Compliance Bulletin

Supreme Court Closes Chapter on Overdraft Fees
June 8, 2009

For five years, ever since a state trial court found that the bank in Miller v. Bank of America was prohibited under California law from recovering overdrafts and charging overdraft fees against any deposit account that contained welfare benefit funds, the possibility that the decision would become final gripped the attention of banks in California and across the nation. Prohibited? Is it possible that California banks have been illegally charging overdraft fees on such accounts ever since the 1970’s when the two principal authorities relied upon in the case—the 1974 California Supreme Court decision Kruger v. Wells Fargo Bank and Financial Code Section 864—came about?

In Kruger, the court determined that a bank is prohibited from setting off a customer’s deposit account in order to satisfy a separate credit card debt where the account contained benefit funds. The setoff was considered analogous to collecting a debt, and debtors are entitled by statute to shield certain amounts of benefit payments from collection actions [1]. Financial Code Section 864, enacted a year later and likely in direct response to Kruger, established limits on banks setting off deposit accounts to satisfy debts but explicitly excluded overdraft fees from the definition of debt.

In the end, Miller’s attorneys were able to convince only one judge of the merits of their argument—the trial judge. The First Appellate District Court unanimously reversed the decision, based on sensible readings of these authorities. It pointed out that in the more than three decades since Kruger, no court has ever construed the decision to apply to account fees. The Appellate Court concurred with the arguments raised in CBA’s amicus curiae briefs that charging overdraft fees was not equivalent to issuing a levy or attachment to recover a debt. Overdraft operations are integral to account processing, which consists of debits and credits arising from a single account.

The Supreme Court, which rejects most of the cases presented for review, typically allows cases to stand if the majority of the justices do not feel strongly enough about the outcome to review them. So when the top court took up Miller for review on a 6-0 vote, speculation was rife about its intentions. The court must have been inclined to overturn the Appellate Court’s ruling, because the alternative explanation seemed too implausible—namely, that the justices were seeking to preserve banks’ rights to charge overdraft fees on benefit recipients statewide.

More than a year passed before oral argument was heard. The parties and amici curiae on both sides had filed their briefs, and waited. But the court’s decision last week, delivered without dissent, was remarkable only for how similar it is to the Appellate Court’s decision. This does not diminish the importance of the state’s highest court reaffirming that Kruger cannot be applied to account fees. Justice Moreno, speaking for the entire court wrote, “In this case, policy concerns about the setoff of independent debt — at issue in Kruger — are not present here, where the credits and debits occur in a single account.”

The fear that the Supreme Court would take the opportunity presented by Miller to extend the principle of Kruger to account fees was tempered by the plain language of Section 864. Like the Appellate Court, the Supreme Court found the language of the statute to be unambiguous, and its examination of the legislative history only confirmed this view. The Court also found support for its decision in OCC Interpretive Letter No. 1082 (June 2007), but this part of the opinion seemed almost superfluous.

Like the Appellate Court, the Supreme Court did not address whether the trial court’s ruling was preempted by the National Bank Act and the OCC’s regulations. That analysis was unnecessary because the case was decided based on California law alone. This is very fortunate because a ruling based solely on federal preemption would have left state chartered depository institutions exposed to liability.

A decision in favor of plaintiffs would have required banks to develop the capability to detect the presence of benefit funds in transaction accounts on an automatic basis and systematically withhold overdraft services from those accountholders. Most banks that have considered this option found it to be either impossible or prohibitively expensive to develop. Moreover, a policy of categorically not honoring overdrawn items of benefit recipients would hurt customers and likely result in greater costs to them in the form of retailer bounced check fees, late fees, cancelled services, and negative credit reports.

Because the decision turned on the interpretation of existing case law and statute, a decision against the bank would have likely subjected all banks to substantial and unwarranted liability for overdraft fees charged on accounts containing benefits funds over the past few years within the applicable statute of limitation period. In short, the decision would have been a disaster.

The Supreme Court’s decision may do little to dampen the debate over overdraft fees and practices. Indeed plaintiffs’ counsel is publicly calling upon the state and federal legislatures to “stop these predatory practices.” Members of Congress such as Carolyn Maloney (NY) have introduced curbs on overdrafts in federal legislation, and a bill in Sacramento was introduced earlier this year that subsequent died. The Federal Reserve Board recently issued an amendment to Regulation DD to enhance the disclosure of overdrafts and is considering a requirement to allow customers to opt out of certain overdrafts under Regulation E.

  1. The relevant statutory authority today is Code of Civil Procedure section 704.080.

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

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