A student loan company accused of hiding fees in loan agreements cannot force the lead plaintiff in a putative class action into arbitration, a federal judge has ruled.
Joshua G. Fensterstock, a 2003 Hofstra University School of Law graduate and now an associate at Isaacs & Associates in Manhattan, sued the lender and a loan processing company in 2008 over terms in his student loan that he claimed would cost him thousands of unforeseen dollars.
But defendants Education Finance Partners and Affiliated Computer Services argued before Southern District of New York Judge Thomas P. Griesa that the arbitration clause in the agreement should be enforced.
But the judge found that the terms of the loan were unconscionable and he refused to compel arbitration in Fensterstock v. Education Finance Partners, 08 Civ. 3622. The decision paves the way not only for Fensterstock's damages action, but the possibility of a class action.
Fensterstock consolidated his existing student loans in 2006 into a single loan for $52,925.
His suit claims the defendants determined how much of a payment is applied to the loan's principal (instead of the amount applied to interest) based on the date the payment is received as opposed to the due date of the payment.
"Thus, if a payment is received on any day other than the due date -- including before the due date -- it will not be applied to principal correctly," Judge Greisa wrote.
By the time he filed his action, Fensterstock claimed he had accumulated $263.19 in damages but asserted he would suffer "thousands of dollars" over the course of the loan.
The loan was governed by a promissory note drafted by Education Finance Partners. While it included an arbitration provision, Fensterstock said the note did not disclose the built-in penalties.
He claimed breach of contract, deceptive advertising and fraud against Education Finance Partners and breach of contract and fraud against Affiliated Computer Services, the company that processes payments and determines how much is applied to the principal.
After deciding that California law applied, Judge Greisa said the lead case on the issue is Discover Bank v. Superior Court, 36 Cal.4th 148 (2005), which holds that an arbitration clause requiring a consumer to waive the right to bring a class action is unconscionable where: "(1) The waiver is found in a consumer contract of adhesion, (2) in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and (3) it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small amounts of money."
Griesa first found that Fensterstock's promissory note was a contract of adhesion because it was presented on a "take it or leave it" basis with no opportunity to negotiate.
The defendants claimed that, as an attorney, Fensterstock was sophisticated enough to have both understood the arbitration waiver and to have pursued other options.
But the judge said there was no showing here that Fensterstock could have obtained another consolidation loan that did not have a similar provision.
This, he said, was enough to show "procedural unconscionability in the context of class action waivers, where there is a high degree of substantive unconscionability because the waiver allows a company to reap a windfall from small injuries to individual consumers, while avoiding litigation."
The defendants argued that damages would be large enough to allow individual actions.
"This contention has no merit," Greisa said. "The critical consideration is whether individual consumers will view their damages as sufficient to warrant the cost of individual litigation."
Finally, the judge said the complaint succeeded in making "precisely" the type of allegation made in Discover Bank -- a party using superior bargaining power to cheat a large number of consumers out of a small amount of money.
Education Finance Partners is now in bankruptcy. In 2007, the company agreed to pay $2.5 million to settle charges brought by Attorney General Andrew Cuomo over its business practices.
Fensterstock is represented by Alan E. Sash of McLaughlin & Stern.
"This is a great decision for all law school graduates or other students with loans," said Sash.
The defendants are represented by Edward Lenci of Hinshaw & Culbertson.