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By David A. Szwak
The United States credit industry is rapidly moving toward replacing
cash with a credit and debit card system which would electronically
transact our financial affairs and track our every move. Smart cards,
the financial information superhighway and complete absence of privacy
appear to be in our future. It is estimated that each American
possesses an average of six (6) credit card accounts. Determining
liability is largely misunderstood. Attorneys must have a working
knowledge of the credit system and its rapidly changing face. This
article presents an overview of the credit cards, their usage, the
liability of cardholder and card bearers, as well as related topics.
WHAT IS A CREDIT CARD?
As a general concept, credit is merely a contract between the cardholder
and the credit issuer. It results from an offer and acceptance. A
"credit card" is merely an indication to merchants that the person who
received the card or template has a satisfactory credit rating and if
credit is extended, the issuer of the card will pay or insure that the
merchant receives payment for the merchandise delivered, and that the
debtor intends to pay the card issuer. The issuance of credit
constitutes an offer of credit which may be withdrawn by the issuer at
any time prior to the acceptance of the offer through the use of the
card by the cardholder. Further, use of a credit card by the cardholder
is an implied, if not actual, representation that debtor intends to pay
for the charges.
NECESSARY INVESTIGATION BY CREDIT ISSUER
Credit issuers usually rely upon applications to perpetuate their
business. Credit issuers may receive anywhere from a few to thousands
of credit applications a day. In the high volume setting one can only
wonder what procedures are in place to insure that the application is
truthful and not fraudulent. American courts have consistently held
that credit issuers have a duty to exercise reasonable care and
diligence in performing a "necessary investigation" of each credit
application received and the investigation of each application must
occur prior to the issuance of credit. As part of the investigation the
issuer must verify the underlying information on the application,
including the applicant's identity and authority, prior to the issuance
of credit. After all, credit issuers are in a superior position to
prevent and stop credit fraud, particularly, "application fraud," where
the cardholder listed on the application never applied for or received
the charge card or template. In Humble Oil & Ref. Co. v. Waters, the
Court found the credit issuer liable for carelessly sending a credit
card through the mail on the authority of an anonymous telephone caller.
The credit issuer failed to use any reasonable procedures to verify the
identity of the caller.
In resulting fraud instances, courts have not held credit issuers
strictly liable for approving fraudulent applications but issuers must
exercise reasonable diligence and care to prevent such losses as it
adversely affects all consumers and, specifically, the targeted victim
of fraud. Credit card issuers frequently have meager, automated
procedures to investigate and evaluate applications and place greater
emphasis on collection. Still others have procedures in place but
employee incentive or laxity results in routine deviation from the
guidelines. At least one court has held that a credit issuer's failure
to follow its own proclaimed standards does not, of itself, prove
negligence of the credit issuer, unless the erroneous information in the
application would have placed a reasonably prudent credit issuer on
notice that the credit application was fraudulent.
INVESTIGATION AT THE POINT OF SALE
One can only wonder why retailers and other merchants do not verify the
identity of credit card users at the point of sale. Some have suggested
a myth created by the credit industry caused this problem. It is a myth
that it is illegal to ask a card user to present identification at the
point of sale. It is outright reckless conduct to tender merchandise to
a card bearer without any verification or recordation of personal
identification. In fact, courts have ruled that retailers have a duty to
exercise reasonable care to inquire about the identity of a purchaser
using a charge card, to examine the charge card or template and only
extend credit as the card or template authorizes and not merely
disregard responsibility for resulting fraud.
WHO IS A CARDHOLDER?
A "cardholder" is generally defined as the person whose identity is
listed on the credit application made to the issuer. The cardholder is
not liable for fraud perpetrated through the use his identifiers. The
Truth-In-Lending Act defines "cardholder" as "any person to whom a
credit card is issued or any person who has agreed with the card-issuer
to pay obligations arising from the issuance of a credit card to
another person." Further, the cardholder is not liable for fraud
committed through the misuse of his account number, card or template.
The cardholder, as a party to the contract with the issuer, is solely
responsible for charges and users and holders of related cards are not
liable for charges made on the account.
Only cardholders are contractually liable for debts incurred by use of
credit card. Mere card users, bearers or holders of related cards, even
if authorized to use the card, are not liable for such debts. The same
may not be true for co-applicants or subsequently added cardholders on
the account, which result in the creation of a joint account. Attempts
to argue that a cardholder does not have authority to use the account
have been unsuccessful. One court held that a corporation's liability
was not limited based upon alleged unauthorized use by an individual
where the individual was the cardholder to whom card was issued. A
cardholder always has actual authority. This holding blurred the
distinction between cardholder and card bearer and may have been more
properly decided upon a failure by cardholder (corporation) to provide
adequate notice of potential or real misuse of the account by a formerly
authorized card bearer. The blurred distinction has also occurred in
cases where the person who received a credit card in their name, used
the card, and received the billings for charge later argued they were
not a cardholder. At least one court found such a person to be a
cardholder and imposed liability for charges.
TRUTH-IN-LENDING ACT DOES NOT APPLY IF AUTHORITY FOR USE EXISTED
The Truth-In-Lending Act provides the consumer certain protections when
fraud or unauthorized use of their credit card(s) occurs. If the court
finds that the card bearer has "actual, implied or apparent authority"
then the Truth-In-Lending Act has no application, per 15 U.S.C. 1602(o),
1643, and the cardholder's contract with the credit issuer and state law
applies. The defense of unauthorized use may be used in situations
where the issuer sues the cardholder in an attempt to collect. In such
situations, the credit issuer has the burden of proving that the
particular use of the card was "authorized".
"AUTHORIZED USE" VERSUS "MISUSE" VERSUS "UNAUTHORIZED USE"
As a general principle, when a cardholder, under no compulsion by fraud,
duress or otherwise, voluntarily permits the use of his credit card or
account by another person, cardholder has "authorized use" of that card
and account and is thereby liable for charges resulting, even if the
cardholder verbally told the other person not to charge over a certain
limit. As to the creditor, once you give authority to the third person,
regardless of the scope, you are liable under agency principles.
"Misuse" occurs when the card bearer exceeds the authority granted by
the cardholder and particular charges are eventually made which were not
contemplated by the cardholder. "Unauthorized use," for purposes of
determining liability of a credit cardholder, is use of a credit card by
a person, other than the cardholder, who does not have actual, implied
or apparent authority for such use and from which the cardholder
receives no benefit. Unauthorized use of a credit card occurs when a
card bearer is not authorized and where there is no proof that the
bearer was cardholder's agent or that cardholder ratified bearer's
Courts are split on whether a cardholder can "after the fact" limit his
exposure for charges attributable to a card bearer, who has gone astray
and begun to misuse the card. The use was initially "authorized" with
actual authority granted. One court has responded that the user of a
credit card to whom the cardholder has voluntarily given permission to
use the card has "apparent authority" to use the card even after actual
authority ceases to exist.
THE IMPORTANCE OF NOTIFICATION TO THE CREDIT ISSUER IF MISUSE OCCURS
There is conflicting jurisprudence as to whether notice to the credit
issuer, that a card bearer has exceeded the authority granted and is in
possession of a charge card, will terminate responsibility for the
charges occurring thereafter. The dissent in Walker Bank & Trust Co. v.
Jones, argued that notification should cut off liability for three (3)
main reasons: (1) credit issuers are in a superior position, once
notified of potential misuse, to limit losses to the cardholder, itself
(credit issuer) and third parties (retailers, etc.); (2) 15 U.S.C. 1643
and state laws of "agency" dictate that agency ends upon termination of
authority by cardholder as to the card bearer and apparent authority
vis-a-vis the credit issuer cannot be argued once the credit issuer is
on notice; and (3) holding the cardholder liable is unrealistic and
promotes a divorcing spouse to usurp the other spouse's credit cards or
account numbers for misuse with the knowledge that the law would hold
the cardholder (other spouse) liable.
Once the credit issuer receives notice of potential misuse of an
account, the issuer has the sole power to terminate the existing
account, refuse to pay any charges on the account, list the credit card
as stolen or lost on national/regional warning bulletins, transfer all
existing, valid charges to a new account and send the cardholder a new
card bearing his new account number. The credit issuer's situation is
far better as a result of notification that a card has been lost, stolen
of misused, as opposed to situations where the card is stolen without
notice, because the issuer is on notice of possible problems and may
even be alerted as to the whereabouts and identity of the card bearer.
Some courts have addressed situations where the misuser (card bearer)
was still in possession of the card and no notice was provided to the
credit issuer. One court found the charges made by cardholder's ex-
husband were authorized. The husband was still in possession of one of
the cards and, at all times, was ostensibly authorized to make charges.
But for the failure of cardholder to explain the situation, the credit
issuer would have prevented further misuse. Yet another court applied
an estoppel theory to preclude an employer's defense to liability for
charges, where the employer had provided charge cards to his employees
for use and then failed to notify the credit issuer when he transferred
the company. On the other hand, one court has held that where the
husband (cardholder) notified the creditor to close his account and that
his ex-wife had a charge card and the creditor knew the exact location
where ex-wife continued to make purchases and that ex-wife was the
person charging, yet the creditor failed to act, the husband was not
IMPLIED OR APPARENT AUTHORITY:
Courts have also imposed liability upon cardholder who clothe another
with apparent authority to use cardholder's account or charge template.
Generally, "apparent authority" exists where a person has created such
an appearance of things that it causes third party reasonably and
prudently to believe that second party has power to act on behalf of
first person. Prior, unrelated occasions where cardholder allowed third
party to use credit card had no bearing on specific subsequent
circumstance of unauthorized use.
Courts have tended to find apparent authority when a cardholder requests
a credit card, in a spouse's name and bearing a spouse's signature on
the card. Such a representation to third persons such as merchants, to
whom the card might be presented, is tantamount to apparent authority
that the spouse is authorized to use the card and make charges. Some
courts have held that mere transfer of the charge template to a spouse
or other third party created apparent authority and the cardholder was
estopped to deny liability. One court has questioned the existence of
apparent authority if a credit issuer has been notified of potential
misuse of a credit account. How can any apparent authority exist between
the cardholder and ultimate retailer, to whom the card is presented,
vis-a-vis the credit issuer? The credit issuer has been placed on
notice of the card theft or loss.
CARDHOLDER'S LIABILITY FOR UNAUTHORIZED USE
As a general rule, a cardholder is not liable for unauthorized use.
There is no liability for unauthorized use of a credit card, except
where the card is an "accepted credit card" then liability is not in
excess of $50.00 and $50.00 is due only when and if: (1) the issuer
provided the cardholder with adequate notice of the limited liability;
(2) the issuer provided the cardholder with a description of means by
which the issuer may be notified of the loss or theft of the activated
card; (3) unauthorized use occurred before the card issuer had been
notified that the cardholder no longer possessed the card or template;
and (4) the issuer provided a method whereby the user of such card can
be identified as a person authorized to use the charge template.
FORGERY AND FRAUD
A cardholder is not liable for charges where another person forged
cardholder's name on a credit card application and cardholder knew
nothing about the credit card until he received bills. Courts have
acknowledged that cardholders have little or no control over the
fraudulent conduct of third persons who come into possession of charge
cards bearing the cardholder's identity and cardholder is not liable for
fraud-related charges unless fault of cardholder is proven.
One court has held that defendant, to whom an unsolicited bank card was
issued but never used by defendant, was not liable for purchases made
with the card by a woman that the defendant subsequently married and who
took the card without his knowledge when they separated several weeks
later. Defendant never expressly or impliedly authorized her use of the
card. It appears the issuer would have violated 15 U.S.C. 1642, if it
had been in effect at the time the card was sent to defendant.
DISSOLUTION OF MARITAL PROPERTY REGIMES AND JOINT ACCOUNTS
When joint credit account holders divorce, they should obtain consent of
their creditors before attempting to enter dissolution of property
decree wherein one spouse accepts responsibility for former joint
account. Both spouses remain liable on the account. At least one court
has rejected claims by joint cardholder against creditor, where the
joint cardholder, a divorced woman, whose report listed bad joint debt
by a credit bureau on the basis of her ex-husband's credit rating,
attempted to recover against creditor on the basis that the dissolution
of property decree freed her from liability for the joint credit charge
account debts which ex- husband agreed to assume in the dissolution.
FAIR CREDIT BILLING ACT: A WEAK EFFORT TO ASSIST CONSUMERS IN RESOLVING
The Fair Credit Billing Act [FCBA], 15 U.S.C. 1666, et seq., sets forth
an orderly procedure for identifying and resolving disputes between a
cardholder and a card issuer as to the amount due at any time. The Fair
Credit Billing Act only applies to transactions under open-end credit
plans. The consumer has a right to challenge a creditor's statement of
an account in consumer's name. The FCBA provides protection to the
consumer from the "shrinking billing period" which is the time within
which to avoid the imposition of finance charges by payment of the
balance or portion of the debt. The consumer has a right to make the
creditor promptly post payments and credits to his account. If the
creditor fails to comply with 15 U.S.C. 1666 and 1666a, the creditor is
subject to forfeiture of their right to collect the disputed amount.
The consumer has the right to assert all claims and defenses against the
credit card issuer which the cardholder has against the merchant
honoring the card. The FCBA applies to credit cards.
The consumer has an action for actual damages sustained from the
creditor who violates FCBA and the creditor must pay a civil penalty of
twice the finance charge (minimum of $100.00, maximum of $1,000.00),
plus court costs and a reasonable attorney's fees. Class actions are
may be instituted under 15 U.S.C. 1640.
Ordinarily, a consumer must notify creditor of alleged billing error
before bring action under FCBA. The consumer is not required to send
written notice of billing error to creditor where the creditor
continues to report the account as delinquent, when in fact it had been
satisfied and the creditor had failed to ever send a periodic statement
to consumer. In cases where the creditor must be notified, the sixty
(60) days notice period commences to run from the date the disputed
statement is received by the debtor. Debtor must make written dispute
within sixty (60) days.
LIMITATIONS OF PROTECTION OF FCBA:
The FCBA has certain limitations which may apply under various
circumstances. The consumer must provide the creditor with written
notice within sixty (60) days of the date the consumer receives the
erroneous (disputed) billing. The notification must contain certain
items of information (completely identify yourself and the account, bill
and/or charges in question) and a clear dispute (explain to the best of
your ability why you think the bill is in error).
Tort claims may not be asserted under FCBA. The consumer (obligor) must
make a "good faith attempt" to satisfactorily resolve the disagreement
with the person honoring the card. The amount of the transaction must
exceed $50.00. The transaction must occur in the same state as the
cardholder's mailing address, or must occur within 100 miles of the
cardholder's mailing address. The amount of the claims or defenses
asserted may not exceed "the amount of credit outstanding with respect
to such transaction at the time the cardholder first notified the card
issuer or person honoring the credit card. Note that payments and
credits to the cardholder's account are deemed to have been applied, in
the order indicated, to the payment of:
(a) late charges in the order of their entry to the account;
(b) finance charges in order of their entry to the account;
(c) debits to the account (other than those above) in the order in
which each debit entry to the account was made.
The above mentioned limitations have an exception that exists when: (1)
the amount of the transaction must exceed $50.00; and (2) the
transaction must occur in the same state as the cardholder's mailing
address, or must occur within 100 miles of the cardholder's mailing
address. In essence, those restrictions do not apply when the person
honoring the credit card (retailer):
(a) is the same person as the card issuer;
(b) is controlled by the card issuer;
(c) is under direct or indirect common control with the card
(d) is a franchised dealer in the card issuer's products or
(e) has obtained the order for such transaction through a mail
solicitation made by or participated in by the card issuer; or
(f) where the defense or claim can be classified as a "billing
error" rather than an assertion of a claim or defense.
TIGHTENING THE SCREWS ON THE CUSTOMER
Courts have recognized that a credit issuer's "ability to report on the
credit habits of its customers is a powerful tool designed, in part, to
wrench compliance with payment terms from its cardholder." Thus, a
creditor's "refusal to correct mistaken information can only be seen as
an attempt to tighten the screws on a non-paying customer." Further, an
erroneous or careless report serves no purpose but to substantially
damage the target of the report, who after publication can do little to
correct the damage caused by the report.
Credit cards, smart card and other electronic transactions will replace
the cash medium in our near future. As attorneys we must understand the
current state of the laws governing credit and be ready to improve our
laws in order to protect the general public while assisting industry.
Few Americans have ever seen their credit report(s) and do not realize
the impact that trade line reporting has on their ability to utilize
their property rights in their reputation and credit worthiness.
Protection of credit rights is an element of damage often overlooked by
attorneys. It is an invaluable service to the client.
Mr. Szwak is a partner in Bodenheimer, Jones, Klotz & Simmons,
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