The U.S. Court of Appeals for the Ninth Circuit recently broke with precedent and ruled in favor of a class action plaintiff – a troubling development in the growing body of litigation over interest-rate increases in credit card agreements.

On March 16, 2009, in McCoy v. Chase Manhattan Bank, the majority held, over a strong dissent, that a bank exercising its contractual discretion to increase the cardholder's interest rate upon default must notify the cardholder by the date the increase takes effect. Making matters worse, the court then found that Chase had violated Delaware law by reserving the right in its discretion to increase the rate on default and had violated the cardholder agreement by failing to provide contemporaneous notice of the rate change. It even held that the rate change might be unconscionable because it was not authorized by Delaware law. 

Regulation Z, adopted by the Federal Reserve Board to implement the Truth in Lending Act (TILA), generally requires that a change in terms notice be sent when the interest rate on a credit card "is increased because of a consumer’s delinquency or default."  However, Reg. Z does not require notice for changes agreed upon by the consumer. An example, as interpreted by the Fed, would be where "the specific change is set forth initially" in the credit card contract. The Ninth Circuit found that the bank violated Reg. Z because the rate change was discretionary and, thus, the cardholder could not know in advance the "specific" rate that would apply upon default.

McCoy conflicts with decisions by several district courts, another Ninth Circuit panel in an unpublished decision, and, most recently, the Seventh Circuit U.S. Court of Appeals in Swanson v. Bank of America, N.A. and FIA Card Services, N.A, issued on March 19, 2009. Without adequate basis, McCoy dismisses the importance of a Fed-issued Advance Notice of Proposed Rulemaking. Fairly read, the ANPR makes clear that the Fed interprets Reg. Z to allow discretionary default rate increases without notice. The U.S. Supreme Court has previously instructed that Fed interpretations of Reg. Z are to be given decisive weight unless they are "demonstrably irrational."

Finally, McCoy had no effective answer for the argument that, without violating Reg. Z, the credit agreement could have lawfully provided for an automatic increase in rates to the maximum level specified in the bank's agreement, coupled with the possibility of an immediate and discretionary reduction in the default rate, to the original rate or any rate in between. In effect, the bank accomplished in a single step a result permitted in a two-step process. In this context, the court should certainly have deferred to the Fed's view that no notice was required.

The Ninth Circuit's interpretation of Delaware law was equally if not more troubling. The Delaware Banking Act allows interest rates that "vary in accordance with a schedule or formula." The Ninth Circuit found that Chase's default rate provision was not authorized by Delaware law because the rate increase was discretionary and its amount could vary without reference to a schedule or formula. Because of its view that the discretionary rate increase was unauthorized, the Ninth Circuit further concluded that the provision might be unconscionable under Delaware law. In addition, because Chase had agreed in the cardholder agreement to notify the cardholder of any change "if required by applicable law," the Ninth Circuit found that Chase's failure to provide notice as required by TILA gave rise to a breach of contract claim.

Ballard Spahr's Consumer Financial Services Group is nationally recognized for its skill in litigation defense and avoidance (including pioneering work in pre-dispute arbitration programs); its guidance in structuring and documentation of new consumer financial services products; and its significant experience with the full range of federal and state consumer credit laws throughout the country.  For further information, please contact Alan S. Kaplinsky, 215.864.8544 or; Jeremy T. Rosenblum, 215.864.8505 or; John L. Culhane, Jr., 215.864.8535 or; or Barbara S. Mishkin, 215.864.8528 or

Copyright © 2009 by Ballard Spahr LLP.
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