The following article is reprinted from Basis Points® , Vol. 2, Issue 7, Copyright © 2003, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

For several years, we have cautioned against trying to use an arbitration agreement that is anything less than completely friendly to consumers. The theory is that courts will seize upon anti-consumer provisions in arbitration agreements as an excuse not to enforce them. One such provision we have been particularly concerned about is one that takes away the consumer's right to obtain exemplary or punitive damages in arbitration. Well, it's a good thing that whoever drafted the arbitration agreement involved in this case didn't listen to us.

Stanley and Patricia Stark sued the assignee of their home loan and deed of trust - EMC Mortgage Corporation, the trustee under the deed of trust, and the law firm and attorney who attempted to collect the debt after an alleged default. They sought damages for violations of the Fair Debt Collection Practices Act and the Truth in Lending Act.

The claims were submitted to arbitration. The arbitrators awarded each plaintiff $1,000 in damages, with EMC and the law firm being jointly and severally liable, attorney's fees in the amount of $22,780, plus all the arbitrator's fees and costs, to be paid by EMC. Finally, they ordered EMC to pay $6 million in punitive damages. Such a punitive damages award in an arbitration proceeding is very unusual.

Both parties apparently appealed the punitive damages award - the plaintiffs (oink, oink) arguing that the award should have been greater (based on the calculation the arbitrators used), and EMC arguing that punitive damages should not have been awarded under the parties' arbitration agreement.

The U.S. District Court for the Western District of Missouri vacated the award of punitive damages and affirmed the remainder of the arbitrator's decision. Although the parties' arbitration agreement forbade an award of punitive damages, the arbitrators found that the agreement was ambiguous. They reasoned that the agreement promised that the plaintiffs could seek all damages allowed by law, but then took that promise away by excluding punitive damages, thus creating an ambiguity.

The court "respectfully" disagreed with the arbitrators' conclusion. The court said: "The parties identified three sources of rules to govern their arbitral obligations, and declared that one - their written agreement - would govern in the event of any conflict between them. The parties also specifically agreed that the arbitrator could not award punitive damages. This is not amenable to an interpretation that punitive damages could be awarded …"

The court indicated in a footnote that if it were not for the arbitration agreement, the award of punitive damages would stand based on the arbitrators' findings.

The lesson here? Whoever drafted this arbitration agreement won his or her bet that a provision prohibiting punitive damages wouldn't lead the court to refuse to enforce the arbitration agreement. On balance, we still stand by our position that the best arbitration agreement is the most consumer-friendly one, and that means not prohibiting punitive damages. It's still a bet, however, and the defendants here would have been $6 million poorer if they had followed our suggestion. Companies using arbitration agreements will have to weigh the pros and cons and decide whether to expressly prohibit punitive damages or not.

For more information, look for Stark v. Sandberg, Phoenix & Von Gontard, P.C., Case No. 01-0407-CV-W-3-ECF (W.D. Mo. May 5, 2003).

To view all other Basis Points Articles, click here.