Bertram v. Beneficial Consumer Discount Co.

• Decision Date: 14 October 2003
• Docket Number: Civil Action No. 1:03-CV-0954.
• Parties: Clyde L. BERTRAM and Linda R. Bonner, Plaintiffs, v. BENEFICIAL CONSUMER DISCOUNT COMPANY, Defendant.
• Court: U.S. District Court — Middle District of Pennsylvania

286 F.Supp.2d 453

Clyde L. BERTRAM and Linda R. Bonner, Plaintiffs, v. BENEFICIAL CONSUMER DISCOUNT COMPANY, Defendant.

Civil Action No. 1:03-CV-0954.

United States District Court, M.D. Pennsylvania.

October 14, 2003.

COPYRIGHT MATERIAL OMITTED

Stephen K. Portko, Bratic & Portko, Dillsburg, PA, for Plaintiff.

Joseph F. Riga, Linda Levitsky, Whittlesey McDowell & Riga, Maple Shade, NJ, for Defendant.

MEMORANDUM

CONNER, District Judge.

Presently before the court is a motion for a stay pending arbitration (Doc. 3) filed by defendant, Beneficial Consumer Discount Company ("Beneficial"), based on an arbitration clause included in a consumer credit agreement between defendant and plaintiffs, Clyde L. Bertram and Linda R. Bonner. Plaintiffs, who seek damages for violations of the Truth in Lending Act ("TILA"), 15 U.S.C. §§ 1601-1667, claim that a notice of rescission sent to defendant pursuant to TILA voided the agreement, including the arbitration clause, and, thus, defendant cannot compel arbitration of this action under the Federal Arbitration Act ("FAA"), 9 U.S.C. §§ 1-16.

The question presented by the motion is whether a notice of rescission under TILA renders a consumer credit agreement void ab initio, precluding enforcement of an otherwise applicable arbitration provision. For the following reasons, the court finds that it does not and, accordingly, will grant defendant's motion to stay this action pending arbitration.

I. Statement of Facts¹

In June 2001, in an effort to refinance an existing mortgage on their home, plaintiffs executed a mortgage agreement under which Beneficial acquired a security interest in the property in exchange for a loan of approximately $150,000. (Doc. 1 ¶¶ 7-9). Concurrently, plaintiffs executed an arbitration agreement, attached to the mortgage agreement as a rider, providing, in pertinent part, as follows:

This Arbitration Rider is signed as part of your [mortgage] Agreement with [Beneficial] and is made a part of that Agreement. By signing this Arbitration Rider, you agree that either [Beneficial] or you may request that any claim ... arising from or relating to this Agreement ... including the validity or enforceability of this arbitration clause ... or the entire Agreement ... shall be resolved, upon the election of you or [Beneficial], by binding arbitration pursuant to this arbitration provision....

(Doc. 4, Ex. A at 1). Subsequent language states that "[t]his Arbitration Rider is made pursuant to a transaction involving interstate commerce, and shall be governed by the Federal Arbitration Act." (Doc. 4, Ex. A at 1).

In connection with this transaction, Beneficial delivered to plaintiffs a disclosure statement, which, according to plaintiffs, failed to provide notice of all information required by TILA and its implementing regulations, 12 C.F.R. §§ 226.1-.36 ("Regulation Z").² In March 2002, plaintiffs sent Beneficial a notice of rescission, purporting to rescind the mortgage agreement pursuant to TILA.

After defendant failed to recognize the termination of the security interest or to return any money to plaintiffs within twenty days, as required by TILA, plaintiffs filed the present action. In their complaint, plaintiffs allege that defendant's conduct violated TILA and was unconscionable and in bad faith, entitling them to monetary relief and a declaration that the mortgage agreement is void.

II. Standard of Review

Granting a motion to compel arbitration, or to stay pending arbitration, effects a "summary disposition of the [factual] issue" of the existence of an agreement to arbitrate, and, for this reason, courts should consider the facts in the light most favorable to the non-movant, giving that party "the benefit of all reasonable doubts and inferences that may arise." Par-Knit Mills, Inc. v. Stockbridge Fabrics Co., 636 F.2d 51, 54 & n. 9 (3d Cir.1980), quoted with approval in Sandvik AB v. Advent Int'l Corp., 220 F.3d 99, 106 (3d Cir.2000). In the context of such a motion, the court may consider the pleadings, documents of uncontested validity, and affidavits or depositions submitted by either party. See id. (citing FED.R.CIV.P. 56(c)).

III. Discussion

Resolution of the claims presented in the instant motion requires, as a threshold matter, clarification of the nature and scope of the issues involved. Plaintiffs' sole contention against enforcement of the arbitration clause is that the notice of rescission sent to defendant automatically voided the mortgage agreement, rendering the embedded arbitration clause ineffective.³ Thus, the court must determine (1) under what circumstances the FAA requires enforcement of arbitration clauses and (2) whether an arbitration clause in a contract subject to rescission under TILA falls within one of those circumstances.

A. Federal Arbitration Act

The FAA, which provides a framework for the implementation and enforcement of private arbitration agreements, establishes a strong presumption in favor of arbitration over litigation. Sandvik, 220 F.3d at 104. Even in circumstances in which the validity of the contract is in dispute, the statute mandates courts to reserve these issues for the arbitrator. 9 U.S.C. § 2; Sandvik, 220 F.3d at 104. The FAA provides that, when the court is "satisfied that the making of the [arbitration clause] ... is not in issue," it "shall ... stay the trial of the action" pending arbitration. 9 U.S.C. §§ 2-4 (emphasis added); see also Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-04, 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967). Phrasing this requirement in the negative, the court may decline to enforce an arbitration clause only when the making of the clause itself, not merely the making of the contract as a whole, is disputed.⁴ See id.

Thus, for purposes of determining the enforceability of an arbitration clause, the FAA requires the court conceptually to sever the arbitration provisions from the remainder of the contract. See Sandvik, 220 F.3d at 106. Under this principle, deemed the doctrine of severability, courts analyze arbitration clauses as individual agreements, executed concurrently with, but not as part of, the encompassing contract. See id. Application of this doctrine means, somewhat anomalously, that a prima facie finding that a contract is voidable does not render an embedded arbitration clause voidable or unenforceable. Id. Rather, as stated in the FAA, only when the making of the clause itself is in issue is the arbitration provision rendered ineffective. 9 U.S.C. §§ 2-4; Prima Paint, 388 U.S. at 403-04, 87 S.Ct. 1801. Thus, to avoid arbitration under the FAA, the challenging party must establish grounds for declaring a contract voidable that relate specifically to the arbitration clause, viewed independently from the remainder of the contract. Sandvik, 220 F.3d at 106.

Although the severability doctrine requires enforcement of an arbitration agreement embedded in an otherwise voidable contract, it does not permit enforcement when the encompassing contract is considered void ab initio. Id.; see also China Minmetals Materials Imp. & Exp. Co. v. Chi Mei Corp., 334 F.3d 274, 282 (3d Cir.2003). The reason for this disjunction lies in the distinction between voidable and void contracts. A voidable contract is one in which a party has the power, "by a manifestation of election to do so," either to disaffirm the agreement, avoiding the legal duties imposed by it, or to ratify the agreement, mandating performance of the contractual obligations by both parties.⁵ RESTATEMENT (SECOND) OF CONTRACTS § 7 (1981), cited in Sandvik, 220 F.3d at 107. A claim that a contract is voidable does not challenge the existence or prima facie validity of the underlying agreement, but charges that inequitable conduct associated with the formation or performance of the agreement renders it unenforceable at the election of the aggrieved party. See id.; Sandvik, 220 F.3d at 107-09. Such a claim does not implicate the making of the arbitration clause itself, and, thus, the FAA requires the court to enforce an embedded arbitration agreement in these circumstances. See id.

In contrast, a declaration that a contract is void nullifies all aspects of the agreement, including an embedded arbitration clause, giving neither party the power to ratify or disaffirm its provisions.⁶ RESTATEMENT (SECOND) OF CONTRACTS § 7 cmt. a ("[A void contract] is not a contract at all."); Sandvik, 220 F.3d at 107-09. Essential to this concept is the principle that a void contract lacks legal existence from inception, and that the subsequent judicial declaration merely clarifies, rather than alters, the legal relationship of the parties. See id. Because arguments that a contract is void ab initio threaten the existence of all provisions of the agreement, including an embedded arbitration clause, such a claim necessarily puts the making of the arbitration clause in issue, rendering resolution of the claim improper for arbitration under the FAA. Id.; see 9 U.S.C. §§ 2-4.

Thus, the FAA mandates enforcement of arbitration provisions in all but two circumstances: (1) when a party alleges that the contract as a whole is void ab initio for any reason, or (2) when a party alleges that the arbitration clause itself is voidable for reasons related specifically to the arbitration clause. In all other situations, the FAA requires the court to enforce the terms of the clause and to refer the matter to arbitration.

B. Truth in Lending Act

TILA, as part of its effort to protect consumers from potentially unfair transactions with lenders and creditors, grants individuals an unfettered right to rescind consumer credit contracts within prescribed time limits after consummation of the transactions. 15 U.S.C. § 1635(a), (f); 12 C.F.R. § 226.23(a)-(d). The limitations period for the exercise of the right to rescission depends on the nature and extent of the creditor's disclosures. 15 U.S.C. § 1635(f); 12 C.F.R. § 226.23(a)(3)....