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Leap Year Interest

posted by Adam Levitin

Call this the Pirates of Penzance card. Chase was recently sued over its calculation of finance charges in a leap year. The suit alleges that Chase computed the daily periodic rate applied to the plaintiff's balance based on a 365 day year when it was a 366 day leap year. The difference in rates resulted in an additional finance charge of 4 cents.

This suit is really pretty funny, unless you're Chase and looking at a class action claim for $100MM. But there's a lot that's confused in the plaintiff's complaint. The plaintiff seems to think that the periodic rate is derived from the annual percentage rate, that is one takes the APR and divides by the number of days in the year. But that's not how it's done. The APR is derived from the periodic rate.

[6/20/08 Correction: On rereading Reg Z, I'm not so sure about this. Sometimes the regs refer to multiplying and sometimes to dividing. The regs on forming the APR speak about multiplication. Multiplication and division are mathematically equivalent, but maybe Reg Z is using them exclusively. Elsewhere in Reg Z discounts on cash purchases are permitted, without permitting surcharges on credit card purchases. So maybe it is possible to be mathematically equivalent, but legally different. Bottom line is that this is an open question, so maybe it is fine to take the APR and work backwards. At least nothing clearly forbids it. In any case, the Regs give issuers a variety of ways to get the APR/periodic rate. Without stating the APR in the suit, one can’t tell whether Chase used the wrong periodic rate or APR—the suit says X is not 1/366 of Y, but the only way we can know that is to know what X and Y are. The suit only tells us X. It never tells us Y. Nor does it state what the cardholder agreement says about the method of calculations. Strange omissions from the pleadings.]

So at worst, Chase would [might] have misstated the APR, not the periodic rate (unless Chase wasn't following TILA calculation guidelines). But TILA/Reg Z has some tolerance for imprecise APRs and good faith errors. And one of the methods permitted for calculating the APR requires a multiplication by 365, regardless of whether it is a leap year. Obviously a lot of stuff depends on the facts, which are not as well pled as they might be. But I think there's a decent chance Chase was TILA/Reg Z compliant. The question, however, is whether that matters.

The plaintiff did not bring a TILA action. Instead, the plaintiff brought state law actions--breach of contract, unjust enrichment, breach of fiduciary duty (this one mystifies me), and unfair and deceptive trade practices. This raises the issue of whether TILA compliance is a defense to state law causes of action. Surprisingly, caselaw is all over the place on this, largely because of TILA's vague preemption language--state law is preempted only the extent inconsistent, which means that the answer will depend on the precise circumstances. I'm surprised the OCC hasn't jumped in on the side of Chase and other national banks. Perhaps that's because Reg Z is the Federal Reserve's domain, so the OCC's interpretation wouldn't get any special deference.

Regardless of the merits of this suit, it serves as a good reminder of why class actions are such an important mechanism. The harm of getting charged an extra day of interest on a credit card is too small for any individual to bother seeking redress (anyone who suggests talking to the issuer about a billing error on this is from Mars). But like the scheme in Office Space, swiping a few cents (or fractions of a cent) from lots of folks can amount to millions of dollars in unjust enrichment. And if we don't care about a few cents here or there, where do we draw the line? A few dollars? A few hundred dollars? While some might object that only the class action attorneys end up better off, this argument misses the deterrence effect of a strong class action bar. There are a lot of things that might prevent the deterrence effect from working as well as it could, such as insurance, risk-aversion, but their presence doesn't justify letting small harms pass.

[Corrected 6/20/08]

Comments

The method using multiplication by 365 applies to those situations in which

"the total finance charge imposed during the billing cycle does not exceed 50 cents ..."

12 CFR Ch.II
226.14 (d)(4)

In such a case the amount involved is truly insignificant. Not so, however, in those cases with high APR's, high balances, or (!) both.

Not only is JP Morgan Chase doing this, but from personal experience I can add Wells Fargo Bank, Bank of America, and Capital One.

The amount of money involved is staggering ...

JA

Correction to my earlier comment:

226.14 (d) does not refer to 50 cent finance charges.

lets just quote the whole thing:

226.14 (d) (d) Calculations where daily periodic
rate applied. If the provisions of paragraph
(c)(1)(ii) or (2) of this section
apply and all or a portion of the finance
charge is determined by the application
of one or more daily periodic
rates, the annual percentage rate may
be determined either:
(1) By dividing the total finance
charge by the average of the daily balances
and multiplying the quotient by
the number of billing cycles in a year;
or
(2) By dividing the total finance
charge by the sum of the daily balances
and multiplying the quotient by 365

JA

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