Five court cases that may affect your CU

Successful lawsuits sometimes have nationwide repercussions

Several important lawsuits either were filed or resolved or are still pending this year in federal courts that could have a major effect on credit unions. Unlike the 1998 Supreme Court ruling against the National Credit Union Administration's (NCUA) field-of-membership regulations, which took an act of Congress to remedy, most cases involve specific financial institutions and apply (at least initially) to limited geographic areas.

Why should you care about lawsuits that don't involve your credit union or the states in which it operates? A successful lawsuit in one part of the country often has nationwide repercussions. Courts often look to other rulings as a precedent to govern their decisions.

Here's an update on five cases CUNA followed closely this year.

MINIMUM PAYMENTS

In 2001, California enacted the Minimum Payment Disclosure Law for Credit Cards. It was scheduled to become effective July 1, 2002, but a district court order has postponed compliance for the moment. This new state law requires credit card issuers, including credit unions, to provide certain disclosures to cardholders residing in California regardless of where the issuer is based.

This law requires additional disclosures on the billing statement about how long it will take to pay off a balance by making minimum payments. Financial institutions can make either generic disclosures (i.e., given a $1,000 balance at 17%, it will take X months to pay off the balance) or individualized disclosures based on consumers' specific balances and annualized percentage rates (APR). For the latter disclosures, if the consumer makes the minimum payment for six consecutive months, the financial institution must repeat the individualized disclosures. If the consumer pays more than the minimum before six consecutive months elapse, further disclosures aren't required.

Financial institutions providing generic disclosures must maintain a staffed toll-free number, open 365 days a year, for inquiries. Regardless of the type of disclosure provided, financial institutions must include a warning in bold type on the balance statement that making only a minimum payment will increase the time to repay the balance and the interest paid.

As a result of a lawsuit brought by the banking industry, the National Association of Federal Credit Unions, and CUNA, the district court has postponed the law's effective date until at least early December 2002, when a court hearing is scheduled on this lawsuit (American Bankers Association et al v. Bill Lockyer, Attorney General of California). Credit card issuers argue federal credit unions and national banks aren't subject to this law regardless of where they're located, and that non-California financial institutions aren't subject to the state law because of the U.S. Constitution's interstate commerce clause. NCUA also has issued an opinion letter (No. 02-0638) that the Federal Credit Union Act pre-empts the California law for federal credit unions.

OVERLIMIT FEES

A federal district court judge once said, "The Truth in Lending Act [TIL] transforms loan documents into contest puzzles in which prizes are awarded to those who can uncover the technical defects. Unfortunately, the prizes are not paid by the sponsor of the contest (the government) but by lenders."

The U.S. Court of Appeals for the Sixth Circuit's ruling in Pfennig v. Household Credit Services Inc./ MBNA America Bank

shows the difficulty in understanding the rules of the contest. Plaintiff Pfennig had the bank's credit card, which had a $2,000 limit. The bank allowed Pfennig to exceed that limit when she made a purchase. Afterward, the bank charged Pfennig an overlimit fee of $29 a month for every month her balance remained over the original credit limit. Pfennig sued the bank, charging the bank violated TIL by omitting the overlimit fee from the finance charge.

Section 226.4(c)(2) of Regulation Z specifically says overlimit fees can be excluded from the calculation of the finance charge. The Sixth Circuit ruled in April 2002 that regardless of what the Federal Reserve Board stated in its regulation, it believes overlimit fees must be included in the finance charge when the fee is imposed incident to the extension of credit. The bank, the Fed, and several trade associations couldn't get the court to change its mind. The decision, therefore, effectively amends Reg Z, but only in the Sixth Circuit.

In July 2002, the Fed issued guidance to its examiners that card issuers in the Sixth Circuit may continue to rely on Reg Z if they don't knowingly permit cardholders to exceed their credit limits and then impose a fee incident to the extension of that credit. Otherwise, they should treat overlimit fees as finance charges.

Outside the Sixth Circuit, the Fed notes there may be circumstances in which such a fee is related to the extension of credit and is in fact a finance charge. Absent such circumstances, card issuers should rely on Reg Z and the official staff interpretation that an overlimit fee isn't considered a finance charge.

No one expects this case to go to the Supreme Court. Perhaps Congress someday will make a technical amendment to TIL to resolve this unusual ruling.

0% FINANCING

Credit unions aren't happy with the 0% financing offers captive auto finance companies advertise because many consumers don't understand the ramifications of choosing 0% financing over a rebate. CUNA has urged the Fed for years to require foregone rebates to be disclosed as finance charges, albeit unsuccessfully. CUNA is monitoring closely a lawsuit to determine whether consumers can successfully argue that the amount of a foregone rebate should be factored in TIL disclosures.

In Coelho v. Park Ridge Oldsmobile Inc., plaintiff Coelho bought a car with a choice of 0% financing or a $1,500 rebate. He chose the 0% financing. Two months after buying the car, however, he sued the dealership claiming a Reg Z violation because the foregone rebate should have been included in the finance charge.

The dealership asked the court to dismiss the case, saying there isn't any issue for the court to address. In denying Park Ridge's motion to dismiss, the court noted in its preliminary analysis that Reg Z specifically provides that finance charges include "discounts for the purpose of inducing payment by means other than credit." In other words, a finance charge is a charge that's avoidable by paying cash. The court noted that because Coelho wasn't given the rebate when he took the 0% interest, it was a condition to the extension of credit, and therefore was part of the finance charge that should have been disclosed.

In June 2002, Coelho and Park Ridge both filed motions for summary judgment. As of press time, the district court hadn't taken further action. Regardless of which side wins, expect the losing party to appeal.

BANKRUPTCY REAFFIRMATIONS

Two members of Katahdin Federal Credit Union in Millinocket, Maine, filed for bankruptcy in 1999 and sought to keep their house and eliminate unsecured debt in Chapter 7 (Jamo v. Katahdin FCU). Consistent with its written policy, Katahdin agreed to reaffirm the debtors' mortgage only if they reaffirmed their unsecured loans. The credit union proposed making concessions on the total amount due, but the Bankruptcy Court ruled, and the Bankruptcy Appellate Panel agreed, that the link between secured and unsecured debt violated the automatic stay. The court ordered the credit union to reaffirm the mortgage under its original terms and discharged the unsecured loans.

The credit union appealed this ruling to the U.S. Court of Appeals for the First Circuit, and the Maine Credit Union League and CUNA filed an "amicus brief' to support the credit union. In March 2002, the court of appeals reversed the lower court's decision, ruling in the credit union's favor. This finding strengthens the ability of credit unions to negotiate reaffirmation agreements without being threatened with sanctions for violating the automatic stay or being charged with using coercive practices.

SOCIAL SECURITY DEPOSITS

In March 2002, the U.S. Court of Appeals for the Ninth Circuit ruled that a bank couldn't offset an overdrawn checking account with monthly Social Security direct deposits (Lopez v. Washington Mutual Bank). The court ruled that the Social Security Act says the benefits aren't subject to execution, levy, attachment, garnishment, or "other legal process," which the court interpreted as offsets. The court said the account and overdraft agreements didn't suffice, and "implicit consent" by Lopez in creating an overdraft to his account nevertheless didn't authorize the bank to use the Social Security funds.

Obviously, this ruling would create an operational nightmare for financial institutions, with the only apparent solution being to eliminate either overdraft protection or direct deposits for Social Security recipients. The Court of Appeals was flooded with requests to reconsider its ruling, not only from financial institutions but also from the U.S. Treasury Department and the Social Security Administration. CUNA inquired if it could file an objection, but the court would permit no more amicus briefs to be filed.

In August 2002, the court of appeals reversed its initial decision with no further hearing. The court ruled that the plaintiff had voluntarily signed up for direct deposit, had signed the account agreement with the overdraft terms and conditions, and could close the account or eliminate the direct Social Security deposits at any time. Therefore he'd agreed that his benefits could be subject to overdrafts and associated fees.

Although this case has been resolved, another decision of the U.S. Court of Appeals for the Tenth Circuit in 1998 involving Social Security benefits still stands. In Tom v. First American Credit Union, the court ruled Social Security benefits in a checking account can't be used to satisfy a delinquent loan. Although this ruling officially applies only in the Tenth Circuit, we believe all financial institutions should review their policies.

For more information about these lawsuits, consult CUNA's e-Guide to Federal Laws and Regulations at www.cuna.org under bankruptcy, Social Security, and TIL.

By Michael McLain Assistant general counsel and senior compliance counsel CUNA & Affiliates

Copyright Credit Union National Association, Inc. Dec 2002
Provided by ProQuest Information and Learning Company. All rights Reserved