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Consumer Credit Regulation: 7.9.1.1 Introduction

Sometimes a consumer prefers to litigate a claim in federal court. Even if the consumer files in state court, the creditor may have the right to remove the case to federal court. This subsection provides a brief outline of issues regarding federal jurisdiction in consumer credit cases, including unique issues that apply to usury claims and claims against federally chartered banks.

Consumer Credit Regulation: 7.9.1.3.1 Nature of complete preemption

The doctrine of complete preemption is a rare, but important, exception to the rule that a case raising only state law claims cannot be removed to federal court simply because federal law might preempt those claims. When a federal statute completely preempts a state law cause of action, then a claim that comes within the scope of the federal statute, even if pleaded solely in terms of state law, is in reality a federal claim and is removable.1043

Consumer Credit Regulation: 7.9.1.3.2 Complete preemption under the National Bank Act

In Beneficial Bank v. Anderson, the Supreme Court identified one portion of the National Bank Act as completely preempting state law: usury claims that are raised against national banks.1050 The Court held that sections 85 and 86 of the National Bank Act provide the exclusive cause of action for these claims. Thus, any case raising a state law usury claim against a national bank is removable to federal court.

Consumer Credit Regulation: 7.9.1.3.3 Assignees, non-banks, and state-chartered banks

In a pre-Beneficial Bank case, the Eighth Circuit held that once an open-end credit account is assigned to a national bank, any claim about the illegality of the interest rate is a usury claim against the bank and thus is completely preempted.1062 On the other hand, the National Bank Act does not completely preempt usury claims against a non-bank purchaser of loans, even loans originated by national banks.1063

Consumer Credit Regulation: 7.9.1.4 Diversity Jurisdiction

For diversity jurisdiction, the action must be between citizens of different states and the amount in controversy must exceed $75,000.1077 The Supreme Court has held that a bank is located, for diversity jurisdiction purposes, in the state where its main office is located, as set forth in its articles of incorporation.1078 This definition permits national banks to sue under the diversity provision or to remove state court actions in every other state.

Consumer Credit Regulation: 7.9.1.5 Jurisdiction under the Class Action Fairness Act

The Class Action Fairness Act relaxes the requirements for diversity jurisdiction over class actions.1080 It allows a class action to be filed in or removed to federal court in certain circumstances, even if the parties do not meet the usual standards for diversity of citizenship. The total amount sought by the class must exceed $5 million. The Class Action Fairness Act is discussed in detail in another treatise in this series.1081

Consumer Credit Regulation: 7.9.2.1 Overview

Whether courts can exercise personal jurisdiction over a lender that is located in another state is a significant question, given high-cost lenders’ attempts to operate from states with lax regulation while making loans in more protective states. The question involves both state law and constitutional issues.

Consumer Credit Regulation: 7.9.2.3 Personal Jurisdiction over Securitization Trusts

Whether courts can exercise personal jurisdiction over a securitization trust that is located in another state is a significant question as more and more obligations are securitized. Courts are likely to find specific jurisdiction if the debtor’s claim relates to a security interest held by the trust in real or personal property that is located in the debtor’s home state.1114 This conclusion is supported by a United States Supreme Court decision, Shaffer v. Heitner:

Consumer Credit Regulation: 4.1 Introduction

This chapter deals with the interpretation of state law restrictions on interest and other charges in credit transactions. In the wave of deregulation that started in the 1980s, some states reduced or even eliminated their restrictions on the cost of credit. However, in many states such statutes remain in force and are the key bulwark against predatory non-mortgage lending. Moreover, even states that repealed most of their caps on interest and other charges often proceeded piecemeal, leaving some restrictions on the books for some types of extensions of credit.

Consumer Credit Regulation: 4.2.1 General Interpretation of “Interest”

Where a law restricts the costs of credit by imposing a restriction on “interest,” the key question is what constitutes interest. As this chapter discusses, if interest were narrowly defined as the application of a percentage rate over a period of time, a cap that restricted only interest would have little effect, as the lender could hide all the cost of credit in other fees and charges.

Consumer Credit Regulation: 4.2.3 Statutes That Exclude Enumerated Charges from Interest or the Finance Charge

Some statutes that cap “interest” set forth a general definition of the term, and then specify charges that are excluded from the definition.46 Statutes that cap the “finance charge” for a transaction rather than capping “interest” are often structured this way as well.47 (The term “finance charge” is more clearly intended as an all-inclusive term than “interest,” so there is less likely to be controversy about whether the term includes charges that are not based on application of a percentage rate

Consumer Credit Regulation: 4.3.1 General

One type of ostensibly non-interest charge that is often used and misused by lenders is a fee calculated as a percentage of loan principal. Depending on the type of lender and loan involved, this fee may be variously described as an “origination fee,” “commitment fee,” “service charge,” or “loan fee,” but is perhaps best known as “points” or “discount points,” with one point being a sum equal to one percent of the loan principal.

Consumer Credit Regulation: 4.3.2 Legal Considerations

When statutes do not specifically address the treatment of points and similar fees, lenders carry the burden of demonstrating that points are justified by actual recognized costs associated with a loan and are not merely extra profit or compensation for overhead expense.66 This is a burden that lenders can seldom carry, and numerous courts have found points and similar fees to constitute hidden interest.67

Consumer Credit Regulation: 4.4.1 Introduction

Interest can be hidden by exaggerating the amount of principal which a borrower has received. The idea behind inflating the principal amount is essentially a variation on the use of discount interest.88 To use a simplistic example, a borrower might receive $100 from a lender while signing a note obliging him or her to pay back $120 in “principal” a year later.

Consumer Credit Regulation: 4.4.2 Fees Added to Principal; General Methods of Overstating Principal

The most common technique used to inflate loan principal is the inclusion of various fees in the face amount of the note.91 Assume that a borrower applies for a $1,000 loan. The lender approves the loan but tells the borrower that she will have to pay a $10 credit investigation fee, a $20 service charge, and $70 for credit property insurance on her car which, by the way, she will have to provide as security.

Consumer Credit Regulation: 4.4.3 Indexing Loan Principal

A less common method of inflating loan principal is to adjust the principal periodically to compensate for currency inflation or some other factor, for example by pegging the principal to the consumer price index.108 If the consumer price index shows a 5% inflation rate for each of several years, and the contract provides for annual adjustments, the outstanding loan principal would be multiplied by a factor of 1.05 at the end of each year. Payments for the subsequent year would be calculated using this adjusted principal amount.

Consumer Credit Regulation: 4.4.4 Compensating Balances

Another method through which a creditor may overstate the principal amount of a loan, and thereby understate the true interest rate, is to require that the borrower maintain an account with the lender with a minimum deposit of, perhaps, ten percent of the stated amount of the loan. This “compensating balance,” which remains in the lender’s control, is frequently described as “security” which is supposed to guarantee payments on the loan. In fact, it is just another form of discount because the borrower is paying interest on a larger sum than he or she is actually receiving.

Consumer Credit Regulation: 4.4.5 Inflating the Sale Price

Interest can be hidden in the price of goods purchased on credit in the same manner that it is concealed in the principal amount of a loan. For example, a seller can offer low-rate financing, but then simply jack up the price of the product for buyers who take advantage of the offer.