Overdraft Class Actions: What Credit Unions Need to Know in 2022

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Overdraft class action lawsuits remain one of the most serious risks facing credit unions. Overdraft class action lawsuits are relatively easy to file and can create multimillion-dollar payouts for law firms. Credit unions should not assume a small membership size or remote location is protection against these lawsuits. Because they are so lucrative, law firms advertise to consumers on their websites, touting multimillion-dollar settlements and frequently demonizing banks and credit unions alike as engaging in illegal or unfair practices.

Key concepts

There are several concepts that law firms use when filing class-action lawsuits. Credit unions should understand the types of overdrafts that place a credit union at risk of a class-action lawsuit.

Types of Fees

  1. Overdraft fee when the credit union approves a transaction that exceeds the balance available in the account.
  2. Nonsufficient Funds (NSF) fee – when the credit union rejects a transaction that overdraws the consumer’s balance.
  3. Overdraft transfer – when the credit union arranges a transfer from one account to another to cover the overdraft.
  4. Extended overdraft – when a consumer leaves the account balance in the negative for a certain number of days.

Available balance versus ledger (actual) balance

Modern banking allows debits and credits to apply to an account before funds are settled between institutions and posting the transaction to the account. The ledger or actual balance is the net sum of all posted credit and debit transactions against an account, while the available balance keeps track of outstanding debts that have not been settled and credits that have been posted but not cleared.

Settlement and posting of ATM and debit card transactions can take place one or more days after a credit union authorizes the transaction, and credit unions are obligated to settle (pay the merchant’s FI) all ATM and debit card transactions authorized up to the amount authorized. Credit unions are subject to overdraft class action lawsuits when the disclosures and/or account agreement is inaccurate regarding the credit union’s methodology for calculating and assessing overdraft fees.

Unfair, Deceptive, and Abusive Practices (UDAAP)

UDAAP is a broad consumer protection concept that can apply to inaccurate information, omissions, or misinterpretations in overdraft program descriptions, disclosures, agreements, or advertising. UDAAP is not limited to overdraft programs; however, UDAAP is often central to overdraft litigation. Mistakes in overdraft program disclosures, even if unintentional, are not a defense to UDAAP allegations.

Lawsuits and legal theories

High to low debit card transaction processing

If a financial institution reorders transactions from high to low regardless of when the transactions are processed, a consumer can incur significantly more fees. In the example below, the consumer spends the exact same amount of money on the same day and by the end has the exact same negative balance of -$60.

However, if the transactions are posted in order, the consumer is hit with only a single overdraft fee. If processed high to low, the consumer is subject to three overdraft fees being assessed.

PURCHASES (STARTING BALANCE OF $120) PROCESSED IN ORDER (RESULTING BALANCE) PROCESSED HIGH TO LOW (RESULTING BALANCE)
$20 $100 $20
$10 $90 -$30
$50 $40 -$50
$100 -$60 -$60

Available balance litigation

Although financial institutions claimed consumers received a benefit in “high-to-low” processing as a customer service that ensured important payments such as mortgages or car payments were handled first, this practice has been consistently held to be a violation of UDAAP.

If a financial institution uses available balance to calculate overdraft fees, law firms will allege available balance as an internal calculation used to assess overdraft fees when there still is money in the account.

As disclosed to the consumer: the credit union discloses that overdraft fees will only be charged when there is not enough money in the account to cover the transaction.

As actually determined: the credit union ignores whether there is money in the account and instead makes an automated determination based on the internal calculation of the available balance.

The allegation is that the use of an internal available balance to calculate overdraft fees rather than the money in the account to determine whether a transaction results in an overdraft fee violates consumer rights if not disclosed.

Improper opt-in

By law, credit unions cannot charge consumers overdraft fees on ATM and most debit card transactions unless the consumer has agreed (“opted in”) to these fees. Recently, courts have held that standalone use of Regulation E’s model form A-9 for opt-in overdraft coverage is not a safe harbor from overdraft litigation. The model form does not address which account balance calculation method is used to determine whether a transaction results in an overdraft. Forms provided by consulting firms or trade associations are also not a defense in these cases.

Multiple fees on the same transaction

The theory on these cases starts when a credit union’s account agreements and fee schedules state that only one overdraft or NSF fee will be charged “per item” or “per transaction.” However, the same item is eligible to incur multiple overdraft and NSF fees when that item is returned for insufficient funds and later re-presented one or more times.

  1. The credit union returns a check or ACH transaction for insufficient funds, the member incurs an NSF fee.
  2. The merchant or third party resubmits the returned transaction which again presents against insufficient funds.
  3. The credit union either (a) returns the resubmitted item and charges the customer a second NSF fee or (b) pays the resubmitted item and charges the customer an overdraft fee

Authorize positive, settle negative

The argument of the law firms will be that the original and resubmitted transactions are the same “item,” and therefore the assessment of more than one NSF or overdraft fee for that single “item” violates the account agreement or fee schedule if these state fees will be assessed on a “per item” basis.

This claim by law firms argues credit union’s account agreements and disclosures do not permit overdraft fees to be charged on items authorized on a positive account balance. Here’s an example of where a transaction can be authorized during a positive balance but settle as a negative balance.

Say a customer initiates a debit card purchase of $70 at a time when they had a $100 positive account balance and the institution authorizes the transaction; a hold is then placed on the customer’s account. Theoretically, they would have a positive balance of $30 left.

However, before the merchant submits the debit card purchase to the institution for payment, a check for $50 posts to the customer’s account, reducing the balance available from $100 to $50. So when the merchant presents the debit card purchase for payment, the customer’s account balance is no longer sufficient to cover it and they incur an overdraft fee, despite having the funds to cover it when the transaction was approved.

Law firms will argue credit unions cannot impose these fees without adequate disclosures.

Regulation D behavior fees

Regulation D was promulgated to ensure financial institutions have sufficient reserves by encouraging consumers to save money. Credit unions were allowed to charge fees if consumers had more than six withdrawals (“convenient transactions”) a month.

However, the Federal Reserve relaxed this rule in April 2020 due to concerns about consumers having enough money during the pandemic. Credit unions may be threatened with class action litigation if they continue to charge fees now that the Federal Reserve has relaxed these rules.

Continuous fees

This is a new theory, alleging sustained overdraft fees constitute interest charged by the financial institution for the use, forbearance, or detention of the money it has loaned to its customer by advancing the funds necessary to pay an overdraft. This theory has not yet been accepted by a court but has received support in some legal circles.

Risk management and mitigation

There is no way for a credit union to prevent litigation around overdraft fees. There are ways for credit unions to reduce the risk of overdraft class action lawsuits, by carefully reviewing disclosures and terms.

Disclosures and terms

The overwhelming common thread in overdraft cases is when the credit union fails to accurately disclose the precise method in which overdraft fees will be charged. All overdraft communications and disclosures need to be consistent, including printed and online materials.

Descriptions of overdraft practices should also be as clear and unambiguous as possible, especially with respect to high-risk practices such as transactions authorized on a positive account balance that can incur overdraft fees. Note that law firms are constantly advancing new overdraft claims and theories, and credit unions should ensure they and their counsel are up to date on the latest lawsuits.

SUBJECT MATTER REVIEW
Understanding account balance for overdrafts Confirm balances and how the credit union determines whether a transaction will cause an account to overdraw and be subject to fees are adequately described
Actual balance Should accurately describe what transactions are included and what ones are not included in the display of the balance
Available balance Needs to accurately describe holds placed on deposits and pending transactions
Example of overdraft fee for insufficient available balance Should describe reasonable scenarios on how overdraft fees can be incurred
How transactions are posted to the account Describe clearly how each transaction is handled so a consumer knows how much money the consumer has available to use in the account

Frequently Asked Questions (FAQs)

Having accurate FAQs as a resource for members can also help a credit union with a defense against an overdraft class action lawsuit. These FAQs could include answers to the following questions:

  • Why does the credit union use debit card authorization holds?
  • Are holds used to increase overdraft fees?
  • Will the debit card authorization hold equal to the final amount of the transaction?
  • How can I reduce the impact of debit card authorization holds?
  • What is a gas station or fuel hold?
  • What is a travel hold?
  • How are online transactions treated?
  • When will an authorization hold be removed?
  • Can I request that a hold be removed?

Other considerations for managing overdraft risk

In addition to the other mitigation options, there are some further considerations for overdraft class action risk mitigation.

  • Does your information clearly explain when an overdraft transfer will occur?
  • Are members informed of the priority of options if their checking account does not contain sufficient available funds? For example, will a transfer of available funds in a savings account occur prior to overdraft protection?
  • Does a member need to specifically identify a priority or does the credit union have a default option (and, if so, is this option known)?
  • If a member has opted in for overdrafts of ATM and one-time debit card transactions, is the member informed of the ability to revoke that consent?
  • Can a member opt-out of overdraft protection completely? If so, is the process for doing so clearly communicated?
  • Does the credit union have clearly communicated special rules for ATM and one-time debit card transactions?
  • Has the credit union ensured that there is an opt-in from members (meaning no opt-in = no fee)? Note that the credit union can pay the transactions, just not assess the fees?
  • Are members informed of alternatives to overdrafts?
  • Has the credit union explained the overdraft priority (and whether members can request an alternative process)?
  • Does the credit union have a process to review those members who are charged the most fees, and have an option to reach out to discuss alternatives?
  • Does the credit union have fee caps, de minimis, or a forgiveness program?

Be open and clear

As stated above, there is no way for a credit union to prevent litigation around overdraft fees, but by ensuring your credit union is open and transparent with how they calculate fees and handle member opt-in and opt-out, they can significantly decrease their chances of facing litigation. Review your credit union’s practices and paperwork to uncover ambiguous phrasing that could lead to confusion.

Authors


  • Internal Auditor, CU*Answers


  • Mr. Vilker has been in the credit union compliance, regulatory, and audit space for over 30 years. Over that time he has served as a regulator, credit union executive, and currently as the leader of AuditLink, a division of cooperative CUSO CU*Answers. Jim achieved his NAFCU Certified Compliance Officer (NCCO) designation in 2009 and recently received his Certified Anti-Money Laundering Specialist (CAMS) certification from ACAMS.

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