SUPREME COURT UPHOLDS REGULATION Z IN PFENNIG
The United States Supreme Court, in a unanimous opinion, today upheld the Federal Reserve Board’s (FRB) exclusion of overlimit fees from the definition of “finance charge’ in Regulation Z. Household Credit Servs., Inc. v. Pfennig, 541 U.S. _, No. 02-857 (April 21, 2004). The case arose from a decision by the United States Court of Appeals for the Sixth Circuit, which held that overlimit fees imposed after a credit card holder is permitted to make purchases beyond the established credit limit fall “squarely within the statutory definition of a finance charge” as “incident to an extension of credit,” and found Regulation Z’s exclusion of such overlimit fees from the definition of “finance charge” to be invalid. The appellate court limited its holding to those creditors who knowingly permit the credit card holder to exceed the established credit limit and then impose a fee incident to that extension of credit.
In disagreeing with the Sixth Circuit’s characterization of the credit transaction under consideration, the Supreme Court stated that “[b]ecause overlimit fees, regardless of a creditor’s particular billing practices, are imposed only when a consumer exceeds his credit limit, it is perfectly reasonable to characterize an overlimit fee not as a charge imposed for obtaining an extension of credit over a consumer’s credit limit, but rather as a penalty for violating the credit agreement.” Id., slip op. at 7. Regardless of characterization, however, the Court recognized a connection between the overlimit fee and an extension of credit. Still, because the phrase “incident to” used in the Truth in Lending Act’s definition of “finance charge” does not make clear whether a substantial or remote connection is required, the Court determined that it could not conclude that the term “finance charge,” the Court determined that it was bound to follow the FRB’s regulation unless it is “procedurally defective, arbitrary or capricious in substance, or manifestly contrary to the statute.” Id., slip op, at 9, quoting United States v. Mead Corp, 533 U.S. 218, 227 (2001). Because, as it had stated earlier, an overlimit fee reasonably can be characterized as a penalty for defaulting on a credit agreement, the Court found the FRB’s regulation to be reasonable.
While the Court’s decision does not alter the long-standing definition of “finance charge” in Regulation Z, it illustrates the importance of careful drafting of credit card agreements, particularly with respect to credit limits and overlimit fees (e.g., using language making it clear that overlimit fees are a consequence of the cardholder’s default).