Wednesday, July 02, 2008

Disclosure, affirmative misrepresentation, and preemption

New York v. Applied Card Systems, Inc., --- N.E.2d ----, 2008 WL 2519797 (N.Y.)

New York’s AG sued various credit card providers for violations of New York’s consumer protection laws. Defendants argued that the federal Truth-in-Lending Act (TILA) preempted the claims that they engaged in fraudulent and deceptive credit card offers. The NY Court of Appeals (New York’s highest court) disagreed, though it held that res judicata from a prior nationwide class action settlement precluded the AG from recovering certain restitution.

Defendants targeted consumers with sub-prime credit. Basically, the AG argued that they misrepresented the credit limits that consumers could obtain from it and failed to disclose the effect its origination and annual fees had on available credit. They told consumers they were preapproved for a credit limit “up to” $2500 or $1000, though disclosed that the actual limit could be as low as $350—the average limit was $400. They explained that upon approval clients would incur a $100 account origination fee and a $50 annual fee, but their explanation that this would reduce available credit was, in the court’s words, “oblique.” These initial charges depleted the available credit for some consumers by 40% or more.

There were similar problems with marketing “secured cards” (secured by savings accounts, with a $10 monthly maintenance fee) with “no late fees*” and “no collections calls*,” where the asterisks were pretty significant. Likewise, defendants promoted a credit insurance program that didn’t deliver the promised benefits in New York and its $35 yearly cost was hard to avoid because the opt-out was confusing and hard to find. Defendants also marketed a “re-aging” service, which allowed banks to avoid writing off delinquent accounts by agreeing on a series of payments, but they didn’t explain that overlimit fees would continue to accrue, and those fees and previously imposed late fees would be due at the end of the re-aging process.

Moreover, the AG’s petition also discussed defendants’ late fees, finance charges, balance calculation method, and lack of any grace period for payments. TILA requires these all to be disclosed in any credit card solicitation, but the AG claimed that many consumers were unaware of how charges and penalties based on these terms were assessed, trapping unwary consumers in a “vicious cycle of pyramiding debt.”

In the Allec case, the California Superior Court approved a nationwide class action settlement for conduct predating January 1, 2002—only 12 New York members of the class opted out. The New York trial court applied res judicata to those claims, but rejected the TILA preemption argument. Based on evidence including more than 200 complaints and affidavits from defendants’ former collection employees, it found that defendants “repeatedly and persistently” engaged in fraud, deception, and false advertising. It enjoined defendants from such acts in the future and awarded over $9 million in restitution, damages, and penalties, an amount reduced somewhat on appeal.

The Court of Appeals affirmed. Applying a presumption against preemption, it held that New York could regulate false advertising without running afoul of TILA’s preemption provision relating to credit card applications and solicitations: “The provisions of [portions of] this title shall supersede any provision of the law of any State relating to the disclosure of information in any credit or charge card application or solicitation which is subject to the requirements of section 1637(c) of this title or any renewal notice which is subject to the requirements of section 1637(d) of this title, except that any State may employ or establish State laws for the purpose of enforcing the requirements of such sections.” 15 USC § 1610 [e].

The defendants argued that §1610(e) preempts every state law relating to the disclosure of information in any credit card solicitation. The AG responded that its claims were based on affirmative deception, not disclosure. The Court of Appeals agreed. TILA doesn’t preempt any state law that “could potentially touch upon any credit information that respondents might choose to include in their credit card applications and solicitations.” Rather, it preempts state laws relating to “disclosure of information” in applications and solicitations “subject to the requirements of section 1637(c).” Thus, preemption is limited to laws that “purport to alter the format, content, and manner of the TILA-required disclosures and those that require credit issuers to affirmatively disclose specific credit term information not embraced by TILA or Regulation Z [implementing TILA].” Because New York’s consumer protection law doesn’t require any disclosure, but does require businesses to refrain from fraud and false advertising, it’s not preempted.

Specifically, the misleading statements about potential credit limits, initially available credit, secured card benefits, credit insurance coverage, the benefits of re-aging, and the like were not disclosures “subject to the requirements of 1637(c),” which only requires the disclosure of APR, grace period, balance calculation methods, and certain fees. “Section 1610(e) preempts only those state laws that relate to the format, content, manner, or substance of the TILA-required disclosures.” The AG’s petition did refer to consumers’ unawareness of the information contained in the disclosures, but the AG didn’t contest the adequacy of defendants’ TILA disclosures and obtained no relief relating to those terms. Nor did the deceptive material “relat[e] to” the disclosure of such information sufficiently to trigger preemption. Defendants are only barred from affirmative misrepresentations about credit terms that currently aren’t regulated by TILA or Regulation Z.

Defendants argued that Congress intended to create a uniform system of disclosure in credit card applications. But the AG’s victory here doesn’t force them to change their disclosures or to affirmatively disclose any additional credit terms. Any indirect economic influence on their solicitation practices isn’t enough to overcome the presumption against preemption. Defendants’ position “assumes that Congress intended the TILA disclosures to provide consumers’ sole protection against credit card companies’ fraudulent and deceptive marketing practices.” The Court of Appeals believed that the limited nature of the preemption provision, and the legislative history, refuted that position. The Conference Report, for example, contemplated that state enforcement agencies could obtain settlements requiring disclosures beyond those required by TILA, which “stands in marked contrast” to the dissent’s claim that Congress intended to “cut off and fully supplant” all state regulation. More broadly, the legislative history was clear that state unfair competition and deceptive practices statutes would still apply to credit card solicitations and applications.

Proposed amendments to Regulation Z would require disclosure relating to some of the practices challenged by the AG here, such as the effect of fees and security deposits on an applicant’s credit limit. And proposed Regulation AA would simply prohibit some of the substantive practices at issue here, such as charging fees and security deposits that constitute a majority of a consumer’s credit limit. Since those amendments aren’t yet enacted, they have no preemptive effect, but they do justify the inference that TILA and Regulation Z don’t currently cover these practices.

Turning to res judicata, the court determined that the AG was in effect in privity with the consumers bound by the California class action settlement, even though the AG had not received notice and even though the AG (and 30 states’ AGs as amici) argued that this was an example of class action abuse—a class action settled at rock-bottom prices to preclude further, more properly valued claims. To the extent that the AG sought relief in the form of restitution for pre-January 1, 2002 claims, he was covering ground already covered by the settlement, which was a final and binding judgment and which had been determined to satisfy consumers’ claims. Though restitution is about making consumers whole, settlement class members “have already compromised their entitlement to a full-measure of make-whole relief in a proper judicial forum.” Respect for the validly entered judgments of other states required application of res judicata.

However, the AG could still seek restitution for people not bound by the settlement and for time periods not covered. And the claims for injunctive relief, civil penalties, and costs were untouched. Moreover, the AG might be able to obtain disgorgement, which is a remedy distinct from restitution.

Justice Read dissented, arguing that the history of TILA amendments revealed an ever-increasing scope of preemption, and that the majority’s interpretation returned to an earlier version of TILA in which only “inconsistent” state regulations, rather than all state regulations, were preempted. In other words, Read argued that TILA occupied the field, except that states could bring proceedings to enforce TILA.

The textual argument focused on §1610(e)’s language “The provisions of [TILA] shall supersede any provision of the law of any State relating to the disclosure of information in any credit or charge card application or solicitation which is subject to the requirements of section 1637(c) or any renewal notice which is subject to the requirements of section 1637(d).” Read argued that “which is subject to the requirements of section 1637(c)” modified “credit or charge card application or solicitation,” not “disclosure of information” as the majority seemed to believe.

However, the majority’s analysis doesn’t depend on what “which is subject …” modifies. The question is whether New York’s consumer protection law “relat[es] to the disclosure of information” in a solicitation or application. If it is true that there is a relevant difference between affirmative misrepresentation and disclosure, or failure to disclose, then New York’s law doesn’t relate to the disclosure of information and isn’t preempted.

Read also recounted the evolution of TILA over time, arguing that Congress ultimately abandoned a ban on requirements inconsistent with TILA in favor of a comprehensive system of requirements so that difference, rather than inconsistency, was enough to find preemption of a state regulation. A state may simply not use its consumer protection laws “to impose additional or different cost-of-credit disclosure on a creditor.” The majority, Read argued, allowed a “patchwork scheme” that ignored potential federal policy reasons not to mandate a particular disclosure that a state considers beneficial.

Again, this doesn’t address head-on the majority’s claim that affirmative misrepresentations are relevantly different. As to that, Read argued that the distinction was evanescent, especially given that TILA preempts state regulations that “relate to” disclosures, and “relate to” is a broad term. The only way for defendants to “dispel the complained-about ‘overall impression’” and comply with the injunction would be to change the form and content of its solicitations—that is, to make different disclosures. Neither the AG nor the majority explained how else defendants might eliminate the misrepresentations. (They could, of course, choose to stop offering such terms—given the intertwined concerns of form and substance here, as recognized in proposed Regulation AA, that might be the right result.)

In the end, Read concluded, “Congress essentially decided that the benefits from a uniform, nationwide regime for disclosure under the aegis of the Board outweighed any loss of protection to consumers under state law.” Thus, the AG’s good intentions, and the federal government’s arguable poor stewardship under TILA, were insufficient to override the Supremacy Clause’s mandate.

Note: for excellent continuing coverage of consumer credit issues, the Credit Slips blog is the place to go.

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