Bankruptcy

Is U.S. Bank Collecting Illegal Interest Rates?

By Bob Lawless

When their customers have complained about an unexpected fee, credit card companies have pointed to the fine print in their credit card agreements. Now, a pro se litigant in California has turned the tables on U.S. Bank, saying it has failed to read the fine print in the North Dakota statute. As detailed in the Santa Rosa Press Democrat, a small-business owner and bootmaker, Michael Carnacchi, is opposing U.S. Bank's collection action against him on the grounds that U.S. Bank's credit card interest rates are illegal.

It all sounds crazy, but it gets crazier. A careful reading of the North Dakota statute and the National Bank Act suggests Carnacchi might be right. U.S. Bank is a national bank located in North Dakota, and the particular language of that state's laws might give it a big headache.

The legal issues are complex. One must begin with the National Bank Act which allows a federally chartered bank to charge the interest rate allowed by the laws of the state where the bank is located (12 U.S.C. § 85). In a seminal decision, Marquette Nat'l Bank v. First of Omaha Service Corp., 439 U.S. 299 (1978), the Supreme Court ruled that section 85 meant that a bank physically located in Nebraska needed only to comply with the relatively more generous Nebraska usury statute rather than the stricter Minnesota statute even when lending to Minnesota residents. The Marquette decision is why U.S. Bank thinks it can export the lax usury law of North Dakota to a California resident like Carnacchi.

The same section of the National Bank Act, however, further specifies that "when no rate is fixed by by the laws of the state . . . ." then the maximum rate a national bank can charge is the greater of 7% or 1% in excess of the rate on 90-day commercial paper in effect at the Federal Reserve (which is currently 0.46%). If a national bank charges an interest rate greater than allowed, the bank cannot collect any interest on the debt, and the borrower can recover twice the amount of interest actually paid during the two years prior to the lawsuit (12 U.S.C. §  86).

North Dakota state law sets a usury rate of the 6-month T-bill rate plus 5.5% (N.D.C.C. § 47-14-09.1). Of course, such an interest rate cap would be too low to attract national banks like U.S. Bank to locate their operations in North Dakota. Thus, in the next subsection, the North Dakota legislature simply wrote, "This section does not apply to a . . . loan made by a lending institution which is regulated or funded by an agency of a state or of the federal government." But, therein lies the problem. As far as I can tell--and this point is key--there appears to be no other provision of North Dakota law that fixes an interest rate for nationally chartered banks like U.S. Bank to charge. The National Bank Act only allows a federally chartered bank to charge the interest rate of the state where the bank is located when state law "fixes" a rate.

The North Dakota statute thus has a lacuna for national banks. By removing all national banks from application of its usury statute, there is no North Dakota law that "fixes" an interest rate within the meaning of the National Bank Act. Under this reasoning, the 7% cap of the National Bank Act would be the maximum for a federally chartered bank located in North Dakota. One response might be that North Dakota has effectively "fixed" an interest rate by having no law whatsoever on the subject. The problem with that reasoning is that it proves too much -- if the absence of state law is "fixing" an interest rate, there would be no reason for the language in the National Bank Act saying the interest rate is 7% where no state law applies (and courts do not like to read statutes in a way that makes part of a statute unnecessary verbiage).

Although I have not undertaken an exhaustive analysis of other states' laws, North Dakota's statutory language appears to be uncommon. South Dakota--another state where it is popular for national banks to locate--states that the maximum rate of interest that may be charged is whatever the parties establish by written agreement (S.D.C.L. § 54-3-1.1). An old Supreme Court case says that such a statute is sufficient to "fix" an interest rate within the meaning of the National Bank Act. Daggs v. Phoenix Nat'l Bank, 177 U.S. 549 (1900). (At the same time, South Dakota also has another section completely exempting regulated lenders from its usury statutes (S.D.C.L. § 54-3-13), meaning banks located there might also be subject to the same reasoning suggested by the North Dakota law.)

Every lawyer "knows" that a federally chartered bank can charge whatever interest rate the market can bear. It can be an odd experience, however, to discover that we "know" less than we thought we did when we go read the statutes. Still, I think Mr. Carnacchi still faces an uphill battle. It can be difficult to persuade a court to upset settled expectations, and settled expectations are that U.S. Bank can charge whatever interest rate it wants. Judging from the newspaper article, Mr. Carnacchi fortunately does not seem to be the type of person who accepts settled expectations.

(Thank you to the Credit Slips reader who brought this fascinating case to my attention--you know who you are. And, thanks to the Santa Rosa Press Democrat for a nice piece of reporting and giving us another example of the service that a good community newspaper can provide.)

Full post as published by Credit Slips on June 05, 2010 (boomark / email).