Between 2005 and 2007, a major bank is California made a paltry $1.4 billion in overdraft fees. However, a California Federal Court found that those fees were a result of misleading practices and ordered that major bank pay $203 million in restitution. The award was recently affirmed by the Federal Appeals Court in the Ninth Circuit.
At the heart of the issue in the case was the bank’s practice of posting debits at the end of the day “high-to-low”; meaning, the largest debit was posted first and sequentially less debits were posted after in order of decreasing amount. The alternative methods identified by the Court would have been “low-to-high” and “chronological”.
- In high-to-low posting, the funds in the account are depleted more quickly, the result being that the remaining smaller debits create a larger number of overdrafts. Thus, the overdraft fees are “maximized”.
- On the other hand, the low-to-high posting allows the smaller debits to be satisfied first, leaving a lower number of overdrafts and thus lower overdraft fees.
The plaintiffs sued the bank under California law for unfair, unlawful, or fraudulent business practices. The bank countered claiming that Federal Law, namely, the National Bank Act preempted (trumped) the state law, and therefore the bank was free to post the debits however they wanted.
The trial court found that:
- The “decision to post debit-card transactions in high-to-low order was made for the sole purpose of maximizing the number of overdrafts assessed on its customers”,
- The bank hid and misrepresented the way debit transactions were posted in their disclosures,
- Federal Law did not preempt the state law and the Bank was liable for being both unfair and fraudulent in its posting high-to-low, and
- The plaintiffs (as a class) were entitled to $203 million in restitution, among other things.
The bank appealed. In the first appellate opinion in this case (entered in 2012), the Ninth Circuit held that Federal Law permitted the high-to-low posting of debit transactions, and preempted the state law claim that the high-to-low posting was unfair.
The Ninth Circuit held that the bank was liable under the fraudulent prong of the state Unfair Competition Law. Specifically, the Ninth Circuit affirmed the trial court’s holding that the Bank’s failure to disclose the effect of the high-to-low posting combined with the bank’s “misleading statements” combined to make [the bank] liable under a fraud theory as a misleading statement. Further – this type of state law violation “is not preempted by the National Bank Act”.
Litigation continued until October 29, 2014, when the Ninth Circuit affirmed (in an unpublished opinion) the trial court’s award of $203 million in restitution and related injunction against the Bank for violation of California’s Unfair Competition Law which prohibits misleading statements.
Normally, I would wrap up with how this would affect lenders, but I think it’s self-evident. However, it is worth summing up a couple of things to consider:
First, lenders might want to take a look at their motivations and disclosures regarding overdraft fees.
Second, lenders should be aware that their activities may be perfectly legal under Federal Law, but nevertheless may subject to them to liability under state law.
At the moment, the ruling considers only California Law, but it’s a safe bet that bank clients around the country who are being charged fees for having no money will be looking at those overdraft fees.