United States: Nutter Bank Report, March 2013


1. Massachusetts High Court Clarifies Rights of Secured Creditors
2. CFPB Removes ATM Fee Sticker Requirement from Regulation E
3. Federal Banking Agencies Issue Updated Guidance on Leveraged Lending
4. Federal Court Limits Liability of a Bank to a Third Party for Negligence
5. Other Developments: Credit Card Fees, CRA and Consumer Information

1. Massachusetts High Court Clarifies Rights of Secured Creditors

The Massachusetts Supreme Judicial Court has held that Article 9 of the Uniform Commercial Code ("UCC"), and not common law, determines the measure of a secured creditor's recovery under Section 9-405 of the UCC. The March 13 ruling clarified that certain common law principles may not be applied to reduce the amount a lender may recover under Article 9 of the UCC when a borrower defaults and the lender must collect on accounts receivable assigned to the lender as security. The case involved a general contractor that had contracted with a subcontractor for part of a large construction project. The subcontractor assigned to its bank the subcontractor's right to receive payment under the construction contract as security for the subcontractor's revolving line of credit from the bank. The general contractor received notification of the assignment and agreed to make payments directly to the bank. However, the general contractor instead made 12 payments to the subcontractor. The subcontractor subsequently ceased business operations and defaulted on the outstanding debt under the line of credit. The bank, represented by Nutter, brought suit against the general contractor for breach of contract and violation of Section 9-405 of the UCC to recover the total value of the 12 payments made to the subcontractor.

Nutter Notes: At trial, the general contractor argued that its liability should be limited, according to common law principles, to the bank's actual damages, a much smaller sum in this case than the full amount of the assigned security, and that no additional liability existed under Article 9 of the UCC. Representing the bank, Nutter argued that Article 9 of the UCC required the general contractor to pay over the full amount of the assigned security. The bank acknowledged that Article 9 would require the bank, in accordance with Sections 9-607 and 9-608, to distribute the amounts recovered in a way that ensured that the bank would not retain any surplus. The trial court agreed with the bank that the UCC, not the common law, provided the measure of damages on the bank's Article 9 claim. The general contractor appealed, arguing that common law principles reduce the general contractor's liability by the amount of a separate guaranty that also secured the bank's loan to the subcontractor, and that the trial court erred in awarding the bank the full amount of the assigned security. The Supreme Judicial Court agreed with the bank on all counts, affirming the trial court's conclusion that Article 9 provides a remedy distinct from the common law. The court also affirmed that the bank's Article 9 damages were not reduced by the separate guaranty. The court noted that the general contractor might seek to recover its losses from the subcontractor.

2. CFPB Removes ATM Fee Sticker Requirement from Regulation E

The Consumer Financial Protection Bureau ("CFPB") has issued a final rule amending Regulation E (Electronic Fund Transfers), which implements the Electronic Fund Transfer Act ("EFTA") to eliminate a requirement that a fee notice be posted on or at automated teller machines ("ATMs"). The March 20 amendment to Regulation E implements 2012 legislation which amended the EFTA to eliminate the ATM fee sticker requirement, and left in place the requirement that a specific fee disclosure must appear on the screen of the ATM or on paper issued from the ATM. ATM operators, including banks, will now only have to provide the on-screen or paper disclosure, which must include the amount of the fee to be charged and be provided before the consumer is committed to the transaction. In addition to the deletion of the rule requiring the "on or at" machine disclosure, the final rule also deletes Official Comment 16(b)(1)-1, which provided guidance on the meaning of certain terms related to the fee sticker requirement. The final rule deleting the ATM fee sticker requirement became effective on March 26.

Nutter Notes: In 1999, Congress amended the EFTA to require certain ATM fee disclosures both to be posted on or at the ATM and to be provided on the screen or on a paper notice issued from the ATM. The EFTA requires that the on-screen notice include the specific amount of the fee the consumer would be charged by the ATM operator, but the notice posted "on or at" the machine only had to disclose "the fact that a fee is imposed by such operator for providing the service." The EFTA prohibited ATM operators from charging a fee if both disclosures were not made. The "on or at" notice typically involved a sticker placed on the machine by the ATM operator. The EFTA allowed ATM operators 5 years to implement the technology needed to make the on-screen disclosures, but did not provide that once the 5 years elapsed operators could cease providing the separate notice "on or at" the machine. Under the EFTA, an ATM operator could be liable for actual damages, statutory damages in individual or class actions, and costs and attorney's fees for failure to provide both required disclosures. In adopting the final rule, the CFPB acknowledged longstanding concerns that the "on or at" notice requirement provides little or no benefit to consumers and at the same time has been the subject of costly litigation in cases where the notice was not properly posted or was improperly removed.

3. Federal Banking Agencies Issue Updated Guidance on Leveraged Lending

The federal banking agencies have issued updated supervisory guidance on leveraged lending, titled Interagency Guidance on Leveraged Lending, which applies to all financial institutions, including small and mid-sized banks, which originate or participate in leveraged lending transactions. The guidance issued on March 21 updates and replaces guidance issued in April 2001, titled Interagency Guidance on Leveraged Financing. The new guidance focuses on establishing a sound risk-management framework, underwriting standards, valuation standards, pipeline management, reporting and analytics, risk rating leveraged loans, the risks of participants (versus originators) and stress testing. According to the guidance, the agencies expect that an institution's management and board of directors will identify the institution's risk appetite for leveraged lending, establish appropriate credit limits and ensure prudent oversight and approval processes. The guidance recommends that an institution's valuation standards should concentrate on sound methods in the determination and periodic revalidation of the borrower's enterprise value. The agencies said that they expect institutions to be able to accurately measure exposures to loans on a timely basis, establish policies and procedures that address failed transactions and general market disruptions, and ensure periodic stress tests of exposures. The guidance became effective on March 22, and institutions engaged in leveraged lending activities must be in compliance with the guidance by May 21.

Nutter Notes: The guidance does not include a bright line test to determine which financing activities constitute leveraged lending. Instead, the guidance advises each institution engaged in leveraged lending to develop criteria to define leveraged lending within the institution's policies and procedures in a manner sufficiently detailed to ensure consistent application across all business lines. The guidance gives examples of the types of criteria institutions should consider, such as transactions where loan proceeds are used for buyouts, acquisitions, or capital distributions, and transactions in which the borrower's post-financing leverage significantly exceeds industry norms or historical levels. As a result, the guidance could apply to some commercial portfolio loans originated by small and mid-sized banks, including, but not limited to, certain asset-based loans. The agencies explained in the preamble to the guidance that an institution that originates a small number of less complex leveraged loans should not be expected to have policies and procedures commensurate with those of a larger institution with a more complex leveraged loan origination business. Although the concept of leveraged lending encompasses all business lines, the agencies said that they do not intend for the guidance to apply to small portfolio commercial and industrial loans, or traditional asset-based lending.

4. Federal Court Limits Liability of a Bank to a Third Party for Negligence

The U.S. District Court for the District of Massachusetts in a recent ruling dismissed a lawsuit brought against two banks by a third party that was not a customer of either bank for allegedly failing to detect fraudulent transfers from fiduciary accounts established at the banks to hold funds on behalf of the third party. The March 5 decision came in a case brought by a law firm whose payroll company had stolen more than $500,000 from accounts the company established at the banks. The law firm claimed that the banks knew the accounts were maintained by the payroll company in its fiduciary capacity, should have monitored account activity, and should have noticed a suspicious pattern of debits and credits and discovered that the company was misappropriating funds from the accounts. Courts have generally held that banks have no duty to monitor fiduciary accounts and may presume that fiduciaries will apply funds from such accounts appropriately. But a 2006 decision by the 2nd U.S. Circuit Court of Appeals created an exception under which a bank may be liable in a case where the bank has "notice or knowledge" of a fiduciary's misappropriation of funds. Under the exception, a bank may be held liable for knowingly failing to report stolen funds from a fiduciary account when the underlying facts support the "sole inference" that misappropriation was intended. The U.S. District Court held that the exception established by the 2006 case did not apply because the banks were not aware of suspicious circumstances giving rise to a "sole inference" of misappropriation, and also that the banks did not owe a duty of care to the law firm.

Nutter Notes: The U.S. District Court held that the law firm's case was distinguishable from the 2006 case based on the facts, which narrows any application of the exception to permit non-customers of a bank to sue the bank for negligence. In the 2006 case, a bank discovered that a fiduciary was embezzling funds from a fiduciary account after documenting frequent account overdrafts. Instead of reporting the misappropriation, the bank assisted the fiduciary in concealing the overdrafts. In the present case, the law firm did not claim that the payroll company overdrew its accounts or that the banks intentionally concealed the misappropriation. Instead, the firm alleged that the banks failed to adequately monitor the payroll company's account activities after one of the banks noticed account irregularities which it communicated to the company. The other bank temporarily froze the company's accounts in response to a search warrant issued by state police and after a bank branch manager allegedly became aware of pending lawsuits against the company. The U.S. District Court held that these events, in the aggregate, did not give rise to a "sole inference" of misappropriation.

5. Other Developments: Credit Card Fees, CRA and Consumer Information

  • CFPB Eliminates Cap on Credit Card Fees Charged Prior to Account Opening

The CFPB on March 22 issued a final rule amending Regulation Z (Truth in Lending) to remove a cap on the total amount of fees that a credit card issuer may require a consumer to pay with respect to a credit card account prior to the opening of the account. The final rule was issued in response to a federal court ruling last year that had granted a preliminary injunction to block a part of the fee cap rule from taking effect. The final rule became effective on March 28.

Nutter Notes: Regulation Z generally limits the total amount of fees that a credit card issuer may require a consumer to pay with respect to an account to 25% percent of the credit limit in effect when the account is opened. Prior to the amendment, Regulation Z stated that the limitation applies both prior to account opening and during the first year after account opening. The limitation now applies only during the first year after account opening.

  • Federal Banking Agencies Propose Revisions to CRA Guidance

The federal banking agencies on March 18 released a proposal to revise the Interagency Questions and Answers Regarding Community Reinvestment. Among other things, the proposed revisions would clarify how the agencies consider community development activities that benefit a broader statewide or regional area that includes an institution's assessment area. Comments on the proposed revisions are due by May 17.

Nutter Notes: The proposed revisions would also describe additional ways to determine whether recipients of community services are low- or moderate-income, and include service on the board of directors of a community development organization as an example of a technical assistance activity that can be provided to community development organizations for CRA credit.

  • Court Rules that Zip Codes Are Subject to Massachusetts Privacy Protections

The Massachusetts Supreme Judicial Court in a March 11 decision ruled that collecting and recording a consumer's zip code as part of a credit card transaction violates a Massachusetts privacy law. According to the decision, zip codes are "personal identifying information" under Section 105(a) of Chapter 93 of the General Laws of Massachusetts, which protects consumers from the unnecessary collection of personal information to complete a credit card transaction.

Nutter Notes: Even though a zip code does not directly identify a consumer, the court found that it can be combined with other information enabling merchants to identify the consumer's address and telephone number which is information that Section 105(a) expressly identifies as "personal identification information." 

Nutter Bank Report

Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, has ranked Nutter's Banking and Financial Services practice among the top banking practices in the nation. The 2012 Chambers and Partners review says that a "broad platform of legal expertise and experience" in the practice "helps clients manage challenges and balance risks while delivering strategic solutions." Clients praised Nutter banking lawyers as "very responsive and detail-oriented." Visit the U.S. rankings at ChambersandPartners.com. The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Melissa Maichle and Thomas Powers.


This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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