Overdraft and non-sufficient funds (NSF) fees can generate consistent and considerable revenue for financial institutions. The fees are not without risk, however, as many financial institutions have been targeted over the last decade in long-running consumer class actions based on overdraft and NSF practices. Though a first wave of overdraft litigation has receded, another is on the horizon. The lessons learned over the last few years can save your financial institution from falling victim to these new theories of liability.

The First Surge

The first wave of litigation challenged banks’ overdraft fee practices and overdraft protection services. In most cases, class plaintiffs contended that banks reordered transactions to maximize overdraft fees. Consumers alleged that banks, in the daily posting process, would pay the largest items first, meaning that a large transaction that overdrafted the account would subject all other transactions to overdraft fees. For example, if a consumer had $1,000 in her account and authorized transactions in the amounts of $50, $25, and $1,100, some banks would post the $1,100 item first, followed by the $50 and $25 items. Consumers complained that this ordering caused them to incur three overdraft fees, rather than just one. Banks, on the other hand, noted that consumers’ largest withdrawals are often the most important – often for mortgages, school tuition, or the like.

These cases had an effect on the industry, leading to major adverse decisions and settlements. At least one financial institution was forced to pay over $200 million in restitution to its customers.

A New Wave on the Horizon

Though the dust has barely cleared from the first wave of overdraft fee litigation, a second wave is upon us. These new claims are largely focused on debit card transactions and feature three interrelated theories of liability: approve positive/settle negative (APSN), ledger balance/available balance, and an omnibus theory.

The APSN theory argues that where a depository institution approves a debit card transaction because of a positive balance at the time of approval, the institution cannot treat the transaction as an overdraft at the time of settlement. This claim is largely based on consumer expectations that debit card transactions are “immediate.” In other words, consumers conflate the preliminary approval and later settlement of charges on debit cards. Because of this confusion, consumers expect that any debit transaction that is approved at the point of sale will not be treated as an overdraft later.

Some financial institutions use the ledger balance (which accounts for only settled items) rather than the available balance (which incorporates both settled and authorized, but unsettled items) when assessing overdraft fees. The ledger balance/available balance theory posits that a financial institution cannot use an available balance method to calculate overdrafts that would count in the calculation of a negative balance due to pending transactions, such as debit card holds. In essence, the ledger balance/available balance theory is the inverse of the APSN theory. Where the APSN theory ignores the fact that items initially approved must later be presented for payment, the ledger balance/available balance theory says that items initially approved, in some cases, may never be presented for payment.

Finally, in the omnibus theory of liability, plaintiffs allege that there is no agreement between the financial institution and the consumer regarding the treatment of overdraft fees. In these cases, the consumer has not agreed to an opt-in program or, if the consumer does opt in, the financial institution charges fees under circumstances that are not contemplated by the agreement.

A View from the Courts

Banks have had limited success curbing this new wave of litigation by challenging the sufficiency of plaintiffs’ complaints. The District of Massachusetts was one of the first to weigh in on these allegations in Salls v. Digital Federal Credit Union.[1] The named plaintiff alleged that the defendant charged her an overdraft fee when the actual balance on her account, i.e., the ledger balance, was sufficient to cover the transaction but acknowledged that the available balance was not. The defendant moved to dismiss the case, contending that its overdraft opt-in agreement, when read in conjunction with the account agreement, negated the plaintiff’s claims. The court disagreed, finding the term “available balance” was not properly defined and was ambiguous. The court further found that neither the overdraft opt-in agreement nor the account agreement properly explained to consumers how their balances would be calculated for purposes of overdrafts. The case was later settled on a class basis for $1.8 million.

In the Eastern District of Virginia, another ledger balance/available balance case survived a motion to dismiss. Liggio v. Apple Federal Credit Union featured a plaintiff who had funds in her account to cover the supposed overdrafts. The defendant credit union challenged the complaint, contending that the plaintiff did not state a claim for breach of contract. Judge O’Grady of the Alexandria Division denied the motion to dismiss without issuing a written opinion. The parties settled the case soon thereafter for $2.7 million.

The Eleventh Circuit recently weighed in on similar claims in Tims v. LGE Community Credit Union.[2] The class plaintiff in Tims argued that the credit union breached its agreement with her when it used an available balance, rather than a ledger balance to assess overdraft fees. The Court of Appeals’ opinion focused on an interpretation of the contract but ultimately concluded that the challenged agreement was ambiguous and the case could proceed.

Key Takeaways

Account terms and conditions are critical to defending this new wave. Financial institutions must know the details regarding their account agreements, including any opt-in agreements. Financial institutions must also know the details of their actual practices – understand whether the promise is the practice. Finally, where a customer complains about overdraft fees or practices, issue a refund of the challenged fees. This increases the likelihood that the customer leaves happy and decreases the likelihood that he or she becomes the next class plaintiff.