Household finance lawsuit

Is your over-limit fee a finance charge?

COMPLIANCE MATTERS

LENDING COMPLIANCE

The Sixth Circuit Court of Appeals in Cincinnati dropped a bombshell in April when it issued an opinion that Regulation Z is wrong to exclude over-limit fees from the finance charge (Pfennig v. Household Credit Services Inc.). The bank that lost the case was joined by the Federal Reserve Board and some industry groups which have asked for a rehearing by the whole Sixth Circuit (en banc).

If the decision stands, it would only be law in the Sixth Circuit (Michigan, Ohio, Kentucky, and Tennessee). However, it's likely that similar challenges to over-limit fees would be brought in other jurisdictions.

The case was a class action brought by a cardholder who was charged a $29 over-limit fee when she exceeded the credit limit on her credit card. The cardholder argued that because the fee was charged in connection with an extension of credit, it had to be a finance charge, because Truth in Lending defines finance charge as "the sum of all charges ... imposed directly or indirectly by the creditor as an incident to the extension of credit."

The court recognized that Regulation Z, which implements the Truth in Lending Act, specifically excludes overlimit fees from the finance charge. But it said the regulation was wrong to do so. Although the court noted that the Federal Reserve Board has broad authority to interpret Truth in Lending, the court said this authority "is not without limits." It explained that Truth in Lending is a remedial statute so it must be given a liberal interpretation in favor of consumers to protect them. (It failed to explain, however, how including over-limit fees in the finance charge protects consumers. The fee was disclosed, even though it wasn't included in the finance charge.)

Also, interpretation isn't necessary when a statute is clear. Because the fee in this case was imposed incident to an extension of credit, the court said it "falls squarely within the statutory definition of finance charge."

A significant factor in the court's decision was the bank's failure to challenge the cardholder's assertion that the bank knowingly and routinely permitted customers to exceed their agreed-upon credit limits and then imposed a fee. The court believed the bank could have declined the transaction that caused the cardholder to exceed her credit limit. Instead, the bank permitted the transaction and then charged a fee for doing so.

By permitting the transaction and then imposing the fee, "the fee clearly is imposed incident to the extension of credit fl This implies that lenders who don't knowingly and routinely permit their customers to exceed their credit limits, may be able to exclude over-limit fees from the finance charge.

The court acknowledged that fees for late charges, default, or delinquency can be excluded from the finance charge because the lender is placed in the position of unexpectedly bearing the cost of the borrower's actions. This suggests the court would be willing to consider an over-limit fee in the same way as a late charge, if the over-limit fee is charged only when a lender can't prevent over-limit transactions from occurring. In this situation the fee is like a late charge because it's charged for the cardholder's unexpected action.

Unless reversed on rehearing, the Pfennig decision would apply only in the Sixth Circuit. But take heed-the cardholder's success will no doubt inspire similar lawsuits in other jurisdictions. Perhaps the only way to avoid a similar lawsuit is to either stop charging over-limit fees or treat them as finance charges.

This means disclosing the fee as a finance charge in the initial disclosures, showing the fee as a finance charge on periodic statements, and reflecting the fee in the annual percentage rate for the statement period. Unfortunately, that might be a data processing challenge that's not easily overcome.

You'll want to track the progress of the Pfennig case to gauge its impact on your credit card operations. m

PAT TORKILDSON is an attorney with Torkildson Law Firm, Madison; Wis.

Pat Torkildson can be reached at 608-441-9851 or at torkildson@tds.net