United States Court of Appeals for the Fourth Circuit Refuses to Enforce Arbitration and Choice of Law Provisions Because of Onerous Loan Terms

Most of us have heard the expression “Pigs get fat, hogs get slaughtered.”  The United States Court of Appeals for the Fourth Circuit did not slaughter the officials of the lenders in its November 16, 2021 opinion in Hengle v. Treppa, but it almost certainly cleared the path to the slaughterhouse.

The lenders in Hengle were “online lenders affiliated with a federally recognized Native American tribe.”  However, they allegedly were operated by non-tribal companies owned by non-tribal defendants on non-tribal land, employing non-tribal employees, and distributing most of their revenues to non-tribal entities and individuals.

The plaintiffs were Virginia residents who had obtained consumer, short-term, “low dollar, high interest loans” from the lenders online.  The amounts of the loans at issue ranged between $300 and $1,575 and the interest rates ranged between 544% and 920%.  The loan agreements to which they agreed online provided that their loans were governed “by applicable tribal law, including but not limited to, the Habematolel Tribal Consumer Financial Services Regulatory Ordinance.”  The loan agreements also provided for arbitration of all disputes and specified that the arbitrator was to apply “the laws of the Habematolel Pomo of Upper Lake Tribe.”  Although the loan agreements allowed arbitration in locations other than on tribal land, they specified that an election of have arbitration occur outside of tribal land “shall in no way…allow for the application of any other law other than the law of the Habematolel Pomo of Upper Lake.”

After defaulting on their loans, the plaintiffs sued the members of the Tribal Counsel of the tribe with which the lenders were affiliated and non-tribal officers of the lenders in the United States District Court for the Eastern District of Virginia.  The plaintiffs alleged violations of Virginia usury and consumer finance laws and violations of the federal Racketeer Influenced and Corrupt Organizations Act (“RICO”).  All defendants moved to: (a) compel arbitration; and (b) dismiss because the loans were governed by Habematolel law under which they were legal, not Virginia law, and because loans that were legal could not be the required “predicate act” under RICO.  The Tribal Counsel defendants also moved to dismiss on the grounds of sovereign immunity.

The District Court denied the defendants’ motions.  However, the District Court also granted the defendants leave to file an interlocutory appeal and the defendants appealed to the Fourth Circuit.

The Fourth Circuit acknowledged that, as a general rule, arbitration clauses are enforceable and whether a particular dispute is subject to arbitration should be determined by the arbitrator, not courts.  However, the Court noted that it had held in prior cases that an arbitration clause is not enforceable if it effects “a prospective waiver of federal rights.”  Because the loan agreements specified that the arbitrator was to apply only the law of the Habematolel Pomo of Upper Lake, the plaintiffs would not be able to pursue their RICO claims if they were required to arbitrate.  Consequently, the arbitration clause effected a prospective waiver of federal rights and would not be enforced.

Moving to the issue of sovereign immunity, the Fourth Circuit recognized that “Indian tribes possess a unique status in our federal system.”  Tribes “exercise inherent sovereign authority” and are afforded “common-law immunity from suit” in state and federal courts.  However, tribal immunity does not bar suits against “individuals, including tribal officers, responsible for unlawful conduct.”  Consequently, the members of the Trible Counsel who had been sued in their individual capacities did not enjoy sovereign immunity.

Finally, the Court addressed the choice of law provision in the loan agreements.  The Court recognized that, under Virginia law, “parties to a contract are free to specify the law that governs their agreement.”  Consequently, Virginia courts give contractual choice of law provisions ”full effect except in exceptional circumstances.”  One such circumstance is when the law selected “not only differs from Virginia law, but is contrary to compelling public policy of the Commonwealth.”  The issue, then, was whether the choice of law of the Habematolel Pomo of Upper Lake violated a compelling public policy of Virginia.

The way that the Court described the issue that it needed to decide was an obvious signal of the decision to follow.  The Court started the discussion by noting that the plaintiffs were required to pay interest at rates “between 544% and 920% on principal amounts ranging from $300 to $1,575 over the course of ten months” and that the specified tribal law provided for no cap at all on interest rates.  By contrast, under Virginia law, the maximum permitted rate was 12%.  The Court then said that “The Supreme Court of Virginia has not addressed whether unregulated usurious lending of low-dollar loans with triple digit interest rates violates compelling Virginia public policy so as to overcome a contractual choice of foreign law.”  In the absence of Supreme Court of West Virginia precedent, the Court said, “We therefore must apply Virginia law to predict how that court would rule.”

The Court noted that the Virginia legislature has regulated usurious loans based upon “considerations of public policy” since 1734.  Under Virginia law, a contract violating the usury limit is “void,” and the lender may not collect “any principal, interest, fees or other charges in connection with the contract.”  A borrower who has paid usurious interest “may sue to recover not only the excess interest paid but also twice the total amount of interest paid during the two years preceding the lawsuit, in addition to court costs and attorneys’ fees.”  Finally, the Court said that “Virginia’s legislature has signaled the importance it attaches to the usury laws by enacting an anti-waiver provision” which provides that any agreement to waive rights under usury laws “shall be deemed to be against public policy and void.”  Based on these provisions of Virginia law, the Fourth Circuit concluded that “the Supreme Court of Virginia would not enforce the governing-law clause because it violates Virginia’s compelling public policy against unregulated usurious lending. “

The defendants in Hengle had the general principles that arbitration clauses and choice of law provisions are to be enforced in their favor.  Yet they still lost because, as the Fourth Circuit said, their conduct “unquestionably shock[s]…one’s sense of right.”  Oink.