This letter responds to your letter from May 13, 2015, in which you ask whether certain overdraftprotection

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1 Karen M. Neeley, Senior Counsel 111 Congress Avenue, Suite 1800 Austin, TX Sent by e mail: kneeley@dykema.com Re: Overdraft protection charges and Texas usury law Dear Ms. Neeley: This letter responds to your letter from May 13, 2015, in which you ask whether certain overdraftprotection charges are interest under Texas usury law. The OCCC s understanding is that under Texas law, nonsufficient funds fees are not interest, but the other overdraft protection charges described in your letter are generally interest. Your letter states: Overdraft protection programs are very common in Texas banks, including both state and national charters, local and regional institutions. The most common program provides for a single insufficient funds (NSF) fee in the same amount that would be applied if the item were rejected. Some programs also include simple interest at a rate that is contracted for in writing. However, other programs also include subsequent continuous daily overdraft fees. Typically, if an account remained overdrawn after five days, there would be an additional flat fee. This could be repeated every five days. The purpose of this memo is to request an advisory bulletin on the application of Texas usury law to these fees. There is a great deal of confusion over such fees among Texas community banks. I. Usury analysis This part of the letter describes the elements of a usury claim in Texas. It applies each of these elements to the overdraft protection charges described in your letter, in order to describe the circumstances where the charges are usurious interest. A usury claim in Texas has three elements: (1) The defendant loaned money to the plaintiff. (2) The plaintiff had an obligation to repay the principal N. Lamar Blvd. Austin, TX occc.texas.gov P F

2 Page 2 of 5 (3) The defendant contracted for, charged, or received an amount of interest that exceeds the maximum amount allowed by law. First Bank v. Tony s Tortilla Factory, Inc., 877 S.W.2d 285, 287 (Tex. 1994). A. Loan of money The first element is a loan of money. A loan is an advance of money that is made to or on behalf of an obligor, the principal amount of which the obligor has an obligation to pay the creditor. Tex. Fin. Code (a)(10). A court will dismiss a usury claim if the transaction does not involve a loan. See, e.g., Garcia v. Tex. Cable Partners, 114 S.W.3d 561, (Tex. App. Corpus Christi 2003, no pet.) (holding that a monthly cable television service did not involve a loan). Overdraft protection generally involves an advance of money on the consumer s behalf. The OCCC s understanding is that there are two main methods by which an institution might advance money in the event of an overdraft. The first is to advance the amount necessary to honor the payment device. The second is to advance money in increments (e.g., $100). Both of these methods involve an advance of money on the consumer s behalf. In addition, the rules of the Texas Department of Banking consider an overdraft to be a loan for purposes of lending limits. 7 Tex. Admin. Code So overdraft protection generally satisfies the first element of a usury claim. B. Obligation to repay The second element is an obligation to repay the amount advanced. The OCCC s understanding is that generally, in the event of an overdraft, the consumer is immediately obligated to repay the amount advanced. See, e.g., Office of Consumer Credit Comm r, Interp. No at 3 (1984) (explaining that under one type of overdraft program, any extension of credit... would be repayable in full immediately although as a practical matter some time would elapse prior to its repayment ). So overdraft protection generally satisfies the second element of a usury claim. C. Interest exceeding maximum amount The third element of usury has three sub elements. The first sub element is that the amount must be interest. Interest is compensation for the use, forbearance, or detention of money. Tex. Fin. Code (a)(4). Use refers to the initial use of the advanced money. Domizio v. Progressive Cnty. Mut. Ins. Co., 54 S.W.3d 867, 873 (Tex. App. Austin 2001, pet. denied). Forbearance occurs when the parties agree to extend the time for payment of a debt. Id. Detention occurs when a debt has become due and the debtor has withheld payment without a new contract giving the debtor the right to do so. Id. In First Bank v. Tony s Tortilla Factory, Inc., the Texas Supreme Court held that an amount is not interest if it is supported by consideration apart from the lending of money. 877 S.W.2d 285, 287 (Tex. 1994). The court held that a nonsufficient funds (NSF) fee was not interest, because the fee was assessed for the additional work required in connection with handling the bad check. Id. at

3 Page 3 of 5 Your request explains that certain banks charge an NSF fee in connection with overdraft protection, and that the amount of the fee is the same regardless of whether the payment device is honored or dishonored. Based on the Texas Supreme Court s decision in Tony s Tortilla, you state that an NSF fee that is charged in the same amount regardless of whether an item is paid or rejected is a fee and not interest under Texas law. The OCCC agrees with this reading of Tony s Tortilla. Whether the payment device is honored or dishonored, the NSF fee is supported by the consideration of handling the device, and is therefore not interest. Your request describes two additional types of overdraft protection charges: simple interest and a continuous daily overdraft fee. It appears that these charges are generally compensation for the consumer s failure to pay back the advance immediately under the agreement, i.e., compensation for the detention of money. In this respect, the charges are similar to late charges for a loan, which Texas courts have held to be interest because they are compensation for the detention of money. See Office of Consumer Credit Comm r, Interp. No at 3 4 (1997) (providing an overview of this case law). Depending on how the agreements are drafted, the charges might alternatively be characterized as compensation for the use or forbearance of the advance. You do not describe any other consideration provided by the lender for these charges, apart from the consumer s failure to pay back the money advanced to cover the overdraft. In the absence of separate consideration, these overdraft protection charges are compensation for the use, forbearance, or detention of money, and are therefore interest. The second sub element is that the lender must contract for, charge, or receive the amount. Your letter states that the charges are included in the parties written agreements, so I assume that the lender contracts for the amount. The third sub element is that the amount of interest must exceed the maximum amount allowed by law. Section of the Texas Finance Code generally allows parties to a written agreement to agree to an interest rate that does not exceed the weekly ceiling, which is currently 18% per year. Office of Consumer Credit Comm r, 35 Tex. Credit Letter no. 2 (July 14, 2015). However, in the absence of a written agreement to charge interest, the maximum rate is 6% per year, beginning on the 30th day after the due date. Tex. Fin. Code In a 1984 interpretation, the OCCC held that the 18% ceiling applies to one type of program providing that a lender would charge interest for incidental overdrafts. Office of Consumer Credit Comm r, Interp. No at 3 (1984). Based on the statements in your letter, I assume that the parties have agreed to the overdraft protection charges in writing, and that no alternative ceilings are applicable. If these assumptions are correct, then the 18% per year ceiling applies to the charges. Whether the interest exceeds the maximum amount depends on the amount of interest charged, the true principal of the loan, the maximum rate, and the amount of time over which the amount is charged. When the interest is due in one payment, the maximum interest can be calculated by the following equation: interest = principal * rate * time. In your letter, you state: The equivalent interest rate would then be determined by applying that fee for the five days of usage. As a formula, this would be (amount of check x 5 days/365 days / $fee) I think. Please confirm whether this is the correct methodology.

4 Page 4 of 5 I do not believe that your formula produces a correct effective rate in accordance with the equation for calculating interest. A simpler method is to calculate the maximum amount of interest that the lender can charge, and determine whether the amount charged by the lender exceeds the maximum. In this case, we will assume that: (1) the loan s true principal is the amount advanced by the lender (which might not equal the amount of check used in your formula), (2) the maximum rate is 18% per year, (3) interest is due in one payment, and (4) the principal does not decrease before the interest is due. The maximum amount of interest would be determined by the following equation: maximum interest = amount advanced * 0.18 * (number of days after which interest is due / 365). If the lender charges more than the maximum amount of interest, then the lender has committed usury. In the case of a repeating interest charge that is charged and due immediately once every five days, you could use the following formula: maximum interest for 5 day period = amount advanced * 0.18 * (5/365). This formula requires assumptions (1), (2), and (4) from the previous paragraph. For example, suppose that the lender advances $100 in connection with an overdraft. The maximum interest for a 5 day period would be $0.24, which is equal to $100 * 0.18 * (5/365). In this case, a lender charging $5 every five days would be charging usurious interest. Alternatively, you could re work this formula to calculate the effective rate of interest charged by the lender: effective rate = interest charged every 5 days / (5/365) / amount advanced. I believe this is the formula that you were looking for in your letter. This formula assumes that the interest is due at the end of the 5 day period, and that you are calculating the rate as of the end of a 5 day period. For example, suppose that a lender advances $100 in connection with an overdraft, and charges $5 for every five days that the overdraft remains unpaid. The effective rate would be 365%, which is equal to $5 / (5/365) / $100. This analysis provides some guidance in determining whether an overdraft protection charge is usurious interest under the Texas Finance Code. The analysis reflects assumptions based on the OCCC s general understanding of overdraft protection programs, but individual programs may vary. Because the OCCC does not regulate state banks, any final determination that a state bank has violated Texas usury laws would be made by a court or another agency, not the OCCC. II. Preemption and parity In your letter, you cite federal statutes, regulations, and an interpretation of the Office of the Comptroller of the Currency (OCC) regarding NSF fees and overdraft protection charges. Based on these statements of federal law, you state that it appears that a national bank located in Texas could similarly charge a continuous overdraft fee and claim preemption. In addition, based on provisions of the Texas Constitution and Texas Finance Code regarding parity between state and national banks, you state: Thus, it appears that a state chartered bank could impose the same fees in an overdraft program as are authorized for a national bank. This point may be outside the scope of an advisory bulletin. If so, please let me know whether a separate opinion should be sought from the Texas Banking Commissioner. The OCCC does not have the authority to determine whether the National Bank Act preempts the Texas Finance Code. The National Bank Act, as amended by the Dodd Frank Act, describes the OCC s authority to make preemption determinations. 12 U.S.C. 25b. These determinations must be made in

5 Page 5 of 5 consultation with the Consumer Financial Protection Bureau, and are subject to judicial review. Id. 25b(b)(3)(B), (5)(A). The OCCC also does not have authority to determine whether a state bank may rely on parity with national banks in asserting that it is not subject to the Texas Finance Code. Section (b) of the Finance Code requires state banks to submit a detailed letter to the Texas Department of Banking before engaging in activity that is authorized for national banks but prohibited under Texas law. The same section describes the circumstances under which the banking commissioner may prohibit the bank from engaging in the activity. III. Conclusion This letter is intended to provide you with advice and assistance your analysis of Texas usury laws. It does not express an enforcement position. The OCCC does not regulate state banks or other depository institutions. Any enforcement of Texas usury laws against a state bank would occur through the courts, the Texas Department of Banking, the Texas Office of the Attorney General, or another agency. This advisory letter is not an interpretation approved by the Finance Commission of Texas pursuant to Texas Finance Code, If an interpretation approved by the Finance Commission of Texas is desired, then an interpretation should be requested pursuant to the procedures set forth in 7 Texas Administrative Code 1.201(b). Sincerely, Matthew J. Nance Deputy General Counsel Office of Consumer Credit Commissioner