment of income). The mortgagor complained that this constituted a predatory lending practice and sought rescission of the contract. He argued that the arbitration agreement was unconscionable and therefore unenforceable.

The case was dismissed by the Federal District Court and the mortgagor appealed to the U.S. Court of Appeals for the Third Circuit. The Third Circuit certified a question to the Supreme Court of Pennsylvania. The mortgagor was relying on a Pennsylvania Superior Court case which held that when a financial institution reserved for itself access to the courts, at the exclusion of the consumer, a presumption of unconscionability was created. Lytle v. CitiFinancial Services, Inc., 810 A.2d 643 (Pa.Super. 2002). Lytle was in conflict with a prior decision by the Third Circuit, which to the contrary stated that such reservations did not make an arbitration agreement unenforceable. Harris v. Green Tree Financial Corporation, 183 F.3d 173 (3d Cir. 1999). Federal policy strongly favors arbitration agreements. It also permits consideration of state contract law defenses such as fraud, duress, or unconscionability. Generally, unconscionability exists when one party lacks meaningful choice in accepting a contract or term (procedural unconscionability) and the contract or term unreasonably favors another party who is asserting it (substantive unconscionabilty). The burden of proving unconscionability rests with the challenging party. Accordingly, the question before the Supreme Court of Pennsylvania was whether or not Lytle accurately reflected the law in Pennsylvania. If so, the mortgagor could prove his case merely by showing the existence of a reservations clause.

The question before the Supreme Court of Pennsylvania was relatively narrow. However, the question was considered in conjunction with several overarching policy issues such as predatory lending practices. Accordingly, numerous amicus curiae briefs were written in favor of both sides. The Supreme Court of Pennsylvania acknowledged that arbitration clauses could be employed by the sub-prime lending industry with predatory effect. However, an arbitrator must determine whether a predatory effect actually resulted. The Supreme Court of Pennsylvania conceded that arbitration clauses, as involved in this case, often resulted in a “split-forum effect” which placed additional burden on the borrower but federal and state consumer protection laws served as mitigating factors. The U.S. Supreme Court has clearly stated that parties may agree to arbitrate some claims while reserving the right to litigate others. Moreover, the Supreme Court of Pennsylvania reasoned that there were appropriate business justifications and sound practical and pragmatic reasons favoring pursuit of foreclosure proceedings in a court of law.

Thus, the Supreme Court of Pennsylvania overturned Lytle, indicating that it “swept too broadly” and there was no presumption of unconscionability. Rather, a party asserting unconscionability is required to prove it in cases involving arbitration agreements, such as the one at issue here, or otherwise. Specifically, under Pennsylvania law, the reservation of judicial remedies within the context of an arbitration agreement consummated in conjunction with a residential mortgage loan is not presumptively unconscionable.

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