The United States Supreme Court held that reckless violations of the Fair Credit Reporting Act (“FCRA”) constitute a willful failure to comply, subjecting violators to liability for actual damages, statutory penalties and potentially punitive damages. Safeco Ins. Co. of America v. Burr, 551 U.S. _____ (June 4, 2007).

The FCRA requires notice to any consumer subjected to an adverse action based in whole or in part on any information contained in a consumer credit report. Congress enacted the FCRA to ensure “fair and accurate credit reporting, promote efficiency in the banking system, and protect consumer privacy.” To achieve these purposes, the Act requires the notice to identify the adverse action, explain how to reach the agency that reported on the consumer’s credit, and inform consumers that they are entitled to a free copy of their credit report and can dispute the accuracy of the report with the agency.

In the context of the insurance world, “adverse action” includes any denial of requested coverage, cancellation or reduction of existing coverage, increase in premiums, additional charges, or other unfavorable change in the terms of the consumer’s insurance coverage.

Both GEICO and Safeco petitioned the United States Supreme Court for review of a determination by the U.S. Court of Appeals for the Ninth Circuit that reckless disregard for the notice provisions constitutes a willful violation of the FCRA.

Rate Quotes

The Supreme Court began its analysis with an examination of both insurers’ practices for quoting insurance rates.

GEICO employed a four-tier system for underwriting auto insurance. The top two tiers were reserved for low-risk consumers and government employees, both of which received the most favorable rates. The bottom two tiers covered moderate-risk consumers and high-risk consumers. With permission, GEICO checked the applying consumer’s credit report, and the information was fed into GEICO’s computer system, which then determined the appropriate tier and rate that would apply to the particular applicant.

Initially, GEICO’s quoted rates were based in part on the applicant’s credit history. GEICO, however, subsequently changed its method of quoting rates by referring to an applicant’s “neutral” credit score rather than his or her actual credit score. GEICO then sent notices of adverse action only to applicants in instances in which the neutral score placed the applicant in a more favorable tier than the applicant’s actual credit

The Ninth Circuit held that the landlord’s clean-up expenses were not limited by the 502(b)(6), cap and should be allowed as a separate claim in the bankruptcy case. The court relied on the difference between damages “resulting from” lease rejection (capped under 502(b)(6)) and damages resulting from the “pile of dirt allegedly left on the property” and not related to 2rejection (not capped under 502(b)(6)). The distinction is between a contract/lease claim—which exists only because of rejection and which a landlord can mitigate by re-letting—and a tort or tort-like claim that exists independent of rejection and cannot be mitigated by re-letting.

The court’s logic, although appealing, may be a bit over simplified. Re-letting of many premises requires a landlord to make a substantial investment in brokerage fees, new tenant improvements, and other costs, but those types of costs are capped. Likewise, the court is silent on what happens if the lease contains ordinary boiler plate provisions forbidding tenant-caused environmental contamina( tion and requiring the tenant to return the premises in its original condition.

Nevertheless, the opinion makes common sense and has a logical discussion of how bankruptcy policy supports the result.

El Toro may affect negotiations over security deposits. Security deposit and other collateral-like letters of credit must 7be applied against the 502(b)(6) cap (In re AB Liquidating Corp.), 416 F.3d. 961 (9th Cir. 2005)), and refunded to the extent such proceeds exceed the cap (In re Builders Transport, Inc. 471 F.3d 1178, 1191 (11th Cir. 2006)), although there is some contrary authority. EOP-Colonnade of Dallas Limited Partnership v. Dennis Faulkner (In re Stonebridge Technologies, Inc.) 430 F.3d. 260 (5th Cir. 2005). In light of El Toro, landlords may demand a security deposit for the potential 502(b)(6) capped loss of rental income, and another deposit for uncapped claims such as environmental problems.