December 2020 OBA Legal Briefs

  • Systemic overdraft problems
  • Resolving escrow shortages and deficiencies
  • An update on the Payday Lending Rule

Systemic overdraft problems

By Andy Zavoina

Let’s talk “politically correct” and separate that from what is legally correct. The former term is used loosely to mean generally accepted by the vocal public, which in this case includes those tired of what they may view as exorbitant bank fees.

Let’s examine a recent case about bank fees. The fees in question are nonsufficient funds fees on checks and it is possible your bank is following the same practice that just led to a $16 million settlement. The case, Ruby Lambert v. Navy Federal Credit Union, became a class action suit. It could likely just as well have been against any bank, possibly even yours, although this case was in the United States District Court, Eastern District of Virginia. It involves a dispute over multiple fees charged for the payment of items for which there were nonsufficient funds in the account, because of the re-presentment of a check.

You should be familiar with your disclosures. If you are not, get one out and see if you have language like this addressing NSFs and fees:

XYZ Bank may return debits to the checking account (e.g., checks or ACH payments) if the amount of the debit exceeds funds available in the checking account. A fee may be assessed in the amount shown on XYZ Bank’s current Schedule of Fees and Charges for each returned debit item.

Automated processes present an item and compare it to the balance available. If the item will not pay, an NSF fee is typically charged to the account and that item can be returned to the payee. The payee then has options. They may choose to call the bank to determine if, at that later date, there are sufficient funds and, if so, the item can be represented for payment. Other payees may automatically re-run the item or in some cases they contact the issuer for payment.

“Banking veterans” remember when checks were more popular and generally a paper item would be run through the clearing system up to two times. The item could then be stamped with a disclaimer similar to “Do Not Re-Deposit” after the second presentment or even have holes punched in the MICR code at the bottom of the check. The intent was to avoid further re-presentments when there was little hope of the item paying. This saved the bank time handling the item and avoided accruing yet another NSF fee that could prove difficult to collect. These items could still be sent as collection items. At the end of the day, one item could accrue two NSF fees, one for each presentment. But that is not an absolute rule.

The OCC’s website meant to answer questions from consumers includes the following Q&A:

Question – How many times will a bank allow an insufficient funds (NSF) check to be redeposited/resubmitted?

Answer – Generally, a bank may attempt to deposit the check two or three times when there are insufficient funds in your account. However, there are no laws that determine how many times a check may be resubmitted, and there is no guarantee that the check will be resubmitted at all.
Overdraft or insufficient funds fees can be assessed each time the check is submitted. Review your bank’s deposit account agreement for its policies regarding overdrafts and the presentment of checks.

(Last Reviewed: October 2020)

With this background, let’s examine the Lambert case. Lambert initiated her suit against NFCU after a preauthorized charge for insurance she had set up was presented in ACH form and refused. NFCU charged a $29 NSF fee as the item was presented, processed, and returned. Two days later the payee submitted another ACH debit request for that same payment, which was still owed. NFCU followed the same procedure and again returned the item due to nonsufficient funds and charged Lambert another NSF fee.

Lambert’s suit claims that the second charge for an NSF fee violates the contractual language in her agreement with NFCU. Any subsequent charge, a second, third, etc. was not authorized as each is a resubmission of the first and only that one charge was authorized. In the sample language above it states NFCU “may” return items and may assess “a fee.” As Lambert views these transactions, all subsequent attempts to charge her account involved the same debit.

She filed two claims based on this belief. First, she believes there was a breach of contract and the covenant of good faith and fair dealing. Secondly, it was a violation of North Carolina’s Unfair and Deceptive Trade Practices Act.

NFCU claims that it enjoys a federal preemption under the Federal Credit Union Act and the Truth in Savings Act as state law claims may be preempted by Congress “either expressly through the statute or regulation’s language or impliedly through its aim and structure.” National banks will also enjoy some preemptions and state banks may enjoy some benefits of parts of these laws under parity rules. Check with bank counsel if you have any questions, but these facts influence this case, which could impact how your bank contracts for fees. At the very least Your compliance and legal departments should feel confident in the terms used in contracts between your bank and your customers.

Analysis of the Lambert claims indicates “12 CFR parts 707 and 740, as well as other federal law, and its contractual obligations, determine the types of fees or charges and other matters affecting the opening, maintaining and closing of a share, share draft or share certificate account. State laws regulating such activities are not applicable to federal credit unions.” In particular § 701.35 “expressly provides that [federal credit unions] are authorized to determine, free from state regulation, the types of disclosures, fees or charges” for their account offerings. And TISA implementing regulations require federal credit unions to provide disclosures regarding “[t]he amount of any fee that may be imposed in connection with the account . . . and the conditions under which the fee may be imposed.”

Some laws, such as those involving breach of contract and misrepresentations of terms, are not federally preempted. Lambert claimed this was at the root of her case because the NFCU “may” charge “a fee” based on the terms in the agreement. This meant there was discretion and the fee imposed was singular (and remember she maintains the subsequent presentments for payments are all related to and part of the initial presentment).

As to the breach of contract, the court dismissed this “because the contract unambiguously gives Navy Federal the contractual right to impose fees in the way that it did.” and “Contracts must be construed as a whole without placing undue emphasis on isolated terms…” While Lambert maintained that two ACH debit requests made by the same merchant, in the same amount, for the same purpose, are the same “debit item,” she disagreed with interpreting the terms to mean that a fee may be charged for each item and that subsequent resubmissions were “new” items. The Court agreed with NFCU based on the facts that the terms were unambiguous and that NFCU was following the terms.

In the Court’s decision, it stated, “Plaintiff’s interpretation is unreasonable in light of the contract as a whole. When Plaintiff was charged the initial nonsufficient funds fee, it was because her insurer’s request for payment (the “debit item”) was returned. The contract specifies that “Navy Federal may return debits to the checking account (e.g., an ACH payment) if the amount of the debit exceeds funds available in the checking account” and assess “[a] fee” for the “returned debit item.” Further, it stated, “Plaintiff’s interpretation is unreasonable in light of the contract as a whole. When Plaintiff was charged the initial nonsufficient funds fee, it was because her insurer’s request for payment (the “debit item”) was returned. The contract specifies that “Navy Federal may return debits to the checking account (e.g., an ACH payment) if the amount of the debit exceeds funds available in the checking account” and assess “[a] fee” for the “returned debit item.”

There was a dispute of how to interpret the agreement. The Court found, “the sentence in dispute must be read in conjunction with the sentence immediately before it. The first sentence states: “Navy Federal may return debits to the checking account (e.g., an ACH payment) if the amount of the debit exceeds funds available in the checking account.” The next sentence warns: “A fee may be assessed in the amount shown on Navy Federal’s current Schedule of Fees and Charges for each returned debit item.” Taken together, these sentences clearly provide that Navy Federal may return a debit item, such as an ACH debit, if there is not enough money in the account (the first sentence), and, if there is a return, Navy Federal may charge the member a fee for that returned debit transaction (the second sentence).

Lambert argued that “returned debit item” meant something different than “returned debit” in the agreement. The court found “that the use of “item” does not render the sentence ambiguous. As noted above, other provisions of the contract demonstrate that an “item” includes various types of transactions that would either add or subtract money from the account. The contract merely uses “debit” as an adjective to modify “item,” just as “returned” is used as an adjective to modify “debit item.” Thus, “debit item” clearly refers to a transaction that attempts to withdraw money from the account, such as an ACH debit request, and the inclusion of “item” in “returned debit item” does not render the contract ambiguous.”

The second claim as to good faith and fair dealings was then addressed in the Court’s decision. This claim was dismissed for the same reasons as the breach of contract.
The Court ruled, “In this case, Navy Federal’s right to charge a fee depended on the existence of an objective fact: whether a debit item had been returned for nonsufficient funds. Thus, although the contract stated that Navy Federal “may” rather than “will” assess a fee for each returned debit item, Navy Federal had the contractual right to assess the challenged fee and, unlike in the cases cited by Plaintiff, had not exercised any contractual discretion in bad faith to cause that right to accrue.” On August 14, 2019 the Court dismissed the case with prejudice.

So, it sounds like this case had a good ending for the credit union and perhaps reassured other financial institutions that similar practices they follow are “legally validated.” But the Lambert case wasn’t over, yet.

Lambert appealed her case to the United States Court of Appeals for the Fourth Circuit. There was also an unsuccessful attempt at mediation under a Fourth Circuit program. Fast forward to October 2020, and we read that NFCU and Lambert have agreed preliminarily to settle the dispute. A final approval is expected in March 2021. The CU will reimburse an estimated 700,000 current and former members who were charged similar fees for nonsufficient fund presentments. This comes at a cost of $16 million, which includes $5.2 million in attorney fees, a $5,000 “service award” for Lambert, and millions in NSF fee reimbursements – and for a case which was originally dismissed with prejudice.

This sounds like a business decision made to help end this two-year-old case and potentially stop future cases from being brought. Because NFCU is a $131 billion financial institution it probably doesn’t consider the settlement exorbitant. There was no admission of guilt or liability. And NFCU will amend its deposit agreement with either the following or similar language:

Navy Federal may return debits (e.g., checks or ACH payments) submitted for payment against the checking account if the amount of the debit exceeds the funds available in the checking account. Each time we return a debit for insufficient funds, we will assess an NSF fee in the amount shown on Navy Federal’s current Schedule of Fees and Charges for each returned debit item. The entity that submitted the debit may submit another debit to Navy Federal even if we have already returned the prior debit for insufficient funds in the checking account. If the resubmitted debit again exceeds the funds available in the checking account, Navy Federal will again return the debit and assess an additional NSF fee. Thus, you may be charged multiple NSF fees in connection with a single debit that has been returned for insufficient funds multiple times.

A question each bank needs to ask itself is, will our disclosures and agreements insulate us from such a claim? Is your current disclosure more like what was cited early in this article, or the one just above? This may be a question for counsel and or your forms vendors. Once a case like this becomes well known there is always a chance others will seek a similar outcome, even though initially the agreement was not found at fault. You will never be insulated 100 percent, but it may be worth a review, especially as many banks may be getting ready to make annual adjustments to fee schedules and agreement terms with the new year approaching.

Resolving escrow shortages and deficiencies

By Andy Zavoina

Often when we have a compliance issue to address, we must first look at the definitions. And that is what we will do here, in just a moment. The issue to address is what seems to be a practice at some mortgage servicing banks to offer “options” to borrowers who are short escrow funds to cover those shortfalls. With 2021 around the corner, many banks will be generating escrow statements, and they may reflect escrow shortfalls.

Now, let’s consider two definitions from RESPA pertaining to Section 1024.17’s escrow rules:

A deficiency is the amount of a negative balance in an escrow account. If a servicer advances funds for a borrower, then the servicer must perform an escrow account analysis before seeking repayment of the deficiency.

A shortage is an amount by which a current escrow account balance falls short of the target balance at the time of escrow analysis.

It is important to understand the differences between the two. A deficiency is an actual negative balance for that escrow account. It is money that is not there, and the bank has effectively made a zero-interest loan to a mortgage borrower for this amount. A shortage is a projection of a running balance like a checkbook ledger. There is a beginning or current balance and cash flows in and out of the account. When the outflows are projected to be greater for that year’s period than the current balance plus the in-flows, we have a shortage.

RESPA defines specifically how to cure a deficiency and a shortage. In both cases the borrower is responsible to pay the difference to the bank so that the bank will have sufficient funds available to pay all escrowed items such as taxes and insurance when those bills come due. If allowed in the agreement with the borrower, there may also be a one-sixth (two month) cushion also allowed to be maintained to handle unexpected increases.

But they are not identical cures, and the amount of the shortfall impacts the cure.

In the case of a deficiency that is confirmed by escrow analysis, if the deficiency is less than one month’s escrow account payment, there are three options:

1. Allow the deficiency to go on – basically ignore it
2. Require the borrower to repay the deficiency within 30 days, or
3. Require the borrower to repay the deficiency in two or more equal payments.

If there is a shortage, the three options are slightly different:

1. Allow the shortage to go on – basically ignore it
2. Require the borrower to repay the shortage within 30 days, or
3. Require the borrower to repay the shortage in 12 or more equal payments.

Now, let’s up the ante and increase the amount of that shortfall. If it is a deficiency that is greater than or equal to one month’s escrow payment, the servicer may

1. allow the deficiency to exist and do nothing to change it or
2. require the borrower to repay the deficiency in two or more equal monthly payments.

If an escrow account analysis discloses a shortage that is greater than or equal to one month’s escrow account payment, then the servicer again has two possible courses of action:

1. allow a shortage to exist and do nothing to change it; or
2. require the borrower to repay the shortage in equal monthly payments over at least a 12-month period.

Note that when we increased the shortfall, the “option” of requiring the borrower to repay that amount within a 30-day period went away. In its Supervisory Highlights, Issue 22, Summer 2020, the CFPB noted that Reg X violations were seen in the treatment of escrow shortages and deficiencies. Examiners found borrowers with either shortages or deficiencies equal to or greater than one month’s escrow payment who were offered a lump sum repayment option. The permitted options for this larger amount are to do nothing or spread the repayment over time. RESPA is a consumer protection regulation and favors the consumer by requiring the bank to amortize the shortfall to a more manageable amount. The cures stated in RESPA are very specific.

The Bureau’s enforcement actions put many banks and others in the mortgage industry on notice that offering this friendly “option” of a lump sum payment for shortfalls of one month’s escrow payment or more is not an option at all. It doesn’t matter if the other allowed means of curing the shortfall are considered or not. Banks are not allowed to impose “options” otherwise.

After the Supervisory Highlights were published, some in the mortgage industry questioned the CFPB’s interpretation of this rule. The bank can predetermine that the first option of ignoring the shortfall is not an option it will accept and that option, which cures nothing, may be ignored and not offered. But if the other two options are offered, plus addition choices, they reasoned, it is still the consumer making the choice of amortizing the payments, or of paying a lump sum. In some cases, the borrower may have just received a tax refund (these start coming to borrowers who file early about the same time as year-end escrow statements are going out). Rather than have an increase in their monthly mortgage payment for escrow, some may want the option of making a lump sum payment while they have that cash, thereby keeping the monthly payment similar to the prior year’s payment. It may be offered as an option, not as a strong suggestion or quasi-requirement. Some feel this lessens confusion for the borrower as well.

The problem with that reasoning is that the interpretation that the CFPB has issued through enforcement actions and in the Supervisory Highlights says, the “enumerated repayment options” in Reg X “are exclusive.” Thus, according to the CFPB, banks that include both a lump sum repayment option and the required repayment period of 12 (or more) months were deemed to have violated Reg X because the first option, lump sum repayment, is not specifically permissible under the regulation. As a result, “the servicers violated regulatory requirements by sending disclosures that provided borrowers with repayment options that they cannot require under Regulation X.” So, while banks see offering options as a good thing, the CFPB says it is not allowed.

The CFPB’s stance makes some sense based on as literal reading of Reg X. The Reg says the bank has two options, and neither allows for a lump sum repayment method. The rule exists so that a bank projecting or seeing a large shortfall in the escrow account cannot require a lump sum payment of a large amount which the borrower had no way of anticipating or preparing for. If this were required of a borrower, it could cause delinquencies of the mortgage or other debts of the borrower. So, an amortization of 12 months (shortages) or 2 months (deficiencies) or more must be the only cure of the shortfall on the table.

But RESPA and Reg X place requirements on the banks, not on the borrowers, or at least not on what a borrower can do. Many will ask, why limit the available options so long as what is required by the regulation is offered, and there is no pressure as to which cure is selected by the borrower. The CFPB is limiting the consumer’s options by not allowing a bank to offer the lump sum.

I have read that informally the CFPB has since indicated that borrowers should be allowed to repay escrow shortages in a lump sum if that’s what they want. I have not found this reduced to writing yet, as the Supervisory Highlights have been. Bankers are urged to recognize the risk in this area and act accordingly.

Still, the CFPB has the power of enforcement and has stated the “enumerated repayment options” are the “exclusive” options for repayment of these larger shortfalls. It certainly indicates that banks may not offer a lump sum payment option and perhaps that borrowers who may prefer having that option, will not. Again, this may not make sense to management, but if your bank is one that sees options as positive things, you may want to re-think that position. The CFPB’s guidance can be interpreted to suggest that a bank may not be permitted to accept a lump sum escrow shortage repayment if a borrower were to offer it. That may not be the CFPB’s intent, but it may be the result.

The CFPB’s current position may actually cause some harm to a borrower by reducing the cure options available to them. For the immediate future banks are urged to review the escrow statements that are being prepared and should review the shortage and deficiency remedies which are stated above and in accordance with 1024.17(f)(3)-(4). Any written or oral discussions with a borrower about a lump sum payment to cure a shortage or deficiency greater than one month’s escrow payment should be clear that it is not an option the bank is suggesting in any way or requiring. If a borrower chooses to remit such a payment, the escrow will not show a surplus based on analysis and the amount would not have to be refunded. I see little or no harm under UDAAP, either, because if the borrower chooses to make a lump sum payment, the monthly (or other periodic payment) going to escrow would balance out over the year. This means only the lost income generated by that lump sum could be considered a borrower cost and would likely be viewed as very little harm, if any.

Recognizing the risk, I recommend that a bank not broach the topic of a lump sum payment of larger shortfalls with a borrower, whether in its written notice or in conversation. And if a borrower cures a larger deficiency or shortage with an unsolicited lump-sum payment, the bank should clearly note the borrower did so despite that option not being offered by the bank.

An update on the Payday Lending Rule

By John S. Burnett

The CFPB’s Payday. Vehicle Title, and Certain High-Cost Installment Loans Rule (usually shortened to “Payday Lending Rule”) initially became effective on January 16, 2018, but it has a general compliance date of August 18, 2019. So why isn’t anyone worried about complying with the rule?

The main reason is that in 2018 the U.S. District Court for the Western District of Texas issued, in the matter of Community Financial Services Association v. CFPB, (No. 1:18-cv-00295), a stay of the compliance date, and that stay continues in place as this article is being written.

The plaintiffs in that case allege that the CFPB was unconstitutionally structured with a single director who could not be removed by the president except for cause. Therefore, the plaintiffs argue, the regulation is invalid or void.

The court stayed not only the compliance date of the regulation, but also the case itself, awaiting action by the Supreme Court on the issue of the constitutionality of the Bureau’s structure.

When SCOTUS finally ruled that the CFPB’s structure was not constitutional, but saved the agency itself by ordering that the wording in the Dodd-Frank Act relating to the dismissal of the CFPB director be changed from “for cause” to “at will,” the Texas court asked the parties to the suit for motions on next steps. In the meantime, CFPB Director had issued a ratification of the prior actions issuing and finalizing the Payday Lending Rule.

The plaintiffs moved that the CFPB be required to go back to “square one” and start a new proposed rulemaking, complete with a comment period and a final rule, as required by the Administrative Procedures Act. To support their motion, the plaintiffs argued that the Rule was invalid when it was issued because the Bureau didn’t have the authority to issue it, and that Director Kraninger’s ratification was ineffective because ratification requires two actors—one that does something without authority to do so, and another that had the authority and now approves the initial action. Since there is only one actor (the Bureau) involved, claims the plaintiff, there can be no ratification.

The Bureau has filed a brief arguing that the plaintiffs’ “definition” of ratification has no precedent and asking for summary judgment dismissing the suit and lifting the court’s stay on the effective date of the rule.

Which leaves us waiting for the court to schedule hearings and ultimately issue a ruling. The court could lift the stay pending its ruling, but that doesn’t appear likely since it could mean the Bureau would have to amend the compliance date only to have the court find for the plaintiff (and order that the rule be rescinded or that the Bureau start over with a new proposal).

In the meantime, the National Association for Latino Community Asset Builders has filed a complaint in the U.S. District Court for the District of Columbia, arguing that the Bureau’s removal of the borrower underwriting (ability-to-repay) standards violated the Administrative Procedure Act. The suit said the Bureau “used an arbitrarily truncated analysis” and didn’t collect data to justify removing the underwriting provisions from the 2017 regulations. The complaint also alleges the CFPB didn’t get sufficient input from consumer groups and other interested parties when crafting the new rules.

My assessment — The status of the Payday Lending Rule is very much in limbo but could be affected by the transition to the Biden administration. For the moment, at least, the outcome of the Texas court case needs to be decided before we can know what’s to become of the rule. If the court finds for the Bureau, we will have to see what the Bureau does to amend the compliance date.