The Federal Reserve Board (FRB) has adopted its final rule, effective August 22, 2010, implementing CARD Act limitations on credit card penalty fees, including late fees, over-the-limit fees, and returned check fees, as well as CARD Act requirements applicable to reevaluations of rate increases.

Our assessment is that the final rule, which amends Regulation Z under the Truth in Lending Act (TILA), will be painful for the credit card industry but not as bad as it could have been.

Penalty Fees. Like the proposed rule, discussed in an earlier Ballard Spahr legal alert, the final rule provides that a penalty fee may not exceed the dollar amount associated with the related violation. Thus, a late fee or returned payment fee may not exceed the amount of the associated minimum payment, and an over-the-limit fee may not exceed the amount by which a consumer has gone over the credit limit. Multiple penalty fees may not be charged for the same event. For example, a late fee and a returned-check fee may not be charged in connection with the same minimum payment. And no penalty fees may be charged for a violation that does not have an associated dollar amount, such as a declined transaction, or for account inactivity or closure.

Subject to the foregoing limits, the final rule establishes a safe harbor for penalty fees against TILA attack. Banks should be able to charge the maximum fee allowed under the safe harbor unless its home state prescribes a lower fee.

Under the safe harbor, issuers will be able to charge $25 for the first violation of a particular type and $35 for an additional violation within six billing cycles after the most recent violation of the same type. Additionally, issuers may impose higher fees if they can establish that the fees represent a reasonable proportion of the total costs incurred as a result of the violation. Like the proposed rule, the final rule does not allow issuers to include loan losses or reserves in cost computations. Unlike the proposed rule, the final rule also does not allow issuers to base their penalty fees on deterrence considerations.

Rate Reevaluations. The final rule is quite similar to the proposed rule regarding periodic reevaluations of increased annual percentage rates (APRs). An issuer that increases an APR based on factors such as the consumer’s credit risk or market conditions is required by the final rule to reevaluate its determination at least once every six months and to continue to do so until the APR is restored to (or below) the pre-increase level. This requirement would apply to accounts with APR increases on or after January 1, 2009. An issuer would not be limited to the same factors it considered when increasing the rate but could reevaluate using the factors it currently uses when setting APRs (and would be required to use these factors in reevaluating APRs increased in the period from January 1, 2009, through February 21, 2010).

If a reevaluation showed that a rate reduction was required (whether to the pre-increase APR or some intermediate level), the issuer would have 45 days to reduce the rate (compared to 30 days under the proposed rule). The reevaluation requirement would not apply to charged-off accounts or to rate increases resulting from the reinstatement of a rate that was lowered under the Servicemembers Civil Relief Act.

The requirement to reevaluate rate increases at least every six months would generally encompass accounts acquired by an issuer. However, the acquiring issuer may instead review all the acquired accounts within six months after the acquisition, using the factors it currently uses to set APRs. The issuer generally would then have to reevaluate only rate increases resulting from that review.

A notice of rate increase resulting from a change in contract terms or the consumer’s default or delinquency would have to include up to four principal reasons for the increase, listed in order of importance.

Ballard Spahr’s Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting new consumer financial services products; its experience with the full range of federal and state consumer credit laws throughout the country; and its skill in litigation avoidance, including pioneering work in pre-dispute arbitration programs. For more information, please contact group Chair Alan S. Kaplinsky, 215.864.8544 or kaplinsky@ballardspahr.com; Vice Chair Jeremy T. Rosenblum, 215.864.8505 or rosenblum@ballardspahr.com; John L. Culhane, Jr., 215.864.8535 or culhane@ballardspahr.com; Barbara S. Mishkin, 215.864.8528 or mishkinb@ballardspahr.com; or Mark J. Furletti, 215.864.8138 or furlettim@ballardspahr.com.


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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.