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before the due date. Furthermore, the adjusted balance method does not offer the debtor the inducement to get himself out of debt entirely with each billing cycle as do the other methods. Such an inducement may well be in the interests of the consumer.
The combination of factors cited above lead us to believe that it is unwise for the Federal government to attempt to legislate any particular method of computing finance charges. It is adequate that the law require, as it does now, that whichever method a creditor employs be adequately disclosed so that the consumer can act upon that information to his best advantage.
We are also opposed to section 167 because of its discriminatory nature. It is discriminatory in two ways. First, it, is applicable, by its own terms, only to those plans which offer the obligor an opportunity to avoid a finance charge by paying his outstanding balance in full by a certain date. A creditor who does not offer such an option to the obligor would be free to use any method of finance charge computation he wished. There is clearly no justification for this type of discrimination.
In addition to being discriminatory because it applies only to credit plans offering an option to avoid finance charges, section 167 is also discriminatory to non-seller operated plans because the seller can increase his prices to recover income lost by the mandated use of the adjusted balance method. Bank card plans have their rates carefully regulated by State law and, thus, often cannot recover such lost income by increasing finance charges. This very situation is an example of the reasons we oppose the Federal government involving itself in the rate regulation area. The interaction between maximum rates and the method of computing the balance to which such rates may be applied clearly must be in the hands of a single authority.
Section 168 would prohibit minimum finance charges, except for two types : a uniform charge designed to recover billing costs and a uniform delinquency charge. This provision would effectively prevent a creditor from charging a minimum finance charge on small extensions of credit for which the finance charge would otherwise not recover the administrative costs of making the extension of credit unless he also assessed such charges against those larger credit extensions even though the finance charge applicable to them is sufficient to recover administrative costs. Such a requirement is not in the consumer's interest. As pointed out at page 107 of the Report of the National Commission on Consumer Finance :
Another issue is whether or not credit grantors should be permitted a minimum charge for extending credit-such as the initial charge on a taxi meter regardless of the length of the journey. Some may view it desirable to eliminate such charges, but the effect on extensions of small amounts of credit again will be as previously outlined. Cash lenders will find it unprofitable to make small loans ... and those offering sales credit will reduce the availability of small credit sales and attempt to recover lost income in higher cash prices. Some consumers may gain, others will lose. There is no convincing evidence that on balance consumers will be better off. If the premise is granted that it is only fair for creditors as a group to recover the costs of providing credit, the same reasoning should apply to the granting
of small versus large amounts of credit. For this reason many State laws expressly authorize a minimum finance charge for small extensions of credit. There is no evidence that the minimum finance charge provisions of State law are being abused. The need for Federal action in this area has not been established. and we, therefore, oppose this provision as an unwarranted and undesirable Federal intervention in an area traditionally left to State regulation.
III. RIGHTS OF CREDIT CARD CUSTOMERS
Section 172 of S. 914 would make card issuers subject to all claims, except tort claims, and defenses arising out of any transaction in which the credit card is used for payment if (1) the obligor has made an attempt to resolve the problem with the card honorer; (2) the amount of the transaction exceeds $50; (3) the place of the transaction was within the same state as that where the issuer maintained a business; (4) the amount of card holder claims or defenses does not exceed (a) the initial amount extended, provided the card holder has given the issuer or honoring merchant notice of such claims within the three months of the transaction; and (b) the transaction amount still outstanding if notice of such claims is given to the issuer or honoring merchant later than six months after the transaction.
We are opposed to these provisions simply because they threaten the ability of the bank card system to evolve into a currency-check substitute and, collaterally, the whole future of electronic money. We no more believe that a bank card issuer should be responsible for the quality of items purchased with it when it is used as a substitute for cash than we believe that the Federal Government should be responsible for defects in goods and services which are purchased with currency it issued or that a bank should be responsible for items purchased with checks or currency that are desposited in the merchant's account. A great deal has been said over shields in merchants' windows that somehow speak a guarantee by the issuer of the merchants' reliability. We see no evidence that card holders make such an assumption any more than they assume the merchant's bank will stand behind him because they paid by check.
While we are opposed to legislation of this sort now because it seems that it is too early in the evolution of the card system to define exactly what indicia of negotiability should apply to cards and what the effect of such a precedent would have on other developing forms of electronic money, such as the giro or pre-authorized payments systems that are now emerging as substitutes for checks, we nevertheless offer the following language as a substitute for Section 172, should Congress feel that some action in this area is warranted. "§ - Rights of credit cardholders
“(a) The right of a card issuer to recover any amounts pursuant to an extension of credit under an open end consumer credit plan arising from the purchase of goods or services through use of a credit card shall be subject to any defenses which the cardholder has against the seller of such goods or services if
*(1) the purchase price of each item as to which the defense is asserted exceeds $100;
“(2) such purchase was made at a place of business of the seller located within the same State as a business office of the card issuer;
“(3) the cardholder shall have first made a written demand on the seller with respect to such purchase and attempted, in good faith and without success, to obtain reasonable satisfaction from the seller; and
“(4) the cardholder gives written notice to such issuer specifying the seller, date of purchase, amount of purchase, the goods or services purchased, the nature of the cardholder's defense with respect thereto, and that the cardholder has complied with paragraph (3) of this section within sixty (60) days of the time when such extension of credit first appeared on the cardholder's periodic billing statement.
"(b) (1) Pursuant to regulations of the Board, a card issuer may, notwithstanding any State law to the contrary, make a written agreement with the cardholder which limits the rights of the cardholder to exercise against the card issuer any defenses he has against the seller, except that such agreement may not limit the rights of the cardholder as set forth in subsection (a).
“(2) With respect to credit card accounts in existence on the effective date of this section, a written agreement made pursuant to this subsection shall be deemed to exist if, prior to the furnishing of any statement required by section 127(b) after the effective date of this section, the card issuer furnishes notice, in a form prescribed by regulations of the Board, to the cardholder of the terms of such agreement and the fact that such agreement shall be binding on such cardholder with respect to any extensions of credit obtained from the card issuer through use of a credit card after receipt of such notice.
"(c) The liability of a card issuer under subsection (a) shall not exceed the amount of the extension of credit arising from such purchase plus any finance charges assessed on such extension of credit.
"(d) Subsections (b) and (c) shall not apply to a card issuer who is the same person as the seller, a subsidiary of the seller, or an owner of the seller, or is commonly owned with the seller by a third person.
“(e) 'Use of a credit card', as the phrase is used in this section, means the presentation of a credit card by a cardholder to a seller of goods and services for purposes of proving the identity of the cardholder and facilitating the imprinting on a credit extension form of pertinent information regarding the cardholder and the seller.
“(f) Not later than fifteen days after receipt by a card issuer at an address designated therefor of notice from a cardholder that he disputes an obligation to pay an amount billed by reason of a defense alleged to be available against the seller, the creditor shall transmit to the cardholder a statement of the rights and obligations set forth in this section, in a form prescribed by the regulations of the Board."
This substitute language is predicated on two basic assumptions. First, in those transactions in which a bank charge card is used essentially as a substitute for cash, a consumer should not be able to exercise defenses against the card issuer since he could not do so if he had paid with cash obtained from the card issuer from a demand deposit or time deposit account.
This is essentially what the NCCF recommended when it stated, at page 38 of its report that:
The abolition of cut off devices should also be extended to credit card transactions. Where the lender is the issuer of a credit card which may be used by the consumer in a sale, lease, or service transaction with the seller, lessor, or supplier of services, the lender issuer should be subject to the customer's claims and defenses, except in those transactions where the credit
card is merely a substitute for cash (e.g. transactions up to $50). It is clear that where a cash advance is obtained and the money is used for a purchase, the card is being used as a substitute for cash. Such transactions are thus exempted from the application of the substitute language. It is not clear, however, when an individual makes a purchase with his card if he intends to use it as a cash substitute or as a vehicle for obtaining credit. Because it would not be practicable or feasible to try to make such a determination in each individual case, the substitute language exempts from application of the section the purchase of any item costing less than $100 on the reasonable assumption that such purchases are probably cash purchases in most cases. In contrast, section 172 of S. 914 does not explicitly exempt purchases made with cash advances and does not make clear whether the $50 limit applies to the total purchase, which may consist of 5 dozen $.49 ball point pens, or to each individual item of a purchase.
The second basic premise is that the right to exercise a defense against a bank charge card issuer should operate in a manner similar to a stop payment order on a check. Thus, the consumer should be given a reasonable time in which to exercise his right to stop payment, but his exercise of that right should apply to the full amount of the purchase. The substitute language thus provides that a cardholder must exercise any defenses he had within sixty days of the time the purchase first appears on his billing statement.
This approach has three major advantages. First, we do not have to reach the question of what order payments should be applied to an account to determine how much of the purchase balance is still outstanding. Second, the consumer can recover the full amount of the purchase even if he has already paid part or all of it. Finally, the purchaser and creditor both know that after the 60 days has run, the purchaser's recourse lies exclusively with the seller or manufacturer and not with the card issuer.
There is another underlying reason why this sixty-day limit is reasonable and equitable. In most cases, a consumer will know within sixty days if the item he purchased has been delivered in accordance with the terms of his contract and whether the item has lived up to his expectations. An item which it properly delivered and performs as expected for sixty days and later proves defective is a warranties problem bearing on the quality of the item, not the integrity of the merchant. Such problems are completely beyond the control of the card issuer and properly the subject of warranties law, not Fair Credit Billing or Truth in Lending.
In contrast to this sixty-day limitation, section 172 of S. 914 provides a complicated formula, allowing full recovery for the first 90 days, but only the amount outstanding as determining by applying payments and credits as specified in the section if notice is given later than six months. This section is silent on the amount of possible recovery in the period between 90 days and six months. Such a complicated and incomplete formula can only lead to litigation and disappointment all around, not to mention substantial additional costs for the card issuer.
In addition to these two major changes in section 172, the substitute language would make a number of technical changes to perfect the section. For example, the substitute language provides that the limits of liability do not apply to a creditor who could not enjoy a holder in due course position in the first place. Thus, the limits would not be applicable to a creditor who is also the seller, who is owned by the seller, who owns the seller, or who is commonly owned with the seller by a third party. Further, the substitute language would require not only that a consumer make a good faith effort to resolve his differences with the seller, but also that he supply the card issuer with the facts pertaining to this effort so that the card issuer can properly perform his role of policing his merchants.
Finally, the substitute adds a provision specifically authorizing waiver of defense provisions in cardholder contracts in those situations where it is not specifically prohibited by the substitute language. Moreover, this authorizing provision would be expressly preemptive of my conflicting State law. There is no comparable provisions in section 172 of S. 914.
The need for this authorizing legislation is clear. As the discussion above amply demonstrates, there are compelling reasons for limiting the degree to which the traditional doctrine of waiver of defense should be modified. For instance, both S. 914 and the substitute language recognize the need to limit the scope of such modifications to purchases made in the State in which the card issuer maintains a place of business. It is clearly impossible to expect a New York bank to police the practices of an San Francisco or Tokyo merchant. The authorizing legislation would effectively prevent a State from enacting a law requiring a bank to police merchants outside the State. Both S. 914 and the substitute language recognize the need to set a floor on the cost of the item. The authorizing legislation would prevent a State from rai ng or lowering that floor. Both S. 914 and the substitute language specify conditions, such as content and timing of notice, which must be met before a consumer can exercise a defense against a card issuer. The authorizing section would prevent a State from requiring conflicting conditions, more elaborate notice schemes, or in any other way confusing the relatively simple mechanism provided to the consumer for exercising his defenses. In other words, the authorizing provision would prevent a State from enacting legislation which would reduce the effectiveness of this mechanism to the consumer or increase the liability or costs of the card issuer. It effectively guarantees that the law regarding waiver of defense with respect to charge card purchases will be uniform throughout the nation.
Section 173 of S. 914 and section 169 of S. 1630 have attempted to deal with the potential conflict between the provisions of the respective bills and State law by providing that State law is not affected except to the extent it conflicts with provisions of the respective bills. The authorizing section does no more than this, since it deals only with State legislation which conflicts with the provisions of the Federal law. However, the need for this explicit authorization is created by the second sentences of sections 173 and 169, which state that "No State law which provides greater protection for the consumers than the protection provided by this law shall be preempted by this law to the extent of the greater protection." In some cases, it will be clear that a State law does afford greater protection-for instance, a State law lowering the floor on purchases subject to the prohibition on waiver of defense clauses in contracts. In other cases, however, such as additional notification requirements or other changes in the mechanism itself, it will not be clear, and the dispute can only be resolved by protracted litigation. Because this potential for litigation exists in many possible areas addressed by this bill, we have grave reservations about the advisability of such language, and we have set out these reservations later in this statement. But the potential for conflict in the waiver of defense area is so clear that we feel it should be resolved once and for all by explicit preemptive language. For that reason, our substitute includes just such a provision.
IV. CIVIL PENALTIES
The Truth-in-Lending Act provides, in Section 130, for a form of civil enforcement through minimum monetary recoveries amounting to a civil penalty. Under that section, a creditor who fails to disclose to any person any information required by the Act to be disclosed to that person, is liable to that person for twice the amount of any finance charge, but not less than $100 even if no actual damages are shown. It is easy to understand how this minimum recovery was originally viewed as a necessary device to make it worthwhile for an individual who might have actual damages of only a few dollars, or even a few cents, to bring an enforcement action. But this minimum recovery feature has now backfired in several ways to the dismay of industry and consumers alike.
The principal difficulty involves the effect of the minimum recovery provision on the maintenance of a class action suit under Rule 23 of the Federal Rules of Civil Procedure. In certain cases class actions can be quite useful. They can reduce burdens on courts, and they can simplify complex suits involving numerous plaintiffs, particularly where individual plaintiffs might not be able to recover adequate damages to justify the expense of bringing suit. Through the class action device, the individual plaintiffs receive the damages to which they are entitled, while the aggregate damages which the defendant must pay are sufficient to have a substantial deterrent effect. Treble damage suits under the antitrust laws are often proper for this type of class action.
But the minimum recovery provision of Section 130 distorts this normal class action picture, for instead of receiving only their actual damages, plaintiffs must receive a minimum of $100 each. Since under the Truth in Lending Act technical violations in the disclosure area may involve millions of potential plaintiffs, the aggregate damages can be astronomical and will generally bear no relation to any real damage done by the creditor in failing to disclose the information involved. This possibility was clearly perceived by Judge Frankel in Ratner v. Chemical Bank New York in which he wrote:
the allowance of thousands of minimum recoveries like plaintiff's would carry to an absurd and stultifying extreme the specific and essentially inconsistent remedy Congress prescribed as the means of private enforcement.
(54 F.R.D. 412, 414 (S.N.Y. 1972)) The persuasive logic of the Ratner decision has met with approval throughout much of the Federal judiciary. As a result, nearly all of the twenty Truth in Lending class action suits decided since Ratner have held that the class action form was not appropriate.
As a result of this trend, the deterrent and remedial effects of the civil liability provisions of the Truth in Lending Act may have been substantially impaired. We say “may” because our own experience shows that bank card issuers take great care to comply with Truth in Lending and in general the class action suits that have been attempted have charged very technical violations and little if any actual damage. On the other hand, we understand that the Federal Reserve Board feels some civil enforcement mechanism is desirable and we are not opposed to a reasonable civil enforcement mechanism, which should meet the following requirements:
First, any civil penalty mechanism must not interfere with the ability of an individual to recover actual damages incurred by him as a result of a violation of the Act, including the ability to employ class actions where appropriate. Thus we do not propose to ban class actions for actual damages where such an action satisfies the criteria of Rule 23.
Second, the civil penalty mechanism should provide an additional financial incentive adequate to encourage an individual to bring an action for a significant violation of the Act. However, only one such penalty suit should be permitted with respect to any single course of action by a creditor in violation of the Act. Other individuals would be limited to recovering actual damages in either individual or class action suits.
We do not believe that it would be necessary to pay the entire civil penalty to the plaintiff. Most of it could probably be paid to an appropriate fund in the Treasury. In this way, the civil enforcement mechanism would simultaneously be able to provide the plaintiff with an adequate incentive to bring suit and permit a sufficient civil penalty to deter violations without unjustly rewarding the person bringing the suit. The mechanism would also avoid the high administrative costs involved in the notice and distribution requirements of a class action without diminishing the effectiveness of the deterrent.
The size of the civil penalty imposed against a violation should be directly related to the degree of wrongdoing involved, such as the amount of actual damages incurred by customers of the creditor, the extent to which the creditor's failures were willful and intentional, and the frequency and persistence of the creditor's violations. In the interests of fairness and equal treatment, the penalty should not be related to the financial size of the creditor. Moreover, such a variable penalty would encourage suits against only the largest financial institutions, and they have by far the best record of compliance with the Act and are more carefully scrutinized by the Federal enforcement agencies.
This point is sufficiently important that we would like to dwell on it for a moment longer. Under present law, the size of the recovery in a class action, if permitted, is directly proportional to the number of potential plaintiffsnamely, $100 per head as a minimum. The tendency of those who bring class action suits is quite naturally to concentrate on those violations of the Act, no matter how minor, which involve the greatest number of affected persons. Ratner is typical of this genre. The court estimated that the size of the class of potential plaintiffs in that case approached 130,000, or a total possible minimum