Federal Court Rejects Preemption Defense for Debt Cancellation, Suspension Products
Blayne V. Scofield | Bloomberg Law
In August 2011 West Virginia Attorney General Darrell McGraw accused several banking organizations of violating state law by illegally administering and marketing debt cancellation and debt suspension products (collectively, Products) to credit cardholders. The banking organizations removed the case to federal court. West Virginia opposed the removal and moved to remand the case to state courts.
On February 10, 2012, the U.S. District Court for the Southern District of West Virginia sided with the state and granted the remand. In doing so, it rejected the banking organizations’ argument that West Virginia’s claims were preempted by federal law.
Payment Protection Plans Challenged
In its complaint, West Virginia asserted that the Products offered by JPMorgan Chase & Co., Discover Financial Services, Inc., GE Money Bank, World Financial Network, First Premier Bank, Bank of America Corporation, Citigroup, Inc., HSBC Bank Nevada, N.A., and certain of their affiliates (together, the banking organizations) violated several provisions of the West Virginia Consumer Credit and Protection Act.
The Products generally allow cardholders to suspend their credit card payments or cancel their debts entirely upon the occurrence of certain events, like death, disability, or unemployment. The banking organizations charged a monthly fee for the Products, usually a percentage of the cardholder’s outstanding balance.
West Virginia alleged that the banking organizations violated the state’s consumer protection law in several ways, including by:
- making it difficult for cardholders to claim benefits;
- enrolling cardholders in the Products without their consent;
- selling the Products to cardholders who were ineligible to receive benefits; and
- making it difficult to unsubscribe from the Products.
Litigation over the Products is widespread. Consumers have filed several individual suits and purported class actions against these banking organizations and others, which generally challenge the same practices alleged here. For a list of cases, see In re: Credit Card Payment Protection Plan Marketing and Sales Practices Litigation, No. MDL 2195 (J.P.M.L. filed Aug. 24, 2010).
Payment Protection Fees Are Not “Interest” For Preemption Purposes
— Federal Courts Have Jurisdiction over Preempted State Law Claims
In seeking to sustain the removal, the banking organizations argued that federal court was the proper forum for this litigation under the complete preemption doctrine. Federal courts are courts of limited jurisdiction. In general, they are only authorized to hear cases where the claims arise under federal law or where the parties to the suit are from different states. The complete preemption doctrine allows a complaint that involves nothing but state law claims to be moved to federal court. This can be done when the claims are entirely preempted by federal law.
In this case, the banking organizations asserted that West Virginia’s claims were preempted by Sections 85 and 86 of the National Bank Act, 12 U.S.C. §§ 85 and 86,1 which penalize national banks for charging usurious interest rates. The Supreme Court held in Beneficial National Bank v. Anderson, 539 U.S. 1 (2003) that these provisions completely preempt state law claims. Thus, the banking organizations sought to invoke the complete preemption doctrine and move the case to federal court by claiming that West Virginia’s attacks on the Products were really nothing more than ordinary usury claims.
— Banking Organizations Claimed that Fees for the Products Are Interest
This theory may sound like a stretch, but there is support for it in applicable law. The implementing regulation issued by the Office of the Comptroller of the Currency (OCC), 12 C.F.R. § 7.4001(a), defines “interest” for purposes of usury as “any payment compensating a creditor . . . for an extension of credit”. This includes the familiar concept of interest—periodic rates charged on outstanding credit balances. But it also includes charges that are not normally thought of as interest like late fees, insufficient funds fees, and membership fees.
The banking organizations argued that payments for the Products were interest (and therefore preempted by federal law) for two reasons. First, they contended that the Products were not standalone products. Instead, the banking organizations asserted, the Products functioned as modifications or extensions of existing credit card loans and, thus, payments for the Products were payments for modifications or extensions of credit. Second, they argued that the structure of the payments charged to cardholders—i.e., a percentage of the outstanding balance—was functionally similar to interest.
The banking organizations relied on OCC’s unusually broad definition of “interest” to argue that West Virginia’s claims regarding the Products were in fact challenges to the interest they charged on credit card accounts. According to the banking organizations, this could only be done under federal law and in federal courts.
— Court Rejected Banking Organizations’ Argument
The court disagreed. The court noted that the fact that participation in the Products was voluntary necessarily meant that payments for the Products were not for extensions of credit, but were for a distinct service. The court found further support for its conclusion in the fact that the charges for the Products were separated from other standard account fees in billing statements. Even though the Product fees were charged as a percentage of the outstanding balance like interest usually is, the court found that this similarity was cosmetic rather than substantive.
The court also indicated that even if it had found that the Product charges were interest, West Virginia’s claims still would not have been preempted. In order for preemption to apply, the court explained, the dispute had to (i) involve interest, and (ii) allege that the amount of interest charged exceeded the level set in Section 85. In this case, West Virginia did not allege that the amount charged for the Products was excessive. It claimed that other aspects of the Products were unfair and deceptive. Thus, the court held that remand was appropriate.
The outcome of this case was favorable for West Virginia. State courts are often perceived as being more receptive than federal courts to state law consumer protection claims, particularly in jurisdictions like West Virginia where trial court judges are elected.
1 The National Bank Act applies to only four of the eight banking organizations. The other four banks are state banks or federal savings associations. However, as the court noted, the same analysis applies to these other institutions pursuant to the Depository Institutions Deregulation and Monetary Control Act of 1980, 12 U.S.C. § 1831d (for state banks), and the Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. § 1465(a) (for federal savings associations).
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