The Banking Law Connection

The Banking Law Connection

Trends and topics related to banking law and litigation

CFPB Targets Payment Processors and Debt Collection Fees

The Consumer Financial Protection Act of 2010 and the Telemarketing and Consumer Fraud and Abuse Prevention Act regulate certain actions of debt relief service providers. Specifically, those Acts prohibit debt relief service providers from requesting or receiving fees from consumers until after the service provider has successfully renegotiated at least one of the consumer’s debts and the consumer has made at least one payment under the renegotiated plan.

On August 25, 2014, the Consumer Financial Protection Bureau (the “CFPB”) filed a Complaint and submitted to the United States District Court for the Central District of California a proposed consent order against Global Client Solutions, LLC (“GCS”) for violating those laws.

The Complaint alleges that GCS violated the law by providing “substantial assistance” to its debt relief service clients by processing the illegal fee payments. Specifically, the Complaint alleges that GCS “knew or consciously avoided knowing” that its clients were charging illegal fees and thereby violated the prohibition on “assisting and facilitating others’” violations.

Pending court approval, the Order specifically finds that GCS does not admit or deny any of the CFPB’s allegations but does require that GCS:

(1) stop processing fees for entities that GCS “know[s] or consciously avoid[s] knowing” are “requesting or receiving unlawful” fees;

(2) perform a “reasonable screening” of all of its clients that provide debt relief services to determine if the clients are complying with applicable law;

(3) “continue to monitor each . . . client pursuant to the reasonable screening requirements” including semi-annual audits of those clients;

(4) pay the CFPB $6,099,000 to be distributed as restitution; and

(5) pay the CFPB an additional $1,000,000 as a civil penalty.

This action follows the CFPB’s earlier action against Meracord, LLC for nearly identical allegations of wrongdoing. In a CFPB press release on the GCS settlement, CFPB Director Richard Cordray is quoted as stating that “Global Client Solutions made it possible for debt-settlement companies across the country to charge consumers illegal fees. Consumers struggling to pay off a debt are among the most at risk and deserve better. We will continue to crack down on illegal debt-settlement firms and the companies that help these operations collect illegal fees from consumers.”

Understanding that the Order pending against GCS is a negotiated settlement, the proposed provisions of the Order are extreme. To require that a payment processor audit and screen its customers to avoid allegations of wrong-doing is indisputably onerous. Such provisions, even in the context of a settlement, raise serious questions about the steps payment processors need to take to protect themselves from the potential liability associated with serving debt relief service providers. Are you ready?

Lender Liability for a Borrower’s Unpaid Employment Taxes

Most taxpayers readily accept that they may be liable for various taxes based on, among other things, their income, the goods they buy and the wages they pay to their employees. On the other hand, the average person would cringe at the thought of being held responsible for tax obligations generated by the activities of an unaffiliated third-party. Commercial lenders, however, are routinely faced with this possibility when lending to distressed borrowers, yet many may not know such potential liability exists under the Internal Revenue Code (and has since the mid-1960s).

Pursuant to Section 3505(b) of the Internal Revenue Code, if a lender advances funds to a borrower for the specific purpose of paying such borrower’s employees, the lender may be held liable to the United States for such borrower’s employment taxes if the advance is made with the actual notice or knowledge that the borrower does not intend to or will not be able to make timely payment or deposit of such taxes. The lender’s overall liability will be capped at 25% of all funds disbursed to the borrower for payroll purposes, but the thought of incurring any penalty while funding a distressed borrower is likely to be unsettling at best.

As is often the case with tax analysis, the devil is in the details and whether the two primary requirements for liability – that the loan be specifically for payroll and that the lender have actual notice or knowledge of the borrower’s inability or intent not to pay – are met will depend on the specific facts at hand. For example, where the parties have an express agreement that the lender will fund a borrower’s payroll, a specific purpose can easily be found. The water becomes murky, however, when a general working capital line (which is normally exempted) allows funds to be earmarked for payroll purposes or when a lender knows that substantially all of a borrower’s general working capital expenses consist of salaries and wages. With respect to the second requirement, the statute does not require a lender to actively patrol the use of all loan funds, but notice or knowledge will include the situation where an individual loan officer is actually aware that a borrower will be unable to pay its employment taxes even if there are no broader warning signs.

In order to minimize exposure to potential lender liability under Section 3505(b), a lender should consider (i) educating its loan officers regarding Section 3505, (ii) including provisions in their loan documentation that allow the lender to make direct payments of payroll taxes and add such payments to the loan balance, (iii) requiring a borrower to use a third-party payroll services company that will ensure the proper payment of all withholding taxes, (iv) requiring a borrower to execute an appropriate Form 8821 to permit the lender to directly monitor or inspect the borrower’s confidential tax information, and (v) documenting the assurances received from a distressed borrower regarding its timely payment of all payroll taxes.

United States Supreme Court Adds Teeth to Bank Fraud Statute

Resolving a split between Federal Circuits regarding the applicability of the federal bank fraud statute, 18 U.S.C. § 1344(2), the United States Supreme Court in Loughrin v. United States has added significant teeth to the statute by ruling that the Government need not prove that a defendant had actual intent to defraud a financial institution in order to secure a conviction thereunder.

Section 1344 of the United States Code provides as follows:

Whoever knowingly executes, or attempts to execute, a scheme or artifice -

(1) to defraud a financial institution; or

(2) to obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses, representations, or promises;

Shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.

The Defendant in Loughrin was convicted of bank fraud under § 1344(2) after forging stolen checks to purchase goods at Target retail stores, only to return such purchases for cash refunds.  The Defendant did not dispute that § 1344(2) required the Government to prove (1) intent to obtain bank property, (2) “by means of false or fraudulent pretenses, representations, or promises.”  However, the Defendant asserted that he only intended to defraud Target and further argued that the Government was required to prove that he had a specific intent to defraud a bank in order to secure a conviction under § 1344(2).  Rejecting the Defendant’s position, the Court held that:

(1) While an intent to defraud a financial institution constitutes a requirement under the first clause of § 1344, such a requirement is not contained in the second clause of the statute, which is separated from the first clause by a disjunctive “or” and, thus, sets forth an independent basis for conviction.  The Court further noted that interpreting the second clause to include the element of specific intent to defraud a bank would subsume it into the first clause, thus rendering the second clause superfluous in violation of the well-established rule of statutory construction that “courts ‘must give effect, if possible, to every clause and word of a statute.’ ”

(2) The Court’s interpretation of § 1344(2) did not violate principles of federalism by subsuming traditional state jurisdiction over all “garden-variety cons” involving payment by check rather than cash. Rather, the Court noted that the “by means of” language of §1344(2) requires that false or fraudulent conduct “have some real connection to a federal bank” and constitute the actual mechanism inducing a bank to part with its funds or assets.  Thus, the Court held that “garden-variety cons” involving merely a fraud upon a consumer, who in turn pays the con artist with a valid check, would fall outside § 1344(2) because the fraud would not directly cause the bank to part with funds or property.  However, false representations made via a forged or altered check submitted by a con artist to a merchant do fall within § 1344(2) because the fraudulent instrument itself would naturally induce a bank to part with funds.

Despite the Court’s attempt to distinguish between the types of fraudulent acts falling within the scope of § 1344(2), the Court nevertheless acknowledged in a footnote that the determination of whether a fraudulent act has a real connection to a bank so as to induce the bank to part with property constitutes a facts and circumstances test which “will depend almost entirely on context.”

Former FDIC Chief Answers The Question I Asked Bob Corker

Nearly a year ago, I had the opportunity to have breakfast with Senate Banking Committee Ranking Minority Member, Sen. Bob Corker [R-TN]. OK . . . the imperative of full disclosure requires that I admit that I was merely one of about 150 people attending an industry group event in Nashville. Sen. Corker, home for the August recess, was making a number of appearances across the state of Tennessee and the event to which I was invited was merely the first of three stops he made that day.

He spoke on a number of topics, but the one to which he devoted the most attention was the conceptual legislation he and Virginia’s Democratic Senator, Mark Warner, were proposing in order to “reform” Fannie Mae and Freddie Mac. Sen. Corker explained his concept of replacing the two government-sponsored entities that facilitate the bulk of mortgage lending in America, with a single new government agency that would function somewhat like the FDIC. As he described it, this new mortgage insurance company would “protect the taxpayers” by having a layer of private capital that would account for the first 10% of the entities’ total capital, and would be the first layer exposed to the risk of default. The federal mortgage “insurance” would not kick in until this private equity layer was exhausted.

When he opened the floor to Q&A, I happened to be the first person called on. I was curious about this Corker-Warner legislation. In particular, I wanted to know whether it would respect the property rights of investors, many of whom are Sen. Corker’s constituents, like for example the Tennessee State Employees Retirement System, which holds a position in Fannie Mae and Freddie Mac preferred shares valued in the tens of millions of dollars. Sen. Corker had a very quick answer: “No,” he said, “I’m going to protect the tax-payers not the investors.” Again, he explained how private capital was going to be the first dollars at risk for covering defaults on bad mortgages. This prompted me to ask a follow-up:

I pointed out that since 2012 the Treasury Department has been sweeping every dollar of earnings out of Fannie and Freddie. And although the GSE’s have made enough money to fully redeem the federal government’s super preferred shares, the Treasury has unilaterally refused to credit the money it has siphoned out of Fannie and Freddie against this obligation. “What confidence”, I asked Sen. Corker, “do you have that private capital will be invested in your new mortgage insurance entity, when the investors’ experience with Fannie and Freddie shows that doing business with the federal government is like having Tony Soprano as a silent partner?”

After first claiming that private capital would not be needed for the 10% equity layer contemplated by Corker-Warner, Sen. Corker brushed off my question with the blanket assertion that “private investors are lining up” to put their capital into the yet-to-be-created mortgage insurance entity envisioned by his legislation. He then dismissed the option for further follow-up with the classic dodge that other guests had questions they wanted to ask.

It has now been almost a year, and I have yet to read or hear a substantive answer to my question from Sen. Corker. In the July 7, 2014 edition of The Wall Street Journal, however, my question was answered; not by Corker, but by William Isaac, former Chairman of the FDIC in the Reagan Administration.

He succinctly lays out the relevant history behind the federal government’s unilateral confiscation of private property from preferred shareholders, and the Treasury Department’s unprecedented redefinition of the role and responsibility of a conservator over the GSEs. He then posits the same question I raised with Sen. Corker:

“Given the government’s dereliction in its duty to conserve value in Fannie and Freddie, an obvious question arises pertaining to any ‘reform’ of housing lending proposed by the administration and enacted by Congress. If the administration plans to wind down Fannie and Freddie with no recourse for investors, or to nationalize them in creating a new federal housing entity, as a Senate housing reform bill would do, where will the capital come from to finance the new system? What investor would put capital into something so uncertain and so unprotected by law as Fannie and Freddie have proved to be?”

He then provides the answer that Sen. Corker refused to give: “Capital follows the rule of law,” he writes, “and if investors can’t count on that in the U.S. and in the housing markets, they will put their money elsewhere.” It seems to me that Mr. Isaac has it exactly right.

In the legislative process, perhaps law makers, like Bob Corker and Mark Warner, and their colleagues Mike Crapo [R. Idaho] and Tim Johnson [D. S.D.], should draw on the expertise of people like Chairman Isaac, who was responsible for cleaning up the wreckage from failed banks, rather than the likes of former Countrywide Financial trader, Michael Bright http://nlpc.org/stories/2014/04/10/former-countrywide-trader-behind-fanniefreddie-reform-bill who before becoming an influential Senate staffer, worked for a company that helped create the sub-prime mortgage crisis.

Makes sense to me. Let me know what you think.

Protection Against Ancient Claims

Put on your law school exam hats, ladies and gentlemen.  It’s time for a hypothetical.

On August 17, 1981, at a time when CDs were paying 15.55%, Woody Clark deposited $10,000 in a three-year Certificate of Deposit at the Bank of Bug Tussle. A few years later, the Bank of Bug Tussle merged into another bank which eventually was acquired by Your Bank. Mr. Clark showed up at Your Bank’s branch in 2014 with his original Certificate and said he was ready to withdraw his money. By his calculations, even without compounding Mr. Clark believes Your Bank owes him $51,315 in interest, in addition to his original $10,000 deposit.

Your Bank has no record that Mr. Clark has ever been its customer. The records of the Bank of Bug Tussle, all of which were paper, were discarded several mergers ago, and Your Bank’s branch in Bug Tussle has been closed for many years.

What happened to Mr. Clark’s deposit? Did his late wife (a co-owner on the CD) manage to withdraw the money without Woody’s knowledge? Did the funds escheat to the State? Did the Bank of Bug Tussle or its merger partner continue to show the CD as a liability on their long-closed books?

If you are in Alabama, the answer might be easier than you think. In obtaining an order dismissing Mr. Clark’s lawsuit against Your Bank for failure to state a claim, we never had to answer those mysteries of history. Alabama has a 20-year common law rule of repose that bars all claims of every kind or character after 20 years of dormancy.

The Common Law Rule of Repose. The rule of repose “bars actions that have not been commenced within 20 years from the time they could have been commenced.” Tierce v. Ellis, 624 So. 2d 553, 554 (Ala. 1993). “[T]he only element of the rule of repose is time. It is not affected by the circumstances of the situation, by personal disabilities, or by whether prejudice has resulted or evidence obscured.” Boshell v. Keith, 418 So. 2d 89, 91 (Ala. 1982). “Lack of notice is not sufficient to avert the application of the [rule of repose].” Am. Gen. Life and Accident Ins. Co v. Underwood, 886 So. 2d 807, 812 (Ala. 2004) (quoting Ballenger v. Liberty Nat’l Life Ins. Co., 123 So. 2d 166, 169 (Ala. 1960)).

“The rule of repose begins running on a claim as soon as all of the essential elements of that claim coexist so that the plaintiff could validly file suit.” Id. “In some instances, . . . [the point in time when the rule beings to run] may be the same as the date of ‘accrual’ of a claim.” Id. (quoting Ex parte Liberty Nat’l Life Ins. Co., 825 So. 2d 758, 764 n.2 (Ala. 2002)). But “repose does not depend on ‘accrual’ because the concept of accrual sometimes incorporates other factors, such as notice, knowledge, or discovery.” Id.

Limitations of Limitations Defenses. In the absence of a rule of repose, ancient claims have to be analyzed under applicable statutes of limitations, which sometimes require evidence of notice or demand. For example, Section 4-111 of the Uniform Commercial Code provides a clumsy, multi-faceted standard for accrual of a cause of action for payment on a time deposit:

A cause of action accrues for payment of a time deposit upon the earlier of: (1) the date demand for payment is made to the bank, but if the time deposit has a due date and the bank is not required to pay before that date, the cause of action accrues when a demand for payment is in effect and the due date has passed; (2) the latter of: (a) the due date of the time deposit established in the bank’s last written notice of renewal sent pursuant to section 5-5A-36; or b. four years after the last written communication from the bank recognizing the bank’s obligation under the time deposit; or (3) the last day of the taxable year for which the owner of the time deposit last reported interest income earned on the time deposit on either a federal or state tax return.

ALA. CODE-1975 § 7-4-111. In most cases, a limitations defense under section 4-111 can be decided from the face of the complaint; so, in the absence of a rule of repose, an ancient claim probably will not be subject to a viable motion to dismiss. In Mr. Clark’s case, he alleged that he had not made a demand for payment prior to 2014 and had never reported interest income on his time deposit.

Solving the Problem. Many states, including Tennessee, do not have a general rule of repose that applies to suits against financial institutions. Drafters of Article 4 of the UCC would be well advised to add a rule of repose for time deposits in the next revision to eliminate the problems that ancient accounts create for banks. Ten years after the expiration of the initial term of a time deposit would be a reasonable outer limit, after which all claims on the account would expire. Banks cannot be expected to retain records in perpetuity, and ten years provides more than a reasonable outer limit for all deposit claims to expire.