The Ninth Circuit recently reversed its previous interpretation of Delaware law restricting a bank from increasing the interest rate charged upon a default of the borrower. In McCoy v. Chase Manhattan Bank, USA, N.A., 06-56278, 2011 WL 3634158 (9th Cir. Aug. 19, 2011), the plaintiff filed a class action lawsuit in the Central District of California against Chase for increasing “his interest rates retroactively to the beginning of his payment cycle after his account was closed to new transactions as a result of a late payment to Chase or another creditor.” The plaintiff claimed that “the rate increase violated the notice requirements of the Truth in Lending Act (“TILA”), 15 U.S.C. §§ 1601–1615, because Chase failed to give notice of the increase until it had already taken effect.” The plaintiff also asserted violations of Delaware state law, “claiming that the Delaware Banking Act did not authorize discretionary post-default rate increases, but only rates of interest that ‘vary in accordance with a schedule or formula.’ 5 Del. C. § 944.” The district court granted Chase’s motion to dismiss for failure to state a claim as to both the TILA claim and the state causes of action.
When it initially reviewed the case on appeal, the Ninth Circuit reversed dismissal of the TILA claim concluding that “McCoy had stated a federal claim for violation of TILA and Regulation Z, 12 C.F.R. § 226, for Chase's failure to give notice of a discretionary interest rate increase due to consumer default.” The court also reversed dismissal of the Delaware state law claims holding that the “decision to increase rates upon default was discretionary and not based on a ‘schedule or formula,’” which the Ninth Circuit interpreted the Delaware statute to require.
The Supreme Court reviewed the Ninth Circuit’s reversal of the district court’s dismissal of the TILA claim. In doing so, the Court first recognized that Section 226.9 of TILA’s Regulation Z requires a lender to provide prior notice before it changes a loan agreement term that is subject to TILA’s initial disclosure requirements. Relying on an amicus brief submitted by the Board of Governors of the Federal Reserve System, the Supreme Court ultimately held that the TILA notice requirement only applies to a change in loan terms. However, when an agreement contains a provision that gives the lender discretion to increase the rate, up to a stated maximum, in the event of the borrower’s delinquency or default, a rate increase made pursuant to that provision is not a change in terms that would trigger a notice obligation. Such is the case because the original terms of the agreement provided for the rate increase and there was no change in loan terms simply because it was triggered. Accordingly, the Court reversed the Ninth Circuit’s interpretation of TILA.
On remand, the Ninth Circuit dismissed the TILA claim in light of the Court’s ruling. Although the Supreme Court had not addressed it, the Ninth Circuit then revisited its prior ruling reinstating the plaintiff’s claim for violation of the Section 944 of the Delaware Banking Act. That provision prohibits a lender from imposing a post-default rate increases, unless such increase was done “in accordance with a schedule or formula.” 5 Del. C. § 944. The court had previously reversed the district court’s dismissal of that claim finding that the discretionary increase permitted by the loan agreement did not qualify as a “schedule or formula” that would satisfy Delaware law.
The Ninth Circuit revisited the state law issue in light of decisions by the First Circuit, in Shaner v. Chase Bank USA, N.A., 587 F.3d 488, 494 (1st Cir. 2009), and the Seventh Circuit, in Swanson v. Bank of America, 563 F.3d 634, 636 (7th Cir. 2009), that were contrary to the Ninth Circuit’s initial interpretation of Delaware law. Those circuit courts held that the statute does not limit discretionary post-default rate increases to only those made pursuant to a “schedule or formula” in the loan agreement. Rather, the statute permits such rate creases as long as they are authorized by the loan agreement, even if not reflected in a “schedule or formula” and are less than the maximum interest rate permitted in the event of default.
The Ninth Circuit also recognized that following its initial review of the case, the Delaware legislature had amended Section 944 with a provision that “[n]othing herein precludes a bank from charging or reserving a right to charge, by discretion or otherwise, a rate lower than any maximum rate provided for in any schedule or formula.” The court took this amendment to the statute as confirming the interpretations by the First and Seventh Circuits and rejecting the earlier Ninth Circuit interpretation.
In so holding, the Ninth Circuit rejected the plaintiff’s argument that reliance on that subsequent amendment to Section 944 amount to an ex post facto application of a law. According to the court, the amendment was made with the purpose of addressing an ambiguity that had previously existed in Section 944, and was not a new law in its own right. There was, therefore, no concern with retroactive application of a new law.
The circuit court also rejected the plaintiff’s argument that the amendment’s reference to a “schedule or formula” simply confirmed the Ninth Circuit’s previous interpretation which limited permissible post default rate increases to only those done pursuant to a schedule or formula. Instead, the court held that “the statute clearly indicates that a ‘permissible schedule or formula’ can include a provision to change the interest rate ‘contingent upon the happening of any event or circumstance specified in the plan,’ which may include borrower default.” Accordingly, the amendment clarifies “that banks are free to charge, by discretion or otherwise, a rate lower than any maximum rate provided for in the agreement.” In so holding, the Ninth Circuit affirmed dismissal of the state causes of action and dismissed the lawsuit with prejudice.
The outcome of the McCoy case is notable because the Ninth Circuit chose to reverse itself in the face of several subsequent circuit court decisions that reached a contrary interpretation. The court’s new interpretation of Section 944 makes sense in light of the Supreme Court’s ruling on the TILA claim which sought to uphold the express provisions of a loan agreement, even if the agreement gave discretion to the lender to raise interest rates retroactively. The Section 944 ruling, likewise, seeks to give effect to the express terms of a loan agreement which would have put the borrower on notice of the lender’s discretion to raise rates when a triggering event, such as a default, occurred.