FYI: 9th Cir Rejects FCRA Putative Class Action Relating to Short Sale Credit Reporting

In a putative class action alleging violations of the federal Fair Credit Reporting Act (FCRA), the U.S. Court of Appeals for the Ninth Circuit recently held that:

 

(1) the credit reporting agency's reporting of short sales was not inaccurate or misleading, even though it knew that a government sponsored enterprise misinterpreted its short sale code as a foreclosure, because FCRA does not make credit reporting agencies liable for the conduct of its subscribers;

 

(2) the credit reporting agency's consumer disclosures were clear and accurate, and 15 U.S.C. § 1681g did not require the credit reporting agency to disclose its proprietary codes that could confuse unsophisticated consumers; and

 

(3) the plaintiffs failed to establish a right to statutory damages because the credit reporting agency conduct was not objectively unreasonable.

 

A copy of the opinion is available at:  Link to Opinion

 

The plaintiffs brought this action against a credit reporting agency ("Credit Reporting Agency") alleging violations of the federal Fair Credit Reporting Act, 15 U.S.C. § 1681, et seq. ("FCRA") based on the Credit Reporting Agency's reporting of short sales and its related consumer disclosures.

 

The Credit Reporting Agency delivered its credit reports in a proprietary computer-generated format that displays credit information "in segments and bits and bytes," but the Credit Reporting Agency provides technical manuals that enable its subscribers to read and understand the credit reports they receive.

 

As you may recall. a short sale is a derogatory credit event that furnishers report to the credit reporting agencies.  When the Credit Reporting Agency receives data reporting a short sale, it translates the data into its proprietary coding before it can export the data to subscribers.  The Credit Reporting Agency's technical manual coded short sales as follows:

 

(1)  Account type:  A mortgage-related account, such as a first mortgage or home equity line of credit.

(2)  "Account condition" and "payment status" code: 68, which corresponds to a Special Comment of "Account legally paid in full for less than the full balance."  The 68 automatically populates a 9 into the first position on the payment history grid to display the "Settled" status.

(3)  Payment history grid showing the final status ("Settled") in the first digit, followed by 24 months of payment history information.

(4)  Date in 25th month in the payment history grid corresponds to the date the furnisher reported the "Settled" status to the Credit Reporting Agency.

 

In other words, the Credit Reporting Agency reported account condition code 68 ("Account legally paid in full for less than the full balance") for short sales, which then automatically inserted the number 9 into the payment history grid (to display a "Settled" status).  However, a lead payment history code of 9 can represent multiple, derogatory, non-foreclosure statuses, including "Settled, Insurance Claim, Term Default, Government Claim, Paid by Dealer, BK Chapter 7, 11 or 12 Petitioned, or Discharged and BK Chapter 7, 11 or 12 Reaffirmation of Debt Rescinded."

 

Foreclosures are reported with a lead payment history code of 8 and an account condition and payment status code of 94 ("Creditor Grantor reclaimed collateral to settle defaulted mortgage").  According to the Credit Reporting Agency's technical manuals, it was impossible for its credit reports to reflect a foreclosure with a lead payment history code of 9.

 

A government sponsored enterprise ("GSE") that purchased mortgage loans from certain lenders used a proprietary underwriting software.  Its rules required that a consumer a with a prior foreclosure must wait seven years before obtaining a new mortgage, but consumers with a prior short sale need wait only two years.

 

The GSE's underwriting software analyzed credit report data from the credit reporting agencies.  In doing so, the software relied on the GSE's payment code, which corresponded to the Credit Reporting Agency's lead payment history code.  Until 2013, the software "identified [mortgage accounts] as a foreclosure if there [was] a current status or [payment history code] of '8' (foreclosure) or '9' (collection or charge off)."

 

Thus, the GSE elected to treat code 9 the same as it treated code 8, even though it knew from the instructions the Credit Reporting Agency that code 9 did not represent a foreclosure, and that it was "necessarily capturing accounts that [were] not actually foreclosures."  The GSE's treatment of lead payment history code 8 and 9 imposed a seven year waiting period on consumers with a prior short sale, when the waiting period should have only been two years.

 

In 2010, consumers and the Credit Reporting Agency raised this issue with the GSE, but neither entity changed its coding.

 

Between 2012 and 2013, the plaintiffs disputed the Credit Reporting Agency's reporting of their prior short sales.  However, the plaintiffs were able to obtain new loans after their prior short sales because their lenders either understood that they had a prior short sale, not a foreclosure, or the lender did not use the GSE's underwriting software.  

 

In June 2013, the plaintiffs filed a putative class action against the Credit Reporting Agency asserting claims for:  (1) a reasonable procedures claim pursuant to 15 U.S.C. § 1681e; (2) a reasonable reinvestigation claim pursuant to 15 U.S.C. § 1681i; (3) a file disclosure claim pursuant to 15 U.S.C. § 1681g.  The plaintiffs requested damages pursuant to 15 U.S.C. § 1681n.

 

The case was stay pending the Supreme Court's resolution of Spokeo, Inc. v. Robins, 135 S. Ct. 1892 (2015).  After the stay was lifted, the Credit Reporting Agency moved for summary judgment.  The trial court granted summary judgment in favor of the Credit Reporting Agency.  

 

This appeal followed.

 

The Ninth Circuit began its analysis on the plaintiffs' reasonable procedures and reasonable reinvestigation claims.

 

As you may recall, FCRA's compliance procedures provide that: "[w]henever a consumer reporting agency prepares a consumer report it shall follow reasonable procedures to assure maximum possible accuracy of the information concerning the individual about whom the report relates."  15 U.S.C. § 1681e(b).

 

Liability under this reasonable procedure provision "is predicated on the reasonableness of the credit reporting agency's procedures in obtaining credit information."  Guimond v. Trans Union Credit Info. Co., 45 F.3d 1329, 1333 (9th Cir. 1995).  To bring a section 1681e claim, the "consumer must present evidence tending to show that a credit reporting agency prepared a report containing inaccurate information."  Id., 45 F.3d at 1333.

 

Additionally, a credit reporting agency must conduct a free and reasonable investigation within thirty days of a consumer informing the agency of disputed information.  15 U.S.C. § 1681i(a)(1)(A).  Consumers must show that "an actual inaccuracy exists" for a section 1681i claim.  Carvalho v. Equifax Info. Servs., LLC, 629 F.3d 876, 890 (9th Cir. 2010).

 

The plaintiffs argued that the Credit Reporting Agency's short sales code combination 9-68 was "patently incorrect" because it caused the GSE to treat short sales as a potential foreclosure.

 

However, the Ninth Circuit noted that the Credit Reporting Agency reported short sales with code combination of 9-68.  Account status code 68 automatically inserted 9 into the lead payment history spot, signifying that the account was "Settled" and "legally paid in full for less than the full balance."  This, according to the Ninth Circuit, was the very definition of a short sale.

 

Further, the Ninth Circuit explained that even if code combination 9-68 stood for other derogatory events, and thus could be misleading, that alone did not render the Credit Reporting Agency's reporting actionable.  The reporting must be "misleading is such a way and to such an extent that it can be expected to adversely affect credit decisions."  Gorman v. Wolpoff & Abramson, LLP, 584 F.3d 1147, 1163 (9th Cir. 2009).

 

As the Ninth Circuit explained, the Credit Report Agency reported foreclosures with code 8-94, which meant "[c]reditor [g]rantor reclaimed [the] collateral to settle defaulted mortgage."  And, as the Ninth Circuit further explained, a foreclosure did not occur where a mortgage account is "legally paid in full for less than the full balance" like a short sale.  Thus, in the Ninth Circuit's view, the Credit Reporting Agency's code system accurately distinguished short sales and foreclosures.

 

The plaintiffs also argued that the Credit Reporting Agency's reports were misleading because it knew the GSE was misreading its technical manuals and failed to take remedial action.  However, the Ninth Circuit rejected this argument because FCRA did not make the Credit Reporting Agency liable for the misconduct of its subscribers.

 

Thus, because the Ninth Circuit determined that the plaintiffs failed to point to any inaccuracies on their credit reports, it did not have to consider whether the Credit Reporting Agency had reasonable procedures or conducted reasonable reinvestigations.

 

Next, the Ninth Circuit turned to the plaintiffs' arguments regarding the Credit Reporting Agency's consumer disclosures.

 

As you may recall, 15 U.S.C. § 1681g(a) provides, in relevant part, that "[e]very consumer reporting agency shall, upon request, clearly and accurately disclose to the consumer:  [a]ll information in the consumer's file at the time of the request."  "A consumer's file includes "all information on the consumer that is recorded and retained by a [credit reporting agency] that might be furnished, or has been furnished, in a consumer report on that consumer."  Cortez v. Trans Union, LLC, 617 F.3d 688, 711-12 (3d Cir. 2010).

 

First, the plaintiffs argued that Credit Reporting Agency's consumer disclosures violated section 1681g(a)(1), because it placed the designation "CLS" (Closed) in the lead spot on the payment history grid on each consumer disclosures, instead of one of the code 9 statuses.  The plaintiffs argued that because the status category on a consumer disclosure ("Paid in settlement") was a separate category from the lead digit in the payment history grid on a credit report, these categories served different purposes.

 

The Ninth Circuit disagreed.  It found that the Credit Reporting Agency complied with section 1681(g) because it provided the plaintiffs with all information in their files at the time of their requests in a form that was both clear and accurate.  Specifically, the Credit Reporting Agency's consumer disclosures conveyed the same information it reported to its subscribers.

 

Additionally, the Ninth Circuit determined that the Credit Reporting Agency was not required to report the actual code 9 in a consumer disclosure.  Requiring the Credit Reporting Agency to provide its proprietary code, in the Ninth Circuit's view, would contradict section 1681g(a)'s requirement that the disclose be "clear."  In order for a consumer to understand code 9, the Credit Reporting Agency would have to report account status code 68 and release its complicated technical manual, which would further confuse unsophisticated consumers.

 

Moreover, the Ninth Circuit was unpersuaded by the plaintiffs' argument that the Credit Reporting Agency violated section 1681g(a)(1), because "there was a material disconnect between the information displayed in [their] consumer reports and the information displayed in [their] consumer disclosures due to the presence of the catchall code 9."  As the Ninth Circuit explained, this was in essence the same argument based on an incomplete interpretation of the Credit Reporting Agency's coding system.  The Credit Reporting Agency's account status code 68 clarified the account's status and the specific derogatory event attached to it.

 

Thus, the Ninth Circuit held that the plaintiffs failed to identify what information the Credit Reporting Agency improperly excluded from its disclosures.

 

Additionally, the Ninth Circuit found that the plaintiffs failed to establish a right to statutory damages under 15 U.S.C. § 1681n, which required a showing that the Credit Reporting Agency willfully failed to comply with FCRA.  

 

The Ninth Circuit stated that even if the Credit Reporting Agency had violated section 1681g, it did not act in an objectively unreasonable manner by electing not to list code 9 in its consumer reports.  Further, the Ninth Circuit noted that the Consumer Financial Protection Bureau investigated the shorts sale-foreclosure problem and determined that the underlying issue was not due to inaccurate reporting by furnishers or credit reporting agencies.

 

Accordingly, the Ninth Circuit affirmed the trial court's grant of summary judgment in favor of the Credit Reporting Agency.

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: 11th Cir Refuses to Compel Arbitration of TCPA Allegations

In an unpublished opinion, the U.S. Court of Appeals for the Eleventh Circuit recently affirmed a trial court's order denying an auto finance company's motion to compel arbitration pursuant to the terms of a retail installment sales contract with a consumer.

 

In so ruling, the Eleventh Circuit concluded that the consumer's TCPA claims were an independent cause of action based on rights created under the TCPA, and not subject to the arbitration provision that only covered disputes arising from or related to the agreement or the motor vehicle collateral.

 

A copy of the opinion is available at:  Link to Opinion

 

A consumer ("Consumer") entered into a retail installment sales contract ("RISC") that was sold and assigned to an automotive finance company ("Creditor").  The RISC included a clause requiring arbitration of any "claim, dispute of controversy… whether preexisting, present or future, that in any way arises from or relates to [the RISC] or the Motor Vehicle securing [the RISC]' (hereafter, the "Arbitration Provision").  The RISC further provided the Creditor the right to send its customers "emails, text messages and other electronic communications" (the "Text Consent Provision").  However, the Text Consent Provision required separate signatures, and was never executed by the Consumer.

 

Several months after the Consumer paid off the RISC, the Creditor began sending text messages to the consumer offering her a new loan.  Even after she requested by telephone that the Creditor stop sending these texts, the Consumer received nine (9) additional text messages.

 

The Consumer filed a class action lawsuit in federal district court against the Creditor under the federal Telephone Consumer Protection Act, 47 U.S.C. § 227 ("TCPA"), alleging that the Creditor used an automatic telephone dialing system to send her, and others similarly situated, non-emergency text messages without their prior express consent, in violation of subsection § 227(b)(1)(A)(iii) of the TCPA. 

 

In response, the Creditor moved to compel arbitration pursuant to the Arbitration Provision.   The trial court denied the Creditor's motion on the grounds that the Consumer's TCPA claim fell outside the scope of the Arbitration Provision  This appeal followed.

 

On appeal, the Eleventh Circuit first examined the Creditor's argument that because the Consumer's complaint asserts the Text Consent Provision governs her alleged lack of express consent to send text messages to her cell phone, that the complaint inextricably ties a prima facie element of the TCPA claim — the lack of consent —to the RISC, thus triggering the Arbitration Provision.

 

The Appellate Court disagreed with the Creditor, concluding that the Consumer's rights to not to receive unconsented-to text messages were established by law under the TCPA — well before she signed the RISC and refused to sign the Text Consent Provision.  See generally, 47 U.S.C. § 227.

 

The Eleventh Circuit further rejected the Creditor's argument that the Arbitration Provision was broad enough to encompass the Consumer's claims.  While acknowledging that the plain language of the Arbitration Provision makes the arbitration provision broad, it does not make it limitless. See Princess Cruise Lines, 657 F.3d at 1218 (stating "the term 'arising out of' is broad, but not all encompassing" while recognizing that the dispute in question must be "an immediate, foreseeable result of the performance of contractual duties").

 

Here, the Consumer signed the RISC, but refused to sign the Text Consent Provision, and the Creditor did not violate the RISC.   Thus, in the Court's view, the Consumer's claims did not arise from the RISC or any breach thereof, but rather from post-agreement conduct in alleged violation of a separate, distinct federal law — the TCPA. 

 

Moreover, the Eleventh Circuit determined text messages do not relate to the financing terms set forth in the RISC, and the Text Consent Provision is a separate stand-alone provision which the Consumer never signed, and thus no agreement regarding text messages exists between the parties.  See Telecom Italia, SpA v. Wholesale Telecom Corp., 248 F.3d 1109, 1116 (11th Cir. 2001) ("Disputes that are not related—with at least some directness—to performance of duties specified by the contract do not count as disputes 'arising out of' the contract, and are not covered by the standard arbitration clause.").

 

Put another way, the Eleventh Circuit explained that the existence of the RISC was irrelevant, unless it had specifically contemplated future TCPA claims — which it did not — and the Consumer could have filed suit under the TCPA without there ever having been a contract between the parties. 

 

Because the Consumer's TCPA claims did not "in any way arise[] from or relate[] to" the RISC, and the Arbitration Provision covered only those disputes arising from or related to the RISC or the motor vehicle securing that agreement, the trial court's denial of the Creditor's motion to compel arbitration was affirmed.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: Wisc Sup Ct Holds New Foreclosure Not Barred By Dismissal With Prejudice of Prior Foreclosure

The Supreme Court of Wisconsin recently held that claim preclusion does not bar a mortgagor from proceeding with a foreclosure complaint despite a prior litigation which resulted in a dismissal with prejudice if the subsequent litigation is based upon a default and acceleration which occurred after the initial foreclosure proceeding.  

   

A copy of the opinion in available at:  Link to Opinion

 

Following a borrower's default on his mortgage loan, the prior servicer of the loan initiated foreclosure proceedings based upon a default and acceleration alleged to have occurred in 2009.  The trial court in this initial foreclosure action determined that the prior servicer failed to demonstrate sufficient evidence that proper notice of default and intent to accelerate was provided to the borrower as required.  Consequently, the trial court dismissed the initial foreclosure complaint with prejudice.

 

After the dismissal of the initial foreclosure complaint, the new loan servicer for the loan provided a new notice of intent to accelerate to the borrower.  After the borrower failed to cure the default, the new servicer filed a second foreclosure complaint alleging that the borrower defaulted in 2009 and that proper notice of acceleration had been provided.

 

The borrower moved to dismiss the second foreclosure complaint arguing that it was barred the doctrine of claim preclusion.

 

The trial court determined that claim preclusion only barred the portion of the complaint which alleged a default prior to the dismissal with prejudice.  However, the trial court allowed the filing of the new foreclosure complaint to provide an allegation of default occurring subsequent to that dismissal.  

 

Following the trial court's ruling, the servicer filed the amended complaint containing the allegations as to the default and acceleration after the dismissal in the initial proceeding and the matter proceeded to trial.  At trial on the amended complaint, the court granted judgment of foreclosure and entered a deficiency judgment against the borrower for the entire loan balance.

 

During the trial, the court also allowed a copy of the original note to be entered into evidence following the production of the original for inspection in open court by counsel and the court. 

 

The borrower appealed the judgment, and the Wisconsin appellate court certified the issue as to whether or not the doctrine of claim preclusion acts as a bar to the second foreclosure action based upon the dismissal with prejudice entered in the initial foreclosure complaint. 

 

In reviewing the issue, the Wisconsin Supreme Court began with a statement as to the standards for the doctrine of claim preclusion in Wisconsin.  As you may recall, there are three elements necessary for the doctrine to apply:  "(1) an identity between the parties or their privies in the prior and present suits; (2) an identity between the causes of action in the two suits; and, (3) a final judgment on the merits in a court of competent jurisdiction."  See N. State Power Co. v. Bugher, 525 N.W.2d 723 (Wis. 1995).

 

As noted by the Court the only element at issue in the matter at hand was the second -- i.e. whether or not an identity between the two causes of action existed.  In Wisconsin, the second factor is determined by applying the "transactional approach"  described in Restatement (Second) of Judgments.  The "transactional approach" views a claim in factual terms and coterminous with the transaction, and to avoid an analysis of the legal theories presented in the matters. See Restatement (Second) of Judgments § 24 (1982). 

 

The Supreme Court of Wisconsin further explained that the transactional approach to claim preclusion reflects the "expectation that parties who are given the capacity to present their entire controversies shall in fact do so."  In other words, the "concept of a transaction connotes a common nucleus of operative facts."  See Kruckenberg v. Harvey, 694 N.W.2d 879 (Wis. 2005).  Pragmatically speaking, the Court summed up the process as looking to see whether or not the claims in the second action should have been presented in the earlier action. 

 

Applying this standard to the matter at hand, the Court concluded that there was no identity between the two foreclosure actions because each lawsuit relates to a set of operative facts that occurred at a different time.   

 

Specifically, as noted by the Court, the default and acceleration alleged in the second foreclosure action "by way of the amended pleading" could not have been included in the first action as they occurred after the dismissal. 

 

The Wisconsin Supreme Court rejected the argument by the borrower that the doctrine should apply because the entire loan balance had been alleged due and owing in both actions.  The Court explained that unlike in cases cited by the borrower, the trial court in the first foreclosure action determined that the loan was not properly accelerated, and consequently, there was no bar to the mortgagee accelerating the loan balance afterwards based upon a subsequent default.  See Johnson v. Samson Constr. Corp., 704 A.2d 866 (Me. 1997); U.S. Bank National Ass'n v. Cullota, 899 N.E.2d 987 (Ohio 2008).  Notably, the Court did not disagree (or agree) with the courts in Johnson or Cullota, but found that factually, those rulings were distinguishable from the present case. 

 

Explaining the law as to the applicable facts, the Court stated that "[a]fter a lawsuit based on the debtor's failure to make one or more payments is dismissed with prejudice but payment of the note was not validly accelerated because it was never proved the borrower was actually in default, the parties are simply placed back into the position they had held before the commencement of the lawsuit, with the same continuing obligations."

 

Here, the Court found that following the dismissal of the initial foreclosure action without a determination that the loan had been accelerated, the borrower's obligation to make the monthly installment payments under the loan continued.  The borrower's subsequent failure to pay as demanded by the subsequent servicer was a default which allowed for the loan balance to be accelerated. 

 

Accordingly, the Supreme Court of Wisconsin determined that claim preclusion did not apply, and affirmed the trial court's judgment in favor of the mortgagee. 

 

The Court also briefly addressed an issue raised by the parties concerning whether the trial court erred in allowing the entry of a copy of the note into evidence over the borrower's objection.  Relying heavily on its recent ruling in Deutsche Bank National Trust Co. v. Wuensch, Case No. 2015AP175 (Wis. Apr. 17, 2018), the Court determined that the trial court did not err.

 

In Deutsche Bank, the Supreme Court of Wisconsin found that a "promissory note endorsed in blank constitutes self-authenticating commercial paper that may be enforced by the holder of the note."  The Court also noted that "generally speaking, a duplicate of a document is admissible to the same extent as the original." 

 

Thus, the Court found that no error occurred because the mortgagee proved that it possessed the original wet-ink note, and there was no issue with admitting a copy into evidence. 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Georgia  |   Illinois   |   Indiana   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC   |   Wisconsin

 

 

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FYI: 7th Cir Rejects Banks' Data Breach Claims of Negligence and UDAP Against Retailer

In a data breach putative class action brought by financial institutions against a retail grocery store chain, the U.S. Court of Appeals for the Seventh Circuit recently held that the economic loss doctrine prevented recovery of economic losses in tort cases.

 

Although the financial institutions had no direct contractual relationship with the retail grocery store chain, the Seventh Circuit noted that the banks and the merchant all participated in a network of contracts that tied together all the participants in the card payment system. 

 

In so ruling, the Seventh Circuit joined the Third and First Circuits in rejecting negligence theory in a data breach case by card issuers against merchants.

 

The Seventh Circuit also rejected the financial institutions' efforts to bring UDAP claims to recover their losses against the retailer.

 

A copy of the opinion is available at:  Link to Opinion

 

In December 2012, hackers installed malicious software on the grocery store chain's ("Merchant") computer network and harvested data from Merchant's system while payment transactions were being processed.  The breach affected 79 of Merchant's 100 stores in the Midwest, many of which are located in Missouri and Illinois.

 

The hackers harvested and sold customer the stolen data which was used to create counterfeit cards and to make unauthorized cash withdrawals, including from the plaintiff banks -- four financial institutions that issued cards and participated in the card payment system (the "Banks")

 

Merchant claimed that it did not learn of the breach until March 2013.  The Banks estimated that for every day the data breach continued, approximately 20,000 cards may have been comprised, and a total of 2.4 million cards may be at risk from the breach.  The Banks alleged that the numerous security steps could have prevented the breach and that those step were required by the card network rules -- a network of contracts between the retail merchant, issuing bank, acquiring bank, and the card network (e.g., VISA, MasterCard).

 

Additionally, under the card network rules, the Banks agreed to indemnity their customers in the event that a data breach anywhere in the network results in unauthorized transactions.  The contracts provided a cost recovery process that allowed issuing banks to seek reimbursement for at least some of their losses.

 

In 2014, the Banks, which may or may not have received some of those reimbursements, filed a lawsuit seeking to be made whole directly by the Merchant.  In effect, the Banks sought reimbursement for their losses above and beyond the remedies provided under the card network contracts.

 

The several of the Banks filed a putative class action against the Merchant.  The putative class of banks included both Illinois and Missouri citizens,

 

The trial court dismissed all of the Banks claims, holding that the Illinois and Missouri tort law did not offer a remedy to card-holders' banks against a retail merchant who suffered a data breach, above and beyond the remedies provided by the contracts between the parties.

 

This appeal followed.

 

The Seventh Circuit began its analysis by examining the economic loss doctrine in commercial litigation.

 

As you may recall, many states generally refuse to recognize tort liabilities for purely economic losses inflicted by one business on another where those businesses have already ordered their duties, rights, and remedies by contract. 

 

In Illinois, this is known as the Moorman doctrine, from Moorman Mfg. Co. v. Nat'l Tank Co., 435 N.E.2d 443 (Ill. 1982).  Missouri generally prohibits "a plaintiff from seeking to recover in tort for economic losses that are contractual in nature."  Autry Morlan Chevrolet Cadillac, Inc. v. RJF Agencies, Inc., 332 S.W.3d 184, 192 (Mo. App. 2010).

 

The Banks argued that they had no direct contractual relationship with the Merchant.  Although that was true, the Seventh Circuit noted that the Banks and Merchant all participated in a network of contracts that tied together all the participants in the card payment system. 

 

Specifically, when the parties joined the card payment system they agreed to abide by the data security standards of the industry, the PCI DSS.  The Merchant agreed to be subject to assessments and fines from the card networks in the event that it was responsible for data breaches and unauthorized card activity.  The Banks agreed to exceed federal requirements for indemnifying their card holders and also consented to the remedial assessment and reimbursement process provisions and related risks. 

 

In the Seventh Circuit's view, this network of contracts imposed duties and provided contractual remedies for breach of those duties.  The Banks accepted some risk of not being fully reimbursed for the costs of another party's mistake, and as such, the Banks cannot seek additional recovery because they were disappointed by the reimbursement they received through the contract that they voluntarily entered into. 

 

The Seventh Circuit concluded that neither Illinois nor Missouri would recognize a tort claim from the Banks where the claimed conduct and losses were subject to contract.

 

Under the backdrop, the Seventh Circuit turned to the Banks' specific common law claims.

 

First, the Banks argued that the Merchant had a common law duty to safeguard customers' data and that duty extends to its customers' banks.

 

The Illinois Supreme Court has not directly spoken on this issue in the context of data breaches.  However, the Illinois Appellate Court addressed this topic in Cooney v. Chicago Public Schools, 943 N.E.2d 23, 28 (Ill. App. 2010) and rejected "'a new common law duty' to safeguard information."  Relying on Cooney, the Seventh Circuit predicted that the Illinois Supreme Court would not impose a common law data security duty proposed by the Banks.

 

The Seventh Circuit noted that Missouri Appellate Courts have said less than Illinois Appellate Courts on the question of duty.  However, the Seventh Circuit indicated that Missouri would likely reach the same conclusion as it applies the same common law duty test that was important to the Cooney court.   See Hoffman v. Union Elec. Co., 176 S.W.3d 706, 708 (Mo. 2005).

 

In any event, the Seventh Circuit predicted that Illinois and Missouri courts would apply the economic loss doctrine to bar recovery anyways, as courts in both states do not permit tort recovery for businesses who seek to correct the purely economic "defeated expectations of a commercial bargain."

Therefore, the Seventh Circuit determined that the District Court's rejection of the Banks' negligence claim was consistent with Illinois and Missouri law.

 

Similarly, the Seventh Circuit found that the Bank's negligence per se claims failed because neither Illinois nor Missouri have legislatively imposed liability for personal data breaches.  This is critical, according to the Seventh Circuit, as the first element of a negligence per se action is a showing that a statute or ordinance had been violated.

 

The Banks also asserted three other claims sounding in the common law of contracts:  unjust enrichment, implied contract, and third-party beneficiary. 

 

The Seventh Circuit noted that Illinois law and Missouri law on these common law contract theories were similar -- they both refused to recognize unjust enrichment claims where contracts already establish rights and remedies.  Illinois and Missouri also do not recognize implied contracts where written agreements define the business relationship.  And, neither state recognizes third-party beneficiary claims unless the beneficiary is identified or the third-party beneficiary benefit is clearly intended by the contracting parties.

 

Moreover, the Seventh Circuit noted that Merchant was not unjustly enriched -- its card-paying customers paid the same amount as those paying in cash -- and there was no unjust enrichment left uncovered outside of the card payment system contracts.

 

Thus, because the network contracts precluded secondary common law contract theories, the Seventh Circuit concluded that the district court properly rejected these claims.

 

The Seventh Circuit acknowledged that the Fifth Circuit predicted that New Jersey would recognize a negligence claim brought by an issuing bank against a payment processor, although not retail merchants.  See Lone Star Nat'l Bank, N.A. v. Heartland Payment Sys., Inc., 729 F.3d 421 (5th Cir. 2013). 

 

However, the Seventh Circuit provides two reasons for reaching a difference conclusion.  One, the Lone Star court relied on New Jersey's practice of being "a leader in expanding tort liability."  Id., at 426-27.  Two, unlike the Lone Star court, there was sufficient information about the card network agreements in the record to inform the Seventh Circuit's analysis. 

 

The Seventh Circuit's reasoned that its predictions were closer to Sovereign Bank v. BJ's Wholesale Club, Inc., 533 F.3d 162 (3d Cir. 2008) (applied economic loss rule to bar negligence claims and rejected most of the other theories invoked by issuing banks against a breached retail merchant) and In re TJX Companies Retail Security Breach Litig., 564 F.3d 489 (1st Cir. 2009) (rejected negligence theory because of the economic loss rule and a third-party beneficiary theory under the card payment system contracts).

 

Thus, the Seventh Circuit joined the Third and First Circuits in rejecting negligence theory in a data breach case where the parties' duties and remedies were defined by contract.

 

The Seventh Circuit then turned to the Banks' claim that the Merchant violated the Illinois Consumer Fraud and Deceptive Business Practices Act (ICFA), 815 Ill. Comp. Stat. 505/2, 505/10a, by allegedly engaging in an unfair practice of having poor data security procedures. 

 

As you may recall, Illinois courts are skeptical of business-v.-business ICFA claims when neither party is actually a consumer in the transaction.  See Athey Prods. Corp. v. Harris Bank Roselle, 89 F.3d 430, 437 (7th Cir. 1996) (a business plaintiff under the ICFA must show a "nexus between the complained of conduct and consumer protection concerns"). 

 

However, the Seventh Circuit did not decide whether the Banks could establish a consumer nexus in an ICFA data breach claim, because the Banks failed to allege any ICFA violation that would make that secondary consumer nexus determination necessary.

 

The Banks advanced a theory that the Merchant engaged in unfair practice by not warning customers or the Banks of its compromised payment system, and it acted deceptively to maintain its prices and to ensure business as usual until it publicly announced the data breach.  The Seventh Circuit found this argument unpersuasive because this type of "market theory of causation" has been rejected in Illinois.  See Oliveira v. Amoco Oil Co., 776 N.E.2d 151 (Ill. 2002).

 

The Banks also argued that the Merchant violated the ICFA by violating the Illinois Personal Information Protection Act (PIPA), 815 Ill. Comp. Stat. 530/10, which requires notice to Illinois residents affected by data breaches. 

 

As you may recall, a violation of PIPA constitutes an unlawful practice under the ICFA.  See 815 Ill. Comp. Stat. 530/20.

 

The problem was, as the Seventh Circuit explained, the Banks failed to explain whether and how the Merchant's conduct fell under one of the operative subsections of the notice statute and not any of its exceptions.  Id.  This was critical as the Banks were advancing a novel legal theory.  Because the Banks did not adequately develop its arguments in District Court, the Seventh Circuit concluded that the Banks failed to preserve the argument on appeal.

 

Accordingly, the Seventh Circuit affirmed the judgment dismissing the action.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
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