United States: CFPB Finalizes Rule Significantly Restricting Credit Card Late Fees—Litigation Immediately Follows

On March 5, the Consumer Financial Protection Bureau ("CFPB" or "Bureau") issued a Final Rule that would significantly restrict late fees that consumer credit card issuers may charge from $30 or $41, in most cases, to a mere $8. As finalized, the rulemaking largely aligns with the Bureau's Proposed Rule on the same subject matter issued February 1, 2023, with certain differences described below.

Within two days, however, the Final Rule already faced a challenge to its validity through litigation brought in the Northern District of Texas by a coalition of trade groups including the United States Chamber of Commerce, the American Bankers Association, and the Consumer Bankers Association. The challenge seeks invalidation of the Final Rule on several constitutional, procedural, and substantive bases, as well as a temporary stay of the rule's effectiveness while the suit progresses.

In this Legal Update, we frame the Final Rule within current law, and describe the changes imposed by it, the current litigation against it, and the likely industry implications were the rule to become effective.

Limitations on Credit Card Late Fees under Current Law

Late fees for traditional consumer credit card accounts are regulated at the federal level by provisions of the Credit Card Accountability Responsibility and Disclosure Act (the "CARD Act," which is an element of the federal Truth in Lending Act ("TILA")) that are implemented by Regulation Z.

Under current regulation, the relevant Regulation Z provisions address "penalty fees" on a basis agnostic to the specific type of fee. A "penalty fee" is any fee imposed on a consumer for violating the terms or other requirements of a CARD Act-regulated credit card account. These include, for example, late fees, non-sufficient funds ("NSF") fees, and over-limit fees.

Each such penalty fee is subject to three distinct limitations.

• First, penalty fees must be set no higher than: (i) specified safe harbor values, currently $30 for an initial violation and $41 for a subsequent violation for credit card accounts,¹ with such dollar amounts subject to automatic annual adjustments for inflation; or (ii) an amount—supported by appropriate analysis updated at least every 12 months—that represents a reasonable proportion of the total costs incurred by the card issuer as a result of the type of violation.² Costs that may be considered largely are hard costs, exclusive of credit losses and associated costs such as those related to holding reserves against losses and analytical costs associated with determining whether consumers are likely to violate the account term at issue.³ In practice, the administrative burden of analysis is sufficient that effectively all consumer credit card issuers impose penalty fees at or below the safe harbor values.
• Second, notwithstanding the safe harbors or analysis-supported fee values, no penalty fee may exceed the dollar amount associated with the violation (e.g., a late fee may not exceed the value of the minimum required payment that was late).⁴
• Third, a card issuer may not impose more than one fee for violating the terms of an account based on a single event or transaction (e.g., attempting to make a required payment with a check that bounces may result in either a fee for the returned payment or a late fee for the minimum required payment not being made, but not both).⁵

Content of Final Rule

The Final Rule would change the fee requirements described above, beginning May 14, 2024, were it to become effective.

In response to comments that the Proposed Rule would impose undue burdens on small card issuers, the CFPB's Final Rule restricting late fees does not apply to "Smaller Card Issuers," which it defines as a card issuer that, together with its affiliates, had fewer than one million open credit card accounts for the entire preceding calendar year. However, if a card issuer and its affiliates had fewer than one million open credit card accounts for the entire preceding calendar year, but then meets or exceeds the one million threshold in the current calendar year, that card issuer will no longer be considered a Smaller Card Issuer as of 60 days after it meets or exceeds the threshold, and will be subject to the late fee restrictions under the Final Rule. Notwithstanding the exemption for Smaller Card Issuers, the Bureau indicates that approximately 95% of card balances would be covered by the Final Rule.

Material amendments likely to be adverse to the interests of card issuers (other than Small Card Issuers) include:

• Reduction of the basic safe harbor limit for late fees for credit card accounts from $30 to $8;
• Elimination of the distinction between first and subsequent violations (violations of the same type that occur during the same billing cycle or in one of the next six billing cycle) for late fee purposes, such that the current $41 safe harbor would no longer apply; and
• Elimination of the automatic annual inflation adjustments to the $8 safe harbor limit, such that the real value of the safe harbor would fall over time unless the Bureau took separate steps to raise the value in any given year.

Instead of relying on the safe harbor limit for late fees, as before the Final Rule, card issuers may still impose fees representing a "reasonable proportion of the total costs incurred by the card issuer" as a result of the violation of the credit card agreement. With respect to that provision, the Final Rule merely clarifies that card issuers must not include any collection costs incurred after an account is charged off in conducting their cost analyses. That said, given that the cost analysis requires significant procedural and examination burdens, virtually all card issuers have relied on the safe harbor limit historically. Indeed, the Bureau noted in the Final Rule that, from its 2022 analysis of credit card agreements submitted to its database, it has found no evidence of any issuers using the cost analysis provisions to charge an amount higher than the safe harbor value.

Limited positive news for card issuers beyond the exemption of Smaller Card Issuers includes that, in the Final Rule, the CFPB:

• did not adopt a provision in its Proposed Rule that would have limited late fees to 25% of a consumer's minimum required payment (down from 100% under current law);
• did not impose a new mandatory 15-day grace period before a card issuer may charge late fees, which it had contemplated in the Proposed Rule; and
• mandated the 2024 inflation adjustment for penalty fees other than late fees (or, for Smaller Card Issuers, including late fees), moving the relevant safe harbor values from $30/$41 to $32/$43 for initial and subsequent violations within six billing cycles.

Litigation Challenging the Final Rule

Ink barely dried on the CFPB's Final Rule before trade groups sued to delay its implementation and, ultimately, seek its invalidation. In a March 7 complaint filed in the Northern District of Texas (the "Trade Group Complaint"),⁶ trade groups raised a series of concerns with the Final Rule and the manner in which it was developed. Each such concern was well-presaged in industry comments submitted in connection with the Proposed Rule, and the limited extent to which the Final Rule varied from the Proposed Rule likely aided trade groups in their ability to bring action quickly.

With respect to particular, substantive statutory obligations imposed on the CFPB's rulemaking in this matter, the Trade Group Complaint takes issue with the Bureau's alleged disregard of statutory standards for evaluating the reasonableness of penalty fees. Specifically, provisions of the CARD Act regarding penalty fee rulemaking required the relevant regulator (initially, the Board of Governors of the Federal Reserve System ("Federal Reserve"), with authority later transferred to the CFPB in 2011) to issue rules establishing standards for assessing the reasonableness and proportionality of credit card penalty fees after consideration of: (i) the cost incurred by the creditor from an omission or violation; (ii) deterrence of omissions or violations by the cardholder; (iii) conduct of the cardholder; and (iv) such other factors deemed necessary or appropriate by the relevant regulator. The CARD Act also granted the regulator discretion to provide for a penalty fee that is presumed to be "reasonable and proportional" to the omission or violation—i.e., a safe harbor value.

The preamble to the Final Rule indicates that the CFPB heavily focused on the cost prong, and received substantial pushback from industry commenters challenging Bureau methodology in calculating costs. Many commenters to the Proposed Rule criticized the CFPB's analysis of the deterrence prong. Several industry commenters asserted that the Bureau did not provide sufficient evidence that the reduced safe harbor limit would deter late payments, arguing that the ability to make late payments for a fee could be viewed as a credit product, the quantity demanded of which increases when price decreases. In finalizing the rule, the Bureau noted that even if the proposed amount results in an increase in late payments, borrowers may benefit from greater ability to pay revolving debt, though a commenter argued that potential consumer benefit is irrelevant to the Bureau's statutory mandate to consider the deterrence effect. The Trade Group Complaint aligns with such comments, alleging that the Final Rule is unlawful because the Bureau did not sufficiently consider the role that late fees play in "deterrence of omissions or violations by the cardholder."

Additionally, under broader requirements of the Administrative Procedures Act not necessarily specific to the particular subject matter of the Final Rule, the Trade Group Complaint takes issue both with: (i) the arbitrary and capricious manner of the Bureau's decision-making around issues such as estimations of card issuer costs, disregard of deterrent effects, and disregard of post-charge-off collection costs, and (ii) reliance on certain non-public data (specifically FR Y-14M data through which the Federal Reserve collects relatively detailed information regarding banks' credit card and loan portfolios on a monthly basis) that has not, and, based on Bureau intentions, will not, be published. Claims challenging rulemaking as arbitrary and capricious for lack of sufficient analysis are relatively common, but the challenge to use of nonpublic data is more specific to this rulemaking. With respect to publication of data, in particular, the Bureau explained that it considered FR Y-14M data from the Federal Reserve, which includes confidential supervisory information that would not be released in raw form. Commenters, and, ultimately the Trade Group Complaint, essentially frame the limitation on data as an Administrative Procedures Act violation because it deprived the public of a reasonable ability to comment on the Proposed Rule or understand the decisions ultimately reached by the Bureau.

Finally, the Trade Group Complaint raises a challenge to the constitutionality of the CFPB's funding structure similar to that already before the Supreme Court in CFSA v. CFPB (argued in October 2023 and likely to be decided before the Supreme Court's 2024 summer recess).⁷ The existing case seems likely to resolve that funding claim, though presentation of the claim in the Trade Group Complaint arguably helps tie the challenge to ongoing litigation in a manner that may support a preliminary injunction staying the Final Rule's effective date pending the outcome of CFSA v. CFPB, as has been the case for certain other CFPB-related litigation, including ongoing actions addressing the Bureau's 1071 small business credit data collection rule⁸ and the Bureau's use of informal guidance, in the form of updates to its Examination Manual, to implement substantive regulation consisting of including anti-discrimination concepts within the CFPB-administered prohibition on unfair, deceptive, or abusive acts and practices ("UDAAPs").⁹ A motion for such a preliminary injunction and a brief in support of that motion were filed alongside the Trade Group Complaint on March 7.

Industry Impact

Given the challenges presented by the Trade Group Complaint, it is possible that the Final Rule may never become effective in its current form. If, however, the Final Rule does become effective (even on a delayed basis), it will likely substantially affect the availability and terms of consumer credit card accounts.

As a first-order effect, dramatic reduction in safe harbor fee values likely will reduce fee revenues and increase delinquency rates for card issuers and investors in consumer card receivables. While fee revenue and deterrent effect reduction could be offset, at least in part for some issuers, through conducting cost analysis to justify higher fees than the safe harbor value, such an outcome seems unlikely given historic reluctance to rely on the cost analysis provisions, the administrative burdens of the analysis itself, and the likelihood that reliance on cost analysis to charge higher late fees would make a card issuer a greater target for regulatory investigation or private actions.

More likely, card issuers may engage in a combination of offsetting behaviors as second-order effects. These may include, for example: (i) increasing top-line numeric interest rates to generate higher revenue on delinquent accounts and serve as a better deterrent; (ii) tightening credit standards, resulting in greater selectivity around credit application approvals and initial credit limit assignments; and/or (iii) more quickly applying after-the-fact protections such as credit limit reductions, line suspensions, or account terminations to delinquent consumers.

Since credit card portfolios are often securitized, there may also be pricing impact on the secondary market. Investors may be concerned with the impact the reduced fee revenue may have on securitization trust metrics such as excess spread, particularly with the recent rising interest rates on issued securitization debt. While the market for credit card receivables is robust enough to handle much of the pricing shock, there may well be some reduction in financing and/or secondary market outlets available to card issuers that could ultimately reduce the availability of card-based credit to at least some portion of the overall consumer population. Moderate-sized card issuers (too large to be exempt from the Final Rule's changes as Smaller Card Issuers, but likely to have somewhat less leverage in the secondary market) and consumers down the credit spectrum seem particularly likely to face adverse impact as a result of the Final Rule—again, if it ever becomes effective in its current form.

Placement within the Broader Regulatory Context—the CFPB's Junk Fee Initiative

The Final Rule is the latest—and potentially most impactful—of the Bureau's moves in its ongoing campaign against "junk fees," through which the Bureau seeks limitations on a variety of consumer-facing charges it deems to be inconsistent with consumer protection objectives.¹⁰ With respect to the Final Rule, CFPB Director Rohit Chopra proclaimed that the Final Rule closed a regulatory "loophole" that major credit card issuers "exploited...to harvest billions of dollars in junk fees" annually.

Other fees the Bureau appears to categorize similarly include, for example:

• NSF Fees—certain non-sufficient funds (NSF) or returned payment fees on transactions a financial institution declines in real time;
• Overdraft Fees—certain fees associated with the extension of short-term overdraft loans in connection with consumer deposit accounts;
• Customer Service Fees—including certain fees for provision of paper statements and fees imposed for provision of customer service related to providing basic account information or responding to inquiries or complaints.
• "Worthless Add-on Product Fees"—including fees for insurance or similar products charged after an auto loan has been satisfied in full or the protected collateral has been repossessed.

Some of the CFPB's action in the junk fee space has targeted narrow fact patterns under which consumers may receive little or no value from the payment of a fee and/or are denied meaningful access to basic legal or contractual protections without paying; but the Bureau's most aggressive positions—including the Final Rule—expand the reach of its junk fee construct to charges that are both: (i) typical and anticipated for the type of consumer financial product or service at issue, and (ii) core to the framing of incentives around responsible access to and use of such consumer financial products and services.

Late fees, in particular, are also among the most understandable and well-disclosed fees that exist across the consumer financial marketplace and play an important role in incentivizing on-time payments that lower the cost of credit across the industry as a whole and help individual consumers build better credit profiles. Yet, the Bureau positions them as though they are little more than financial institution cash grabs.

While the Bureau has a clear statutory authority and responsibility to establish rules regarding appropriate late fees for consumer credit card products, looping the Final Rule into a broader political campaign against junk fees suggests a more moralized approach than the technical one structured by TILA. In that light, it should be no surprise that the industry views the Final Rule as unwarranted and destabilizing.

Footnotes

1. A separate safe harbor of 3% of the delinquent balance on a charge card account that requires payment of the outstanding balance in full at the end of each billing cycle if the card issuer has not received the required payment for two or more billing cycles is not affected by the Final Rule and is not further discussed in this Legal Update.

2. 12 C.F.R. § 1026.52(b)(1).

3. Official Interpretation to 12 C.F.R. § 52(b)(1)(i).

4. 12 C.F.R. § 1026.52(b)(2)(i).

5. 12 C.F.R. § 1026.52(b)(2)(ii).

6. Chamber of Commerce et al. v. Consumer Financial Protection Bureau, Case No. 4:24-CV-213 (N. D. Tex. Mar. 7, 2024).

7. Community Financial Services Association of America, Ltd. v. Consumer Financial Protection Bureau, Case No. 1:18-CV-295 (W.D. Tex. October 19, 2022).

8. Texas Bankers Assoc. v. Consumer Financial Protection Bureau, Case No. 7:23-cv-00144 (S. D. Tex. October 26, 2023).

9. Chamber of Commerce v. Consumer Financial Protection Bureau, Case No. 6:22-cv-00381 (E.D. Tex. September 8, 2023).

10. For a general discussion, see Mayer Brown's March 2023 and February 2024 Legal Updates.