Navigating risks while taking action to manage overdraft/non-sufficient funds fees

Banks can take several steps to mitigate challenges surrounding overdraft/NSF fee lawsuits and enforcement actions.

By Therese Kieffer

In recent years, financial institutions have faced numerous lawsuits on overdraft and non-sufficient funds fees practices and disclosures. Regulators have also been taking a hard look at such practices and disclosures—and have handed out several findings or even consent orders alleging unfair, deceptive, or abusive acts or practices (UDAAP). Given the regulatory and litigation risks, financial institutions should understand some of the more common practices at issue, and steps they can take to mitigate the risks.

“Authorize positive, settle negative” overdraft fees

TOOLKIT–Download an ABA staff analysis on overdraft fees from “authorize positive, settle negative” transactions.
One of the most common practices targeted by lawsuits and enforcement actions is the “authorize positive, settle negative” scenario, or “APSN.” This occurs, for example, when a debit card transaction is initially authorized against an amount available in the account. Prior to settlement, however, intervening transactions reduce the available balance, resulting in an overdraft when the authorized transaction finally settles.

Lawsuits typically argue that this is a breach of contract, since the account agreements suggest that the financial institution would set aside funds at the time of authorization in order to pay for that transaction. The customer’s understanding is that those funds would not be used for anything except the authorized transaction.

Agencies have historically viewed this practice as “deceptive,” when the disclosures are unclear, but more recently are calling it “unfair.” For example, the CFPB’s December consent order against a large bank simply describes APSN overdrafts as “unfair” since consumers could not reasonably avoid the fees, and they were not outweighed by any countervailing benefit. This position was reinforced in more detail in the CFPB’s October Circular and most recently in a special Supervisory Highlights, in which the CFPB observed that consumers could not reasonably avoid the injury caused by unfair APSN overdraft fees, regardless of the content of disclosures.

Other regulators have taken the same position, including the New York Department of Financial Services which recently stated they expect financial institutions to “discontinue the practice” of charging overdraft fees related to APSN transactions.

Non-sufficient funds NSF fees on re-presentment

Another common enforcement and litigation target is the practice of charging a non-sufficient funds fee on a check or other item that is being re-presented due to nonpayment the first time. Consumers often do not understand that the financial institution has no control over when or how often a check is re-presented.

Lawsuits again typically center around the disclosures, which often say a fee may be charged “per item,” but do not explicitly state that a fee may be charged each time a check is re-presented for payment by the merchant. Courts have made decisions both in favor of and against plaintiffs in this area.

Regulators have indicated this may be a deceptive practice under UDAP or UDAAP if the disclosures do not clearly describe when a fee may be charged. But they also view this as a potentially unfair practice if consumers are not properly informed at the time of the NSF and are not given adequate time to bring their account balance current.

Action items for financial institutions

Financial Institutions can take several steps to mitigate the risks surrounding these overdraft/NSF fee lawsuits and enforcement actions.

First, to address deception concerns, institutions must review and update their account agreements and disclosures to ensure that they are clear and match the institution’s actual practices. Particular attention should be paid to disclosing how the account balance is calculated; how the account balance may be affected by transactions that intervene between authorization and settlement; how frequently a fee may be assessed on a transaction; whether the “same” transaction may be subject to additional fees if re-presented by the merchant; as well as any maximum fees a single transaction might incur.

Second, to avoid fees being perceived as unfair, regulators recommend that institutions review their customer notification practices to ensure customers are receiving notices regarding overdraft and NSF fees, ideally in real time. On the re-presentment issue, regulators have indicated that customers should also be given adequate time to bring their account current before additional fees are assessed. In July of 2022 the New York Department of Financial Services recognized that financial institutions might not be able to eliminate charging multiple NSF fees in the short-term, since the merchant controls presentment rather than the financial institution. NYDFS indicated, however, that in the long-term banks and credit unions were expected to put pressure on their processors or software providers so that they would be able to identify re-presentments automatically and avoid charging multiple fees. The FDIC echoed this requirement, suggesting that financial institutions need to be able to control the “timing of fees” so that customers had enough time to restore their account balance to a sufficient amount in order to avoid subsequent fees.

Third, where institutions have identified that consumers had been charged unfair NSF or overdraft fees, the NYDFS, the FDIC and the CFPB all indicated that consumers must be refunded the additional fees. The CFPB, in particular, warned that the bureau would be engaging in “follow-up work” with institutions on overdraft and NSF fee issues, and recommended self-reporting, remediation, and cooperation “above and beyond what is required.”

Fourth, since many of the lawsuits are brought as class actions, institutions may wish to consider limiting their exposure by consulting their counsel regarding the inclusion of an arbitration agreement as part of their deposit account agreement. Institutions should be mindful that this is an area under much regulatory scrutiny. Although the CFPB’s final rule regarding arbitration agreements was tabled in 2017, the general thought is that the CFPB is exploring other ways to address arbitration agreements buried in so-called take-it-or-leave-it consumer contracts.

Institutions should weigh the pros and cons of either including an arbitration agreement within their deposit account agreements or using a separately signed agreement. Although it might appear easier to include an arbitration agreement in the account agreement in order to apply the update to existing customers, there is a strong compliance argument for a separately signed arbitration agreement.

Consumer advocates, and the CFPB’s tabled rule, frown on arbitration agreements buried in the so-called boilerplate, referring to these as “forced” and even an “unfair” practice. In addition, although it may be difficult to obtain a signed arbitration agreement from existing customers, at least one jurisdiction has ruled that institutions may not add arbitration clauses to existing agreements that do not address dispute resolution without some affirmative evidence of the customer’s consent.

Of course, not every jurisdiction requires a separate consent. The Supreme Court of Arizona, for example, recently adopted the second restatement on contracts to hold that an arbitration clause might be unilaterally added to an account agreement, provided the consumer receives notice of the change, has a reasonable opportunity to opt out and is notified that failure to opt out constitutes acceptance (Cornell v. Desert Fin. Credit Union, 2023 Ariz. LEXIS 651, Az. S. Ct. 2023). Since it is ultimately the institution’s attorney who will need to defend the arbitration agreement in the jurisdiction relevant to the financial institution, the attorney should be involved in its drafting and have input as to how the new arbitration requirements will be extended to customers.

Given these variables, institutions will need to work closely with their compliance officers or attorneys in order to make an informed compliance decision that will work best for the institution in its jurisdiction and with its customers.

Therese Kieffer, JD, CRCM, is a specialized consulting manager with the regulatory analysis team of Wolters Kluwer’s Compliance Center of Excellence.