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Statutory Interest Cannot Accrue on Charged-off Credit Cards, Says Kentucky Supreme Court

The Kentucky Supreme Court recently ruled that a debt buying company may not charge or collect statutory interest under section 360.010 of the Kentucky Revised Statutes on an account it acquired after it was charged off by the original creditor.

Carol Harrell’s credit card account was charged off by the original creditor on Jan. 18, 2011 and was sold to a debt buying company in November of the same year. In a collection lawsuit brought in April 2012, the debt buying company sought judgment for the charged-off balance plus statutory interest from the date of charge off. In response, Harrell counterclaimed alleging that because the original creditor charged off her account, it was no longer permitted to charge interest. In seeking statutory interest, Harrell alleged the debt buying company violated the federal Fair Debt Collection Practices Act.

The Kentucky Supreme Court held that once a credit card account is charged off and the original creditor ceases sending monthly statements, federal law prohibits further contract interest charges. Because the original creditor stopped assessing contract interest, it waived its right to collect “agreed-to interest.” That waiver amounted to a waiver of any right to assess interest, including statutory interest. As the assignee of the original creditor, the debt buying company had “no greater right to collect interest” and so could not seek statutory interest as part of its collection lawsuit.

A copy of the opinion in Unifund CCR Partners v. Harrell is available at: Link to Opinion.

FDCPA Troubles

The statutory interest sought by the debt buying company was less than $100, but that $100 claim Harrell alleged, was also a violation of the FDCPA. The Court also found that Harrell stated a claim for violations of sections 1692e and 1692f of the FDCPA arising from the debt buying company’s request for statutory interest in its state court collection complaint.

As Harrell’s case was making its way through the Kentucky state court system, the Sixth Circuit Court of Appeals in Stratton v. Portfolio Recovery Associates, held a consumer stated a claim for violation of the FDCPA when a debt buying company’s collection lawsuit sought statutory interest under the same section of the Kentucky Revised Statutes at issue in Harrell. But there was a dissenting opinion in the Stratton decision, which criticized its holding because the issue of whether statutory interest could be charged in these circumstances was undecided under Kentucky law. The dissent in Stratton concluded that imposing FDCPA liability under such circumstances “impermissibly expands the scope of the FDCPA, exposing debt collectors to liability under federal law whenever we later determine a debt collector’s reasonable construction of an as-yet uninterpreted state law is wrong.”

Does Reg Z Cause a Waiver of Statutory Interest?

To establish a waiver of a known contractual right, most decisional law (including Kentucky’s) requires a demonstration that the waiver was “voluntary” relinquishment of a known right. The federal regulation at the center of Harrell and Stratton (12 C.F.R. 226.5(b)(2)) is the Truth in Lending Act’s Regulation Z, which governs when periodic statements must be provided for open-end credit accounts. The regulation excuses the sending of a periodic statement “if the creditor has charged off the account in accordance with loan-loss provisions and will not charge any additional fees or interest on the account . . .” Following the reasoning of Stratton and Harrell, this demonstrates that when a creditor makes this election under Regulation Z, it has decided it will no longer charge interest and has waived the right.

The Harrell decision was not unanimous and the dissent noted that the majority opinion misconstrued the federal regulation. The regulation, the dissent noted, requires banks to charge off accounts to prevent them from inflating their net worth with assets that are noncollectible. Second, the act of charging off an account serves the purpose of terminating further use of the card and establishes the balance owed as a liquidated sum. Under Kentucky law, the dissent notes, prejudgment, statutory interest is a “matter of right on a liquidated demand.” The majority decision “punishes banks for their compliance with federal regulations and it bestows an unearned and undeserved windfall upon delinquent debtors.”

The dissent’s view in Harrell, that creditors have a “right” to seek prejudgment, statutory interest on a liquidated claim, is also contained in decisional law in other jurisdictions. Kentucky, however, has spoken and no right exists – at least in the context of a charged-off credit card account.

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