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From Banking and Finance Law Daily, January 21, 2014

Constitutional limits on tort punitive damages do not limit contract claims

By Richard A. Roth, J.D.

Credit card companies would not violate the U.S. Constitution by charging consumers late fees and over-the-limit fees that were disproportionate to the harm the companies suffered, the U.S. Court of Appeals for the Ninth Circuit has decided. The substantive due process requirements of the Constitution that limited punitive damages in tort cases were not applicable to contract-mandated penalties, the court said (Piñon v. Bank of America, Jan. 21, 2014, Nelson, Senior Circuit Judge).

The facts of the case, as outlined by the court, were simple: a class of consumers who had either made credit card payments late or engaged in transactions that exceeded their credit limits sued the issuing banks, claiming that the resulting fees vastly exceeded the harm their contract violations caused the companies. According to the consumers, the companies were adequately compensated by the increased interest rates they charged after the breaches, and therefore the fees were unenforceable penalties.

The consumers asserted that, as a result, the credit card issuing banks were charging interest that exceeded what was permitted by the National Bank Act and the Depository Institutions Deregulation and Monetary Control Act.

These claims were dismissed by the district court, and the class appealed the dismissal.

Federal laws. The National Bank Act allows a national bank to charge its customers interest at the rate permitted by the bank’s home state, regardless of where the customers were located, the court noted. DIDMCA gives the same right to Federal Deposit Insurance Corporation-insured state banks. The fees the consumers were complaining about clearly constituted interest under those laws, the court added, so the banks could export them along with the contractual interest rates.

The court summarized the consumers’ argument as claiming that the late and over-the-limit fees violated the Constitution and thus could not be charged under the laws of the banks’ home states. If the fees could not be charged under the laws of the banks’ home state, they could not be exported to customers in other states.

No due process violation. According to the court, the consumers wished to apply to private contract liquidated damages clauses the same constitutional due process restrictions that the Supreme Court had applied to punitive damages in tort suits in BMW of North America, Inc. v. Gore, 517 U.S. 559 (1996). The court refused, reluctantly, to take that step.

There is a difference between a liquidated damages clause and a penalty clause, the court began. A liquidated damages clause, which is intended to be a good faith effort by parties to a contract to estimate the damages that would result from a breach, generally is enforceable; on the other hand, a penalty clause, which is intended to punish a breach or coerce performance, generally is not enforceable, the court said.

If punitive damages are allowed for contract breaches, they are subject to constitutional limits, the court added.

However, the late fees and over-the-limit fees charged to the consumers were not punitive damages assessed by a jury, like the damages that were addressed in Gore, the court pointed out. The fees originated from contracts the consumers had signed. The due process analysis that was relevant to jury punitive damage awards was inapplicable to contractual penalty clauses, the court decided.

Concurring opinion. A concurring opinion by Judge Reinhardt, and joined by the author of the court’s opinion, expressed significant dissatisfaction with the result while agreeing that it was required by the current law. The concurring opinion made clear the author’s belief that the court’s decision was required by the law as it now stands, but that the law as it now stands should be changed.

Applying a substantive due process analysis to tort punitive damages claims but not to contract penalty clauses—especially when those clauses are contained in consumer contracts of adhesion—yields a result that protects businesses but denies comparable protection to consumers, the concurring opinion said. The opinion drew on an article written by one of the plaintiff class’s attorneys to illustrate the scope of its concern, noting that:

  • the fees resulted in a compensatory-to-punitive damages ratio of more than 1-to-100; and

  • credit card companies collected more than $7.3 billion in late fees in 2002.

According to the concurring opinion, the Gore rule had so far “served primarily to protect wealthy corporations from liability for repeated wrongdoing.” Consumers who signed contracts of adhesion in order to obtain “many of the practical necessities of modern life” deserved comparable protection in the case of “minimal beaches of contract.”

“A grossly disproportionate punishment is a grossly disproportionate punishment,” regardless of whether the consumers had agreed to that punishment, the concurring opinion asserted. While this might not be the time to expand the punitive damages limits to consumers, the opinion said, “in the end the principles of fairness and equality will dictate that consumers are entitled to (at least) the same constitutional rights as corporations.”

The case is No. 08-15218.

Attorneys: Seana Shiffrin (UCLA School of Law), for the plaintiffs. Rebecca J.K. Gelfond (Wilmer Cutler Pickering Hale and Dorr LLP) for the defendants.

Companies: Bank of America Corporation; Bank of America, N.A.; Capital One Financial Corporation; Chase Bank USA, N.A.; Citibank, N.A.; Citigroup, Inc.; Federal Deposit Insurance Corporation; HSBC Finance Corp.; HSBC North America Holdings, Inc.; JPMorgan Chase Bank NA; JPMorgan Chase & Co.; Wells Fargo & Company Long Term Disability Plan

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