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A Kentucky appellate court upheld a trial court's determination that an agreement to arbitrate contained in a mortgage contract was unconscionable because it limited the consumer's right to recover statutory damages.
In Mortgage Elec. Registration Sys., Inc. v. Abner, No. 2007-CA-000574-MR, 2008 WL 2852433 (Ky. Ct. App. July 25, 2008), Abner executed a promissory note with the Bank of New York and a mortgage with Mortgage Electronic Registration Systems, Inc. (MERS) to secure the note. The note and the mortgage related to real estate located in Waco, Kentucky.
The mortgage contained an agreement to arbitrate. Thereafter, MERS filed a foreclosure action against Abner. In response, Abner filed a counterclaim alleging that the arbitration agreement violated the Home Ownership Equity Protection Act (HOEPA) and the Truth In Lending Act (TILA).
MERS moved to compel arbitration. The trial court concluded that the arbitration agreement was unconscionable and denied the motion. On appeal, MERS contended that the trial court erred in finding the arbitration clause unenforceable.
Generally, Kentucky law favors arbitration agreements, but the existence of a valid arbitration agreement is a matter that must first be resolved by the court. The Court noted that, under the Prima Paint standard, claims that attack only the arbitration agreement, but not the entire contract, are subject to judicial determination.
The Court stated that the plain language of the arbitration agreement rendered it unconscionable as it limited the consumer's rights of recovery. The offending provision read that an arbitrator shall not have the power to award consequential, punitive, exemplary or treble damages, but only to award actual damages.
The Court, while not examining the merits, determined that Abner had asserted valid claims under HOEPA and TILA, statutes designed to protect consumers from predatory lending practices. The arbitration agreement effectively precluded Abner from pursing a claim under either of these statutes, as an arbitrator could only award actual damages.
Thus, Abner would not be able to recover any of the statutory damages available under HOEPA or TILA. Because the arbitration agreement deprived Abner of substantive remedies, the Court determined that agreement to arbitrate was indeed unconscionable and unenforceable.
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