Friday, February 23, 2007

Are Credit Card Penalty Fees Unconstitutional?

Kevin LoVecchio over at Warren Reports writes a post entitled The Problem with Credit Card Penalities writes a compelling argument why credit card late fees, overlimit fees, universal default clauses and mandatory arbitration clauses are unconstitutional. To wit:

Contracts aren't punitive, so penalty clauses in contracts aren't enforceable. Liquidated damages are valid, which essentially means that parties can contract in advance for a reasonable amount to be paid should a party breach a contract, but liquidated damages are meant to cover the costs associated with the breach rather than serve as a penalty. Terms which call for a penalty above and beyond such an amount, however, are invalid.

Credit card contracts are loaded with penalty clauses, either on the face of the text or as put into operation by the lenders. For example, how many readers are familiar with a situation where a credit lender raises your interest rate for a late payment? You also get slapped with a late fee. It's arguable whether the fee is really a reasonable amount of liquidated damages given the fact that the credit card companies won't really have significant costs associated with your paying a day or two late. But regardless, assuming the fee does serve as a liquidated damages amount, how can the additional step -- the hiking of your APR -- be anything other than a penalty once the liquidated damages amount is covered? Under any argument, either the fee or the interest rate hike must serve as a penalty clause.

Universal default clauses are no different. These clauses basically allow the credit lender to raise your rates for any credit-based mistake, such as a late payment, to other lenders. In other words, if you pay your phone bill late Citibank can raise your credit card APR from 12% to a default rate of 29%. Does Citibank have a tangible cost associated with your late phone bill? Did you breach your contract such that this clause would serve as liquidated damages? Clearly this is a penalty.

As one more example, I'll point to the simple "change terms at will" clause in contracts. I've written numerous times about the problems associated with these provisions being included in a contract, but there's one further problem to note. Any time a credit lender uses this clause to negatively change the terms of your contract in response to your actions -- whether that means raising your APR, hiking your fees, stripping away your rewards program or promotional incentives, or anything else -- they are employing a penalty clause. This is clear simply by the fact that the contract itself specifies particular fees (liquidated damages) for all such situations. The additional step of altering your contract can be nothing more than the imposition of a penalty, and is therefore invalid.

It's time to make credit card companies play by the rules, whether those be constitutional restrictions or the basic principles of contract law -- rules that govern everyone who doesn't have a multi-billion dollar lobbyist arm to push the rules out of the way.

Mr. LoVecchio's post points to a scholarly paper written by Seana Shiffrin.

Now, if only we can find someone to litigate it. Oh wait. I guess there is already. Kevin posted a comment later which said:

So, what to do? First, I'll note that we are pursuing litigation options to really drive these points home. This is something we take seriously, and we don't mean to just toss out blog posts in a vacuum. Efforts are underway to battle these issues out using the resources, training and experience of an extraordinary group of attorneys.

Second, I'll suggest a new line of thought that might sound a bit absurd at first glance: the First Amendment. Remember that oft-overlooked portion of the amendment known as the Petition Clause? It guarantees us the right to petition the government for a redress of grievances. The Supreme Court has held that the Petition Clause applies to all branches of the government -- including the judiciary. I would argue that state laws which enforce (a) mandatory arbitration argeements in contracts, and (b) class action bans, effectively deny citizens the right of access to the judiciary to sound complaints such as those we've raised here. As you might imagine, this is a line of thought that has never been explored (or at least isn't found in) current First Amendment jurisprudence, but maybe it's time to make that push.

I hope they can make some headway. They have a lot of hurdles to overcome before they succeed.

1 comment:

Brad said...

Put me down as one who would be willing to join any class action suit against credit card companies. I am one who has fallen victim to the outrageous "universal default" clause with no tangible reason provided (I didn't miss any payments, I wasn't late on any payments, I wasn't over my limit, my credit score had actually improved since first opening that account) when they raised my APR from 12.99 to 29.99, with no notice (even though they claim to have sent some letter which we never received).

The credit card companies are legalized loan sharks under the protection of a sympathetic government. For some reason, this industry has convinced (through various forms of bribery and coercion) our representatives in Washington that their record-profit-making companies need protection from increasingly financially squeezed average families.

Sign me up.