May 2024 OBA Legal Briefs

Military Customers – A Protected Class?

By Andy Zavoina

For starters, service members are not a protected class under Reg B or ECOA, but note I added a question mark in the title of this article. The question is, do you want to treat them as a protected class? In my opinion, a bank often mitigates risks most effectively by putting service members in the same category as the Reg B protected categories of race, color, religion, national origin, sex, marital status, age (provided that the applicant has the capacity to enter into a binding contract), the fact that all or part of the applicant’s income derives from any public assistance program, or the fact that the applicant has in good faith exercised any right under the Consumer Credit Protection Act.

I remind you of these prohibited basis categories for two reasons: to drive home the point that violations of a service member’s rights can yield severe consequences similar to those of Reg B violations, and the fact that if your bank has a fair lending violation (Reg B included), the Department of Justice (DOJ) is the government agency that will enforce it, and the DOJ is the same agency that will enforce the Service members Civil Relief Act (SCRA) as well. Under the SCRA, the Attorney General is authorized to file a federal lawsuit against any person, or entity, who engages in a pattern or practice of violating this law. Does “a pattern or practice” remind you of a term you have heard in fair lending training? For clarity, the DOJ is directly responsible for enforcing the SCRA, whereas the CFPB monitors complaints and can enforce unfair, deceptive, or abusive practices against banks for mistreating service members.

Often, we hear about the homeless problem and there is a subcategory of those who are veterans and that seems to get more attention because it seems more wrong when a veteran is involved. If there is an action against a debt collector, a repossession agent, or a bank charging overdraft fees, it sounds bad in the media, and then they add, “and this included veterans and service members,” because that garners more attention as well. This is both a reputation risk issue and one compounded by the fact that the SCRA may have been violated and because it carries the same weight as the Reg B consumer categories that are mentioned above. Yes, service members and veterans have given up a lot to defend our country and way of life. But as to salary, service members are also paid for what they do, and unlike many years ago when the draft helped ensure the armed services had the required manpower that was needed, today many service members make as much or more in the military as they would in the civilian sector, so compensation is not necessarily lower, especially when the entire compensation and benefits package is considered. The pay and benefits are competitive as to regular duties, but certainly those making the ultimate sacrifice could never be paid enough.

Putting aside the original spirit and intent of this law, while a part of that is still intact, a big part of it is not, and has been replaced with the idea that the SCRA is a benefit of military service. That is how it is explained to many service members. The Consumer Financial Protection Bureau (CFPB) explains that “The SCRA is a law created to provide extra protections for service members in the event that legal or financial transactions adversely affect their rights during military or uniformed service. These protections enable service members to devote their entire energy to the defense needs of the Nation.” So, while there is little obligation on a service member to validate any financial hardship that adversely affects them, they do need to be able to focus on their mission and the defense of our country.

While this is not an educational substitute for a class in lending to the military or the SCRA, I would be remiss not to remind you that, in addition to service members, the SCRA also protects commissioned officers in active service of the Public Health Service (PHS) and the National Oceanic and Atmospheric Administration (NOAA). While the key focus of the SCRA is military, as we discuss this group, read it with the PHS and NOAA included.

As more support for informally adding service members to the Reg B protected bases, the CFPB has a separate department just for these matters, the Office of Service member Affairs (OSA). Annually the CFPB also provides separate reports on service members, including how this group fares in the submission and resolution of consumer complaints. They are specifically separated so that they may be evaluated as a sole category separate from all others. What you do and how you serve your military customers is under a microscope.

In June 2023 the CFPB published “The Office of Servicemember Affairs: Annual Report” for 2022. Complaints submitted by service members serve as a key initial indicator of emerging issues and continuing trends. The report provides data and analysis around the most common complaints submitted by service members.

The Bureau received approximately 66,400 complaints from military consumers in 2022. This was a 55.5 percent increase over 2021. Reviewing the complaints handled by the OSA allows us the opportunity to examine internal procedures for responding to complaints and to improve communication and training to avoid similar complaints in your bank.

This brings me back to the DOJ. In July 2022 the DOJ issued a joint letter with the CFPB that was not directed to banks, but to the auto industry. That absolutely does not mean banks could not learn from the message, and it absolutely does not mean banks have not been penalized for violating these guidance items since 2022. The message is as pertinent today as it was two years ago.

In that letter there are three main provisions they wanted auto lenders to be aware of. Banks make auto loans, and other loans might be applicable as well. The three issues that were addressed included:

Wrongful Vehicle repossessions

The SCRA prohibits repossession of a vehicle during a period of military service unless you (the lender) have a court order or that vehicle loan was made before the period of service, making the loan not covered by the SCRA. There is no notice requirement from your borrower to have this protection, because the burden of determining whether the borrower is protected is on you, the lender. Verification is easiest via the Defense Manpower Data Center (DMDC) website, and I recommend checking that before any repossession order is issued. It may be wise to check it again if you have any reason to believe the borrower may become protected and/or check it again after the repossession to ensure the borrower is not protected at that point. That does not cancel out the fact that the vehicle of a covered borrower was repossessed, but if you verified the DMDC database prior to repossession you should be able to claim a safe harbor from fault. And if you check right after the repossession you can proceed with the return of personal items and a commercially reasonable private sale or auction on the vehicle knowing you will not receive a claim of protection and have to “un-do” that sale, which can be difficult. The DMDC has no separate hard cost, so it is a minimal investment of an employee’s time for peace of mind.2. Failure to terminate vehicle leases without penalty

Failure to terminate vehicle leases without penalty

Under the SCRA, a service member can terminate motor vehicle leases early without penalty after entering service or upon receiving qualifying permanent change of station (PCS) or deployment orders. When service members terminate motor vehicle leases, the SCRA requires that they be refunded all lease amounts paid in advance after the effective date, including “capitalized cost reduction” amounts. This has been a major bone of contention for several larger leasing institutions. The lesson learned here for banks is that upfront fees and costs that are considered part of the overall loan, like a rate buy down, should be amortized and not considered “one and done” as a cost of the loan or lease.

Interest rate benefits

If a loan was incurred prior to military service, the SCRA limits the interest rate to 6 percent upon a proper request from the service member. A proper request should include a formal request and a copy of their orders. The CFPB encourages lenders to use the DMDC checks as proof by itself and to provide rate reductions based on that information. A service member’s commander could also write a letter confirming the service member’s status, and that would satisfy the requirement for any verification. The amount above 6 percent must be forgiven and not deferred or added to the final payment, and it must be effective as of the date of SCRA eligibility, not the date of the request. Remember too, when the borrower is on active duty or the reservist receives their activation orders, they are a covered borrower. This provision allows the service member to make their request during the period of service or within 180 days after leaving the service.

Are banks or other financial institutions better than the auto industry and not deserving of such guidance? Of course not. And to go a step farther, I would point out that another form of enforcement comes not from the regulators or DOJ, but from the courts. So, there are several fronts that pose a compliance enforcement risk on your bank.

DOJ cases

Let’s start with a few DOJ cases and then look in detail at class action lawsuits which can take years to resolve and result in highly expensive litigation. All of this should be considered in a risk assessment concerning loan products. I want to ensure you are aware of some of these cases because they are not typically in mainstream media.

In March 2023, the DOJ filed two statements of interest for cases involving arbitration. The first was Espin v. Citibank, N.A. and the second was Padao v. American Express National Bank. Both cases were in the U.S. District Court for the Eastern District of North Carolina and were concerned with the right of the service members to bring class action litigation under the SCRA instead of being forced into private arbitration proceedings on their own.

The service members were disputing adherence to the 6 percent interest rate rule and were seeking to bring class actions against the banks on behalf of themselves and other service members who may have been affected by violations of this requirement. The complaint alleged that Citibank failed to comply with Section 3937 of the SCRA, requiring lenders to limit the interest rate charged to covered service members to 6 percent during periods of military service. Citibank and American Express were seeking to have the cases dismissed and to require each service member to bring their own individual claim in private arbitration. The DOJ’s statements of interest urged the court to deny each bank’s motion and allow the plaintiffs’ SCRA class claims to proceed.

On September 29, 2023, the court denied Citibank’s motion to compel arbitration in Espin v. Citibank. This class action lawsuit brought by four service members who held credit cards issued by, or had other interest-bearing obligations to, Citibank. In its statement, the DOJ argued that the SCRA gives service members pursuing SCRA claims the right to participate in a class action case in federal court even where a defendant seeks to enforce a contract clause mandating individual arbitration. The DOJ also argued that the relevant portion of the SCRA applies even where the arbitration agreements were executed before the change in law in 2019. The court’s opinion adopted the position advocated by the DOJ.

The Padao case was a class action lawsuit brought under the SCRA by a single service member on behalf of a class of service members who held credit cards issued by, or had other interest-bearing obligations to, the bank. While this was a different lender and plaintiff, the dispute was the same as was the specific Section 3937 reference to the 6 percent rate. The difference here is that this case was based on a single service member’s complaint and expanded to a class. The Padao case is still pending.

In these two cases, the banks are both large. Oftentimes a small community bank sees these very large banks as all-knowing. They have plenty of legal staff to understand all the requirements and react to them. But case after case shows that is not always true. Some like to push the limits or rely on their own interpretations of a requirement. What is your bank’s appetite for risk?

I want to draw attention to the fact that similar to other SCRA cases, especially involving repossessed collateral, significant actions are brought against a bank because of its actions with a single borrower. Just one person starts a snowball that turns into an avalanche. Some readers will be of the opinion that their bank has many military customers, and they know how to handle them as to SCRA compliance. Others may believe they have no military customers and do not need to know SCRA requirements, as they have yet to be an issue. The reality is, you should not be complacent, but be compliant. Evaluate risk, evaluate training, test your procedures, and verify all of it with controls and audits.

At any time, a civilian borrower could enlist in the service and suddenly you find you have an SCRA request. You could also have a reservist called up to active duty who would then be protected. The bank needs to have personnel trained on how to handle these accounts and evaluate the requests. It needs to look not just at loan records, but at overdrafts and safe deposit boxes because after all, a safe deposit box is a lease and the SCRA has a section just for leases. Just as the bank should train everybody in the bank in some basics, where is the Public File for CRA, how do I file a claim for an unauthorized withdrawal from my deposit account, what should they do in event of a robbery, they should recognize “I’m now in the military” as a key phrase that deserves immediate attention of the bank.

You may be surprised if an examiner, or a DOJ lawyer, asks you how many borrowers you have under SCRA protections, especially taking advantage of the 6 percent rate. Regardless of your answer, none, one, or one thousand, the next question may be asking how many were denied SCRA protections? Natural follow-ups to that will be how do you know, how do you track it, who makes the decision, and what factors are involved in that decision. Then, what controls are in place for quality assurance. When there is one complaint, they will look for other cases where the person accepted your answer but did not complain to a regulatory agency or the DOJ.

I do not know of any bankers who want DOJ lawyers in their banks asking questions about loan files. Lawyers are neither lenders nor bankers, and you could find yourself explaining every form and the reasons for every action taken on every loan made in the last five years. You do not want to spend your days doing that and catching up on your regular work at night and on the weekends.

In 2023, I found only four civil money penalties under the SCRA. Two were against towing companies and two were for lease termination problems involving homes. The penalties totaled only $53,000. Not that you would want to justify to your board any civil money penalty as being fair. Fortunately, these were not banks. But that does not mean all banks are getting it all right. The two arbitration cases mentioned earlier are examples even though one is still pending. There are costs incurred already; should we expect a different outcome from the same court for the same complaint?

Let’s revisit a few basic requirements of the Military Lending Act (MLA) and the SCRA, which I have indicated as “M” and “S” below. You can find each of these at www.BankersOnline.com/regulations, near the bottom of the page under the “Other” section. As a general rule the MLA applies to new loans made to service members and the SCRA applies to loans made to people who later became service members. (Please take note that the service member can include dependents, and some SCRA protections are not dependent on this pre-service test.)

M1 – Under the MLA your rate is capped at 36 percent. This applies to a covered borrower with a covered loan.

M2 – The 36 percent is calculated using the Military Annual Percentage Rate, which is like an all-in Reg Z APR. That is, it includes many more finance charge components such as any credit insurance premium or fee, any charge for single premium credit insurance, any fee for a debt cancellation contract, or any fee for a debt suspension and credit-related ancillary products sold in connection with the credit transaction for closed-end credit or an account for open-end credit; (exception bona fide fees). This can make 36 percent easily reachable.

M3 – You are not required by law to verify the applicant’s military status, but if you do not and violate the MLA, the first issue on the borrower’s list of cures is that the loan contract becomes void.

M4 – To obtain a safe harbor, the bank needs to verify the military status before the loan is consummated, by either checking with the MLA database at the DMDC or by obtaining that verification on the credit report. The source for the credit report is the DMDC so that is the sole resource for verification.

[Prior to a change in the MLA rules banks would obtain a signed statement from the applicant as to their military status. Very recently I mentioned in live training that this method is no longer acceptable and banks should have ceased using the form years ago. I almost did not mention it as I also said I think all banks have done away with it. Then during the next break, a banker verified with me that the form they were getting signed was of no use. All it does is create a document the bank creates, has signed, verifies it is signed, and then it is filed away until that file is involved in an audit or quality control check when more time is spent checking it. It provides no safe harbor and only costs the bank time and money and demonstrates that it does not understand the current MLA requirements. Check that your bank’s policy and procedures is updated if you have any doubts. And if your policy does require an MLA verification, it should be completed for that reason with an approved source.]

S1 – Generally, the maximum rate of interest for an SCRA-covered borrower on a covered SCRA loan is 6 percent. This rate can be requested up to 180 days after the service member is released from the service and it is retroactive to the date they were covered, not the date of the request.

S2 – Late fees are considered “interest” for the SCRA. If the bank reduces the interest rate to 6 percent, the maximum rate allowed, turn off late fee accruals or you could be usurious.

S3 – The rate caps apply when a person is on active duty, or a reservist receives their orders. What about National Guard? Title 32 outlines the role of the United States National Guard; normally Title 32 members are not covered under SCRA. To be considered for SCRA coverage a Title 32 member must be called “…to active service authorized by the President or the Secretary of Defense for a period of more than 30 consecutive days under section 502(f) of title 32, United States Code, for purposes of responding to a national emergency declared by the President and supported by Federal funds.” Also, this protection is afforded to joint loans with both the service member and their spouse.

S4 – The CFPB published a report in December 2022 that service members have paid millions of dollars in interest needlessly and that regardless of the law’s requirement that they request protections and provide documentation such as orders, banks should be proactive. This includes not waiting for a service member to make a claim for the interest rate reduction and proactively looking for signs that they may qualify. One way to accomplish this is verification through the DMDC database mentioned above. It has been fine-tuned more and more for accuracy and to reduce update latency. Banks can verify individual service members as well as batch process requests. Many banks adopted the batch processing method and would check the banks CIF records against the database on a monthly or other basis. New hits could be shown on the bank’s records as on active duty immediately and individual verifications could be initiated with the customer if desired.

Another case example

Now let’s turn to a very recent and newly filed class action case involving the SCRA. The case is Nowlin et al v Wells Fargo Bank, N.A., and it was filed in the U.S. District Court for the Eastern District of North Carolina on March 20, 2024. What the suit alleges that the bank “…illegally and negligently charged thousands of American service members and military families excessive interest rates and fees and compound interest on principal balances that were improperly inflated due to the bank’s misconduct.” We only have the plaintiff’s 29-page lawsuit because the filing is so recent and Wells Fargo has not yet replied to it.

The lawsuit notes that Wells Fargo heavily markets itself as being dedicated to the military. Yet even after claiming this, the bank has charged covered borrowers, with covered loans, in excess of the 6 percent interest rate limit, and that it must forgive that interest difference because it cannot be deferred or added to the loan, and that the bank is not waiving all fees as required. As identified above late fees would be considered interest but we do not have a specific description in the reports available as to what those fees are.

By way of background, the service members discovered the problem in 2022. Actually, Wells Fargo appears to have discovered the problem before that. The bank attempted to correct the issue at least with some of the service members by sending them a check and a letter explaining why the check was issued. However, rather than just being grateful for the unexpected checks, some service members questioned the “misleading correspondence” that explained it. These customers began investigating the issues on their own and determined there were “wholesale violations” and that the bank, in fact. has improperly damaged thousands of military families in this process.

The suit accuses Wells Fargo of failing to reduce the interest rates on service members’ accounts, waive fees, comply with the SCRA’s requirement that interest rate deductions are effective on the date military orders are received, and forgive incurred interest. It also criticizes Wells Fargo’s internal systems and then indicates that there is a miscalculation of principal, interest, and payoff amounts. Anyone who has ever manually calculated loan disclosures or done a series of calculations where one is dependent on the next understands that if one of those calculations is incorrect, all those that follow and rely on the first will be incorrect. They have to be. Again, these are all from the plaintiffs’ filing.

In addition to the miscalculations, they accuse Wells Fargo of imposing more interest, fees and other charges than is allowed. And that makes sense if the bank was not providing the reductions of interest in a timely manner or subsequently waiving fees and other charges. There seems to be a bit of piling on in this filing, but I suppose they need to paint a picture of an incompetent bank that already has a soiled reputation.

It is particularly stated that the bank’s internal audit (or compliance) program discovered the errors, and the bank was aware it both violated the SCRA and the bank’s own military benefits program. In the correspondence the bank has not admitted to any violations. Wells Fargo issued reimbursement checks but failed to adequately describe the methodology used to calculate those refunds.

Since the suit mentions the separate Wells Fargo Military Benefits program, there should be discussion as to whether or not such a program is actually a contract with the service members who relied on it. Since a contract is not a federal issue, the contract side of the discussion would be based on state law, but then again, could this be elevated to an unfair, deceptive, or abusive act or practice which may be punishable under federal UDAAP regulations? The suit alleges that without this special program, many of those service members would have banked elsewhere. A comment such as this, compounded with allegedly not reducing interest and not waiving fees demonstrates financial harm. That should immediately raise UDAAP red flags.

Lastly, the suit, in my opinion, piles on to the claims of illegal activity as it states Wells Fargo is, “still in possession of certain funds belonging to” impacted service members. The suit seeks to define the class of plaintiffs as those service members banking at Wells Fargo as far back as January 1, 2006. That means the bank is potentially responsible for more than 19 years of records reviews, calculations and statements, etc.

As you read this, reflect on any comparable situation your bank has been involved with. As a preventive measure, consider your bank’s position if a similar claim was made. Has training been adequate? Could the bank have been more transparent without admitting guilt in the letters explaining what transpired? Should the method of calculating the reimbursements been better defined to those with a need to know? Would that transparency and clear math alone have prevented what could be a lengthy and costly litigation? And will the examiners immediately demand to know what happened and why, because this could elevate the risk to the bank in the case even more? Remember, according to Andy Z, a service member is as good as a protected class.

Legislation to watch

In closing, I will point out that on April 17, 2024, Florida’s Senator Rick Scott and Georgia’s Senator Jon Ossoff introduced a bipartisan bill to lower costs for service members and their families through their bipartisan SCRA Benefit Utilization Act to expand access to financial protections and benefits. According to a post by Senator Scott, “The bipartisan bill would expand existing financial literacy programs to include information about these protections; require the Department of Defense’s annual survey to include information about these programs; include benefit information on all activation orders; and require creditors to apply a 6 percent cap to all eligible accounts under their jurisdiction once a service member invokes their SCRA rights.” Companion legislation was introduced in the U.S. House of Representatives by Pennsylvania’s Congressman Matt Cartwright.

Expect more claims.