Bank can raise interest rate without notice

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A bank’s retroactive amendment of a credit card customer’s interest rate does not violate the Truth in Lending Act (TILA).

However, while the Seventh Circuit’s Mar. 19 opinion purports to be consistent with every other court to have considered the issue, it actually creates a circuit conflict, as the Ninth Circuit held to the contrary just three days earlier.

In the Seventh Circuit case, Laura M. Swanson filed a class action against Bank of America, N.A., after it raised the interest rate on her credit card.

The original contract provided that, if she exceeded her balance at the end of two months in any 12-month period it could increase her interest rate from 18 to 32 percent.

A subsequent notice said that the higher rate would take effect at the beginning of the billing cycle to which it applied. It was undisputed that, by continuing to use her credit card, Swanson agreed to this contract term.

However, she later sued, alleging that TILA forbids rate changes that apply retroactively.

The district court ruled in favor of Bank of America. Swanson v. Bank of Am., 566 F.Supp.2d 821 (N.D.Ill. 2008).

Swanson appealed, but the Seventh Circuit affirmed, in an opinion by Judge Frank H. Easterbrook.

At issue was a regulation issued by the Federal Reserve and the Board’s Official Commentary to that regulation, both of which the court found ambiguous.

That regulation — 12 C.F.R. 226.9(c) — provides that whenever “any term required to be disclosed” (which includes the interest rate) is changed, the creditor must provide prior notice.

However, it provides an exception for “over-the-limit” charges.

The court found that this regulation did not clearly prohibit or allow the retroactive rate in increase at question, so it turned to the Board’s Commentary.

The first sentence of Comment 1 states that no notice is required for, among other things, pre-authorized rate increases.

However, the second sentence of the Comment states that prior notice must be given if the rate increase is discretionary with the lender.

The court did not resolve the ambiguities either way.

Instead, the court wrote, “With the regulation and the comment both ambiguous, there is no good reason to override the contract between Swanson and the Bank — a contract that unambiguously authorizes the Bank to act as it did.”

Despite not resolving the ambiguity, the court did defend the result on policy grounds. The court noted that the purpose of requiring prior notice of a rate change is to permit the customer to shop around for a better rate.

But, it was undisputed that the bank could have accomplished the same result by imposing an over-the-limit fee equal to or greater than what was generated by the higher interest rate, and then increased the interest rate only for successive months.

Thus, the court concluded, “Structuring penalty interest to have the same effect as a penalty fee in the initial month therefore does not undermine the goal of advance-notice requirements. Swanson and others in her position still can shop for better rates for future months.”

Finally, the court noted that, effective July 1, 2010, an amendment to sec. 226.9 will take effect that will explicitly prevent retroactive changes to interest rates.

Finding that the reason for the amendment was that the regulation, as it exists now, does not prohibit penalty rates, the court concluded that interpreting the regulation in favor of Swanson would give her the benefit of a law not yet in force.

Accordingly, the court affirmed.

Analysis

The court explicitly noted that, by ruling as it did, it was avoiding a conflict with any other circuits, in that one circuit court and at least six district courts had all held that banks may apply higher rates of interest to the entire billing cycle in which a default occurs.

The court of appeals opinion that it cited was from the Ninth Circuit, but was unpublished.

Evans. v. Chase Bank USA, N.A., 267 Fed.App’s 692 (9th Cir. 2008). Also included in the string-cite was an unpublished district court opinion from California, McCoy v. Chase Manhattan Bank, USA, 2006 U.S. Dist. LEXIS 97257 (C.D.Cal., Aug. 10, 2006).

However, three days before the Seventh Circuit issued its opinion, the Ninth Circuit reversed the lower court in McCoy. McCoy v. Chase Manhattan Bank, USA, No. 06-56278 (9th Cir., Mar. 16, 2009).

At first blush, it would seem unlikely that this circuit split would warrant the U.S. Supreme Court getting involved, inasmuch as the issue will become moot on July 1, 2010.

Discussing the amendment, the Seventh Circuit wrote, “The reason the Federal Reserve added sec. 226.9(g) was precisely that it recognized that the existing regulation did NOT prohibit penalty rates that begin at the start of the billing cycle in which the consumer’s default occurs.

The Federal Register has an extensive commentary on sec. 226.9(g) in which the agency recognizes that sec. 226.9(g) will change the way penalty-default interest rates are applied. See 74 Fed. Reg. at 5350–56 (emphasis in original).”

However, the Ninth Circuit acknowledges the same amendment, but disagrees.

That court wrote, “while language scattered throughout the 2007 ANPR offers some support for each view of the Official Commentary, the ANPR does not clearly weigh in favor of either interpretation of Regulation Z. This ambiguity is not surprising because the primary purpose of the 2007 ANPR (and the 2004 ANPR that preceded it) was to announce proposed amendments to Regulation Z and solicit comment, not to offer additional staff commentary on Regulation Z’s current requirements.”

So, despite the Seventh Circuit’s view that time will resolve any ambiguity, there will remain a split in the circuits, with the Ninth Circuit taking the view that the regulation remains as ambiguous as ever. So, review in the U.S. Supreme Court would not be as irrelevant as it would seem from reading the Seventh Circuit’s discussion.