Treasury Issues Report Proposing Changes to FSOC Designation Process

By Gordon S. Woodward

On April 21, 2017, President Trump issued a Presidential Memorandum directing the U.S. Department of the Treasury to evaluate and make recommendations on the Financial Stability Oversight Council’s (FSOC) designation process.  The FSOC is a panel consisting of the heads of U.S. financial regulatory agencies, including the Treasury, the SEC and the CFPB, which was created by the Dodd-Frank-Act of 2010 to monitor the financial system. The panel may designate nonbank firms as “systemically important financial institutions” (SIFIs), which subjects them to enhanced supervision by the Federal Reserve. The intent was to identify and monitor firms, other than big banks, whose failure could imperil the economy (large banks such as JPMorgan Chase and Goldman Sachs were automatically designated as SIFIs under Dodd-Frank).

On November 17, 2017, the U.S. Department of the Treasury responded to the April 21st Presidential Memorandum with a report proposing changes to FSOC’s designation process. Proposed changes include enhancing communication between FSOC and the companies under review. In addition, FSOC should assess the likelihood of a firm’s financial distress and conduct a cost-benefit analysis, designating a firm only if the “expected benefits to financial stability outweigh the costs of designation.” The report also calls for an “off-ramp” that companies may follow to avoid the SIFI designation.

The Treasury proposal differs significantly from the approach proposed in the Financial CHOICE Act, which the U.S. House of Representatives passed in June. That act would strip the FSOC of most of its regulatory authority, including the ability to designate nonbank financial firms as SIFIs.

As a result, the administration has signaled a middle ground approach to SIFI regulation.  The FSOC will, for the time being, survive Congress’s deregulatory push but with limitations designed to address Wall Street’s most significant concerns.

SCOTUS Clarifies Who is a Debt Collector Under FDCPA

By Stephen A. Fogdall

The Fair Debt Collection Practices Act (FDCPA) prohibits a “debt collector” from using any “false, deceptive, or misleading representation or means in connection with the collection of any debt,” as well as any “unfair or unconscionable means to collect or attempt to collect any debt.”  15 U.S.C. §§ 1692e, 1692f.  The critical predicate for liability under these provisions is that the party allegedly engaged in the improper conduct is, in fact, a “debt collector.”  It is well-settled that a party seeking to collect for its own account a debt it itself originated is not a “debt collector,” while an independent party in the business of collecting debts owned by others is a “debt collector.”   However, over the past ten years a circuit split arose regarding whether a party that buys debts originated by someone else, after those debts have gone into default, and then seeks to collect those debts for its own account is a “debt collector.”  The Third and Seventh Circuits concluded that such parties are debt collectors under the FDCPA, while the Fourth and Eleventh Circuits concluded that they are not.  The U.S. Supreme Court recently weighed in in Henson v. Santander Consumer USA Inc..  In a unanimous decision authored by Associate Justice Gorsuch (his first), the Court concluded that at least one part of the FDCPA’s definition of a “debt collector” excludes such parties.

The FDCPA broadly defines a “debt collector” as “any person” who (1) “uses any instrumentality of interstate commerce or the mails in any business the principal purpose of which is the collection of any debts” (sometimes referred to as the FDCPA’s “first definition” of a “debt collector”)  or (2) “who regularly collects or attempts to collect, directly or indirectly, debts owed or due or asserted to be owed or due another” (sometimes referred to as the “second definition” of a “debt collector”).  15 U.S.C. § 1692(a)(6).  The statute then lists six exclusions, one of which is relevant to the Henson decision.  Specifically, this exclusion provides that the term “debt collector” “does not include” “any person collecting or attempting to collect any debt owed or due . . . another to the extent such activity . . . concerns a debt which was not in default at the time it was obtained by such person.”  15 U.S.C. § 1692a(6)(F)(iii).  This exclusion is discussed further below.

The Court in Henson addressed the second definition, the portion that applies to those who “regularly collect . . . debts owed or due . . . another.”  The Court specifically declined to address the first definition, the portion that applies to persons “in any business the principal purpose of which is to the collection of any debts,” stating that “the parties haven’t much litigated” this portion and it was outside the scope of the grant of certiorari.

Addressing the second definition, the Court fairly easily concluded that it excludes those who, like the respondent in Henson, purchase debts (even, importantly, after the debts have already gone into default) and seek to collect those debts for their own account.  Because the second definition by its terms refers to the collection of debts owed to “another,” it follows, the Court held, that the definition does not include those who collect debts for themselves.

The petitioners’ primary argument against this conclusion was that the second definition uses the word “owed” in the past tense.  Thus, according to the petitioners, a subsequent purchaser of a debt that was at one time “owed” to “another,” namely, the originating lender, would qualify as a “debt collector.”  The Court rejected this argument, noting that the word “owed” could easily be understood in the present tense, and, in any event, construing it in the past tense would be difficult to square with the nearby word “due” (“owed or due . . . another”), which indisputably is used in the present tense.

The Court then addressed the exclusion, alluded to above, removing from the definition “any person collecting or attempting to collect any debt owed or due . . . another to the extent such activity . . . concerns a debt which was not in default at the time it was obtained by such person.”  15 U.S.C. § 1692a(6)(F)(iii).  The Court rejected the petitioners’ suggestion that by excluding a person collecting a debt that “was not in default at the time it was obtained by such person,” the definition of “debt collector” impliedly included a person collecting a debt that was in default “at the time it was obtained by such person” (which allegedly was the case with the debts at issue here).

The Court concluded, first, that the term “obtained” in this exclusion does not mean “purchased,” but rather having taken “possession” of a debt “for servicing and collection.”  Second, the Court concluded that since the exclusion removes persons from the scope of the term “debt collector” who would otherwise fall within it, the exclusion does even not apply unless the person at issue does indeed satisfy the initial definition.  In other words, a person must, as a threshold, “attempt to collect debts owed another” in order for the logically secondary question to arise as to whether that person is within the terms of the exclusion.  The Court observed that the “petitioners’ argument simply does not fully confront this plain and implacable textual prerequisite.”

Although it is now clear that a party seeking to collect a debt for its own account (even when it acquired the debt after it had already gone into default) cannot be a “debt collector” under the second of the two definitions in the FDCPA, by declining to address the first definition, the Court in Henson left open the possibility that a party collecting  for its own account might still qualify as a debt collector if it is “in any business the principal purpose of which is the collection of any debts.”  15 U.S.C. § 1692a(6).  Indeed, the Eleventh Circuit, after concluding, like the Supreme Court in Henson, that the second definition excludes parties collecting debts for their own accounts, expressly acknowledged that such a party might nevertheless be a debt collector under the first definition if its “‘principal purpose’ is the collection of ‘any debts.’”  Davidson v. Capital One Bank (USA), N.A., 797 F.3d 1309, 1316 n.8 (11th Cir. 2015).

There are comparatively few decisions analyzing the first definition, but that presumably will change in the wake of Henson, as plaintiffs, and their lawyers, seek to make use of this still potentially open path to attempt to establish that a debt owner is a “debt collector.”  Parties that purchase and collect debts for their own accounts should pay close attention as this issue evolves.  This blog will track and report on significant developments.

The CFPB Takes Aim at Arbitration Clauses in Contracts for Consumer Financial Products

Schnader Alert by Monica Clarke Platt:

The Consumer Financial Protection Bureau (CFPB) last week issued two proposals aimed at weakening and discouraging arbitration clauses in contracts for consumer financial products. First, the CFPB proposes prohibiting the application of arbitration clauses to class actions proceeding in court. Specifically, the Bureau is considering a requirement that arbitration clauses in covered consumer financial contracts provide that the arbitration agreement is inapplicable to putative class actions filed in court unless and until class certification is denied or the class claims are dismissed. This proposal could significantly increase putative class claims in the consumer finance sector (indeed, increasing access to class litigation appears to be the Bureau’s goal). Second, the Bureau seeks to require entities that use arbitration agreements in their contracts to submit to the Bureau notice of claims filed in arbitration proceedings and arbitration awards, potentially for publication.

Please click here to read the full Alert.

The U.S. Supreme Court Unanimously Rules Against the Creditor in Jesinoski

By Stephen A. Fogdall

We predicted here that at least five U.S. Supreme Court Justices would reject the creditor’s argument in Jesinoski v. Countrywide Home Loans, Inc. that a borrower must file a lawsuit within three years of the consummation of the loan in order to preserve the statutory right to rescind under the Truth in Lending Act. As it turned out, the Court rejected that argument unanimously, holding instead that mere written notice to the creditor within the three-year period is sufficient. “[The statute] explains in unequivocal terms how the right to rescind is to be exercised,” the Court stated. “It provides that a borrower ‘shall have the right to rescind . . . by notifying the creditor . . . of his intention to do so’ (emphasis added). The language leaves no doubt that rescission is effected when the borrower notifies the creditor of his intention to rescind. It follows that, so long as the borrower notifies within three years after the transaction is consummated, his rescission is timely. The statute does not also require him to sue within three years.”

Pennsylvania Supreme Court Formally Adopts “Gist of the Action” Doctrine

By Stephen J. Shapiro

Pennsylvania’s “gist of the action” doctrine prohibits plaintiffs from pursuing tort claims for what are, in actuality, breach of contract claims.  A variety of defendants, including those in the financial services industry, regularly have invoked the doctrine to seek dismissal of contract-based claims that are “dressed up” as tort claims in an effort to pursue damages – such as consequential and punitive damages – that might not be available under a breach of contract claim.

Although the Pennsylvania Supreme Court had never formally recognized the doctrine, the intermediate appellate courts in Pennsylvania, as well as the Third Circuit, had applied the doctrine for years, predicting that the Supreme Court would adopt the doctrine if given the opportunity.  In the recent case Bruno v. Erie Insurance Company, the Pennsylvania Supreme Court confirmed the accuracy of those predictions.

In Bruno, the plaintiff homeowners purchased an insurance policy from the defendant insurer that, among other things, insured the homeowners against physical loss to the property caused by mold.  While renovating their home, the homeowners discovered mold growing on their basement walls.  Agents of the insurer told the homeowners that the mold was harmless and that they should continue with the renovations, which they did.  When the homeowners began to suffer from severe respiratory ailments, they had the mold tested and learned that it was toxic.  One of the homeowners later developed cancer, which her physician believed was caused by the toxic mold.  Unable to remove the mold, the homeowners eventually were forced to demolish the house.

The homeowners sued the insurance company for, among other causes of action, negligence, alleging that the insurer negligently misled them about the health risks posed by the mold.  The insurer filed preliminary objections to the negligence claim, arguing that it was barred by the gist of the action doctrine.  The trial court sustained the preliminary objections and, on an interlocutory appeal, the Superior Court affirmed the dismissal of the negligence claim, holding that “the gravamen of [the homeowners’] action . . . sounds in contract – not in tort.”

On appeal, the Pennsylvania Supreme Court formally adopted the gist of the action doctrine.  The Court explained that a claim can be categorized as a contract claim or a tort claim as follows:

“If the facts of a particular claim establish that the duty breached is one created by the parties by the terms of their contract – i.e., a specific promise to do something that a party would not ordinarily have been obligated to do but for the existence of the contract – then the claim is to be viewed as one for breach of contract.  If however, the facts establish that the claim involved the defendants’ violation of a broader social duty owed to all individuals, which is imposed by the law of torts and, hence, exists regardless of the contract, then it must be regarded as a tort.”

The Court went on to specify that:

“[A] negligence claim based on the actions of a contracting party in performing contractual obligations is not viewed as an action on the underlying contract itself, since it is not founded on the breach of any of the specific executory promises which comprise the contract.  Instead, the contract is regarded merely as the vehicle, or mechanism, which established the relationship between the parties, during which the tort of negligence was committed.”

The Court cautioned that, when applying the gist of the action doctrine, the substance of the plaintiff’s allegations, not the label placed on the claim, governs:  “[T]he substance of the allegations comprising a claim in a plaintiff’s complaint are of paramount importance, and, thus, the mere labeling by the plaintiff of a claim as being in tort, e.g., for negligence, is not controlling.”

Applying the gist of the action doctrine to the facts before it, the Court held that the homeowners’ negligence claim was “not based on [the insurer’s] violation of any . . . contractual commitments.”  Rather, the homeowners alleged that the insurer’s agents acted negligently “while they were performing [the insurer’s] contractual obligation to investigate the claim made by the [homeowners] under their policy.”  Because, the Court explained, “[t]he policy in this instance merely served as the vehicle which established the relationship between the [parties], during the existence of which [the insurer] allegedly committed a tort,” the gist of the action doctrine did not bar the homeowners’ negligence claim.  Therefore, the Court reversed and remanded for further proceedings.

NJ Banks May Not Face Common Law Tort Claims for Improper Electronic Funds Transfers

By Edward J. Sholinsky

The New Jersey Supreme Court in a matter of first impression held that a non-customer of a bank cannot bring a common law negligence claim against that bank for an improper money transfer via the Internet.  In ADS Associates Group, Inc. v. Oritani Savings Bank, the court held that the state legislature intended Article 4A of the UCC to create the exclusive remedy for an alleged breach of a duty when a bank makes an electronic funds transfer and preempts any common law remedies.

At issue in ADS was whether New Jersey’s version of the UCC provides the exclusive remedy when a non-customer alleged an unauthorized electronic funds transfer via online banking, or whether the non-customer could bring a common law negligence claim against the bank.  The trial court held that a non-customer could not bring a common law negligence claim; the state’s intermediate appellate court reversed in an unpublished opinion.  The Supreme Court reversed the appellate court and reinstated the judgment of the trial court.

Plaintiff Brendan Allen entered into a business relationship with co-defendant Asnel Diaz Sanchez to bid on a large construction project.  Rather than creating a new entity, Allen and Sanchez used Sanchez’s then-existing business ADS Associates, Inc., to bid because ADS was an established minority-owned business.  The pair went to Oritani Savings Bank and opened an account.  The account agreement required both Allen and Sanchez to sign checks drawn on the account.  The account agreement also allowed both Allen and Sanchez, as authorized signatories, to use online banking to transfer funds.  Sanchez had other ADS accounts at the bank, and eventually began to electronically transfer money from the ADS account he opened with Allen to other ADS accounts without Allen’s permission.

When Allen discovered the allegedly unauthorized transfers, he brought suit, in his own name and in the name of ADS, against both the bank and Sanchez.  The suit stated claims alleging violations of Article 4A of the UCC, as well as common law claims.  It was undisputed that ADS, and not Allen, was the bank’s customer.  At issue in the Supreme Court was “whether Allen may maintain a common law non-customer negligence claim against Oritani.”

Article 4A of the UCC (codified in New Jersey at N.J.S.A. 12A:4A-101, et seq.) controls the electronic transfer of funds.  The statute sets out a detailed regime for properly authorized electronic transfers, including online banking transfers, and allocates the risk of loss between the bank and the customer.  Per the court, “Article 4A thus defines in detail the rights and obligations of banks and their customers in the event that funds are transferred in accordance with a payment order that the customer has not authorized.”  Relying on the commentary to Article 4A, the court determined that only a customer could pursue a remedy under Article 4A.

In reaching its conclusion, the court distinguished City Check Cashing, Inc. v. Manufacturers Hanover Trust Co., which held that, in the limited circumstances where a non-customer could show that he had a special relationship with the bank, the non-customer could assert a common law tort claim against the bank. The ADS court held that, regardless of any alleged special relationship, when a dispute arises out of “a bank’s acceptance of an order transferring funds from one account held by its customer to another of that customer’s accounts” that the “Legislature intended Article 4A to constitute the exclusive means of determining the rights, duties and liabilities of affected parties.”

Permitting a non-customer to bring a common law negligence action would “contravene” the risk allocation and redefine bank’s duties, which the court declared the “essential objective of Article 4A.” Indeed, the court reasoned that permitting non-customers to bring common law claims could give them more rights than bank customers in unauthorized transfer cases.

After ADS, in New Jersey only bank customers may bring claims against banks relating to unauthorized electronic transfers – including those made through online banking – and those claims only may be brought under Article 4A of the UCC.  Non-customers may not bring claims alleging breaches under the common law, because the exclusive remedy for those transfers is set out in Article 4A.

Ninth Circuit holds that, for purposes of diversity jurisdiction, a national bank is not a citizen of the state in which it maintains its principal place of business

By Stephen J. Shapiro

For purposes of determining diversity jurisdiction, national banks are “deemed citizens of the States in which they are . . . located.” 28 U.S.C § 1348.  In the recent case Rouse v. Wachovia Mortgage, FSB, the Ninth Circuit held that a national bank is not “located” in the state of its principal place of business, but rather is located only in the state of its main office.

The plaintiffs in Rouse sued Wells Fargo in California state court for claims relating to their home loan. The bank removed the case to federal court, alleging both federal question and diversity jurisdiction. When the plaintiffs, who are citizens of California, amended their complaint to assert only state law causes of action, the district court concluded that it lacked diversity jurisdiction and remanded the case to state court. The district court reasoned that the parties were not diverse because, in addition to being a citizen of South Dakota, the state in which its main office is located, the bank also is a citizen of California, the state in which its principal place of business is located.

On appeal, the Ninth Circuit reversed. The Court first noted that, although the Supreme Court held in Wachovia Bank, N.A. v. Schmidt that a national bank is not “located” for purposes of section 1348 in each state in which it has a branch, it did not address the instant question – whether a national bank is a citizen of the state in which it maintains its principal place of business. Therefore, the Ninth Circuit set out to determine the Congressional intent behind section 1348.

Looking to the history of the diversity statutes, the Court observed that, at the time the current version of section 1348 was enacted (in 1948), state-chartered corporations were deemed citizens only of the states in which they were incorporated. In 1958, though, Congress revised 28 U.S.C. § 1332(c)(1) to provide that state-chartered corporations also would be considered citizens of the states in which they maintain their principal places of business. When it made this change, however, Congress did not amend section 1348 to make a similar change for national banks. Given that history, the Court concluded that: (1) at the time it enacted section 1348, Congress did not intend that a national bank’s principal place of business would determine its citizenship; and (2) Congress purposefully passed on the opportunity to provide otherwise by refraining from amending section 1348 as it had amended section 1332(c)(1). Therefore, the Ninth Circuit (like the Eighth Circuit) held that “under § 1348, a national banking association is a citizen only of the state in which its main office is located.”

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