Petition for Writ of Certiorari — Towers World Airways, Inc. v. PHH Aviation Systems, Inc.

~ | Supren Court us,

60-1980 FILLED

No 0. JUN 26 i899 |

SS a

IN THE

Supreme Court of the United States

OCTOBER TERM, 1990

—_ >

TOWERS WORLD AIRWAYS, INC., THE TOWERS ORGANIZA4-

TION, INC. and TOWERS FINANCIAL CORPORATION,

Petitioners,

—_V—_—

PHH AVIATION SYSTEMS, INC.

and PHH Group, INC.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

DALE A. SCHREIBER

STEPHEN P. KRAMER

Counsel of Record

for Petitoners

PROSKAUER ROSE GOETZ

& MENDELSOHN

Attorneys for Petitioners

1585 Broadway

New York, New York 10036

(212) 969-3000

June 25, 1991

a a

QUESTION PRESENTED

Does the Truth in Lending Act limit the liability of a credit

card hoider for charges made on the card by a previously

authorized user after notice to the card issuer that the card

was being used in an unauthorized manner?

il

List of Parties

1) Petitioners

2)

(Plaintiffs-Appellants

below):

—o |

(Defendants-Appellees

below):

Towers World Airways

Inc., The Towers

Organization, Inc., and

Towers Financial

Corporation.

PHH Aviation Systems Inc.

and PHH Group, Inc.

ili

TABLE OF CONTENTS

Page

QUESTION PRESENTED ......ccccscceces i

EE ee ee ll

py Fe hay 8 iy y |: Se Vv

Ce 2

EEE ee oe ee eee 2

STATUTES AND REGULATIONS INVOLVED ... 2

Daraneeeen Ge bee CASE ow ww ee eee es 6

REASONS FOR GRANTING THE WRIT ........ 8

EE eee 16

APPENDIX

Second Circuit Opinion, Towers World

Airways Inc. et al. v. PHH Aviation

Systems Inc. et al., dated May 17,

ne ee ee le sw ee es la

iV

District Court Memorandum Opinion and

Order, Towers World Airways Inc. et

al. v. PHH Aviation Systems Inc. et

al., dated May 30, 1990 ...........

Federal Trade Commission Letter, dated

Ss Baoan ea ee

Vv

TABLE OF AUTHORITIES

Cases Page

Cities Serv. Co. v. Pailet, 452 So.2d

319 (La. Ct. App. 4th Cir. 1984) ........... 14

Martin v. American Express, Inc.,

361 So.2d 597 (Ala. Civ. App. 1978) ........ 15

Matter of Shell Oil Co., 95 F.T.C. 357 (1980) ..... 14

Standard Oil Co. v. Steele, 22 Ohio Misc. 2d 27,

489 N.E.2d 842 (Mun. Ct. Akron Co. 1985) .... 15

Walker Bank & Trust Co. v. James, 672 P.2d 73

(Utah 1983), cert. denied, 466 U.S. 937 (1984) .. 15

Statutes and Regulations

Truth in Lending Act (15 U.S.C.

Sg Sf i rte, oa? passim

ae Uae. OD 2 oc ds 6 a eee 2

Be Un BE 6 0 6 6 0s bere 2

ae UB... § SI kc 8 ae ee 2

vi

Statutes and Regulations (con’t.)

Federal Reserve Board Regulation Z

by Eat FR 8 ee

Federal Rules of Appellate Procedure

Se 6s a eee ee

S. Rep. No. 259, 100th Cong., 2d Sess. 1,

reprinted in 1988 U.S. Code Cong. &

Rae, TE Be cs bee ee whee Cowsees

Act of Oct. 26, 1970, Pub. L. No. 91-508,

tit. V, 84 Stat. 1126, amending Truth in

Lending Act of 1970, 15 U.S.C. § 1601-81(t)

Other Authorities

Consumer Cred. Guide (CCH) ¢ 3302 (1996) ...

R. Rohner, F. Miller, S. Mancuso, The Law of

Truth in Lending, { 10.03 at 510-18

er ee ee ee eee

Note, Credit Cards: Distributing Fraud

Loss, 77 Yale L.J. 1418 (1968) .........

Weistart, Consumer Protection In The Credit

Card Industry: Federal Legislative Control,

70 Mich. L. Rev. 1476 (1972) ..........

IN THE

Supreme Court of the United States

OCTOBER TERM, 1990

No. 90 -

+

TOWERS WORLD AIRWAYS, INC., THE TOWERS

ORGANIZATION, INC. and TOWERS FINANCIAL

CORPORATION,

Petitioners,

— Vv. —

PHH AVIATION SYSTEMS, INC. and PHH GROUP, INC.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Towers World Airways Inc., The Towers Organization

Inc. and Towers Financial Corporation petition for a writ of

certiorari to review the decision of the United States Court of

Appeals for the Second Circuit.

2

OPINIONS BELOW

The summary judgment Memorandum Endorsement of the

district court granting defendants’ counterclaim against

petitioners (Appendix, infra 13a) is unreported. The opinion

of the Court of Appeals affirming the judgment of the district

court (la) is not yet reported.

JURISDICTION

The opinion of the Court of Appeals (la) was rendered

on May 17, 1991. Issuance of the mandate was not stayed,

despite petitioners’ application under Rule 41(b) of the

Federal Rules of Appellate Procedure for such a stay. The

jurisdiction of this Court is invoked under 28 U.S.C.

§ 1254(1). Jurisdiction in the District Court was invoked

under 28 U.S.C. § 1332(a)(1). Jurisdiction in the Court of

Appeals was based on 28 U.S.C. § 1291.

STATUTES AND REGULATIONS INVOLVED

Section 1602(0) of the Truth in Lending Act, 15 U.S.C.

§ 1602(0), provides:

The term ‘unauthorized use’ as used in section

... [1643 of this title] ... means a 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.

Section 1643 of the Truth in Lending Act, 15 U.S.C.

§ 1643, provides:

3

(a)(1) Liability of holder of credit card. A

cardholder shall be liable for the unauthorized

use of a credit card only if — (A) the card is

an accepted credit card; (B) the liability is not

in excess of $50; (C) the card issuer gives

adequate notice to the cardholder of the

potential liability; (D) the card issuer has

provided the cardholder with a description of

a means by which the card issuer may be

notified of loss or theft of the card, which

description may be provided on the face or

reverse side of the statement required by

section 127(b) or on a separate notice

accompanying such statement; (E)_ the

unauthorized use occurs before the card issuer

has been notified that an unauthorized use of

the credit card has occurred or may occur as

the result of loss, theft, or otherwise; and (F)

the card issuer has provided a method whereby

the user of such card can be identified as the

person authorized to use it.

(2) For purposes of this section, a card

issuer has been notified when such steps as

may be reasonably required in the ordinary

course of business to provide the card issuer

with the pertinent information have been

taken, whether or not any particular officer,

employee, or agent of the card issuer does in

fact receive such information.

(b) Burden of proof. In any action by a

card issuer to enforce liability for the use of a

credit card, the burden of proof is upon the

4

card issuer to show that the use was authorized

or, if the use was unauthorized, then the

burden of proof is upon the card issuer to

show that the conditions of liability for the

unauthorized use of a credit card, as set forth

in subsection (a), have been met.

(c) Liability imposed by other laws or by

agreement with issuer. Nothing in this section

imposes liability upon a cardholder for the

unauthorized use of a credit card in excess of

his liability for such use under other applicable

law or under any agreement with the card

issuer.

(d) Exclusiveness of liability. Except as

provided in this section, a cardholder incurs

no liability from the unauthorized use of a

credit card.

12 C.F.R. § 226.12(b), as promulgated by the Federal

Reserve Board, provides:

(1) Limitation on amount. The liability of

a cardholder for unauthorized use of a credit

card shall not exceed the lesser of $50 or the

amount of money, property, labor, or services

obtained by the unauthorized use before

notification to the card issuer under

paragraph (b)(3) of this section.

(2) Conditions of liability. A cardholder

shall be liable for unauthorized use of a credit

card only if:

(i) The credit card is an accepted credit

card;

5

(ii) The card issuer has provided adequate

notice* of the cardholder’s maximum potential

liability and of means by which the card issuer

may be notified of loss or theft of the card.

The notice shall state that the cardholder’s

liability shall not exceed $50 (or any lesser

amount) and that the cardholder may give oral

or written notification, and shall describe a

means of notification (for example, a

telephone number, an address, or both); and

(iii) The card issuer has provided a means

to identify the cardholder on the account or the

authorized user of the card.

(3) Notification to card issuer.

Notification to a card issuer is given when

steps have been taken as may be reasonably

required in the ordinary course of business to

provide the card issuer with the pertinent

information about the loss, theft, or possible

unauthorized use of a credit card, regardless of

whether any particuiar officer, employee, or

agent of the card issuer does, in fact, receive

the information. Notification may be given, at

the option of the person giving it, in person,

by telephone, or in writing. Notification in

writing is considered given at the time of

receipt or, whether or not received, at the

expiration of the time ordinarily required for

transmission, whichever is earlier.

(4) Effect of the other applicable law or

agreement. If state law or an agreement

between a cardholder and the card issuer

6

imposes lesser liability than that provided in

this paragraph, the lesser liability shall govern.

(5) Business use of credit cards. If 10 or

more credit cards are issued by one card issuer

for use by the employees of an organization,

this section does not prohibit the card issuer

and the organization from agreeing to liability

for unauthorized use without regard to this

section. However, liability for unauthorized

use may be imposed on an employee of the

organization, by either the card issuer or the

Organization, only in accordance with this

section.

* ‘Unauthorized use’ means the 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.

STATEMENT OF THE CASE

This case concerns the extent of protection from liability

for unauthorized credit card use that the Truth in Lending Act

provides to cardholders who have informed card issuers that

a card is being used improperly. The Act reflects a clear

congressional intent that the risk of loss fall on the card

issuer whenever, after notification to the card issuer of the

loss, theft, or unauthorized use of a card, unauthorized use

occurs, since the issuer is in the best position to develop

technological or other means to limit credit card fraud.

7

Nevertheless, the opinion below carves out an exception to

this policy where the unauthorized use is by a formerly

authorized user, even when the card issuer has been notified

that the user is no longer authorized to use the card. This

holding dramatically alters the allocation of risk and

responsibility for fraudulent credit card use under the Act.

The opinion also precludes a cardholder from limiting its

liability by notifying the issuer that a third-party card may be

used only in a specified manner.

The card issuer in the case at bar — respondent PHH

Aviation Systems Inc. ("PHH") — issued a credit card to

petitioner Towers World Airways Inc. ("Towers") to

purchase fuel and other aircraft-related goods and services for

a corporate jet leased by Towers from PHH. Towers

designated Fred Jay Schley as the chief pilot of the leased jet

and gave him permission to make purchases with the credit

card for Towers’ use of the plane. Towers had granted

Schley authority to use the credit card for flights by Towers’

executives, but not for charters by _ third parties.

Nevertheless, Schley used the credit card to provide service

both to Towers’ executives and to third parties who chartered

flights. Towers disputed the propriety of charges in

connection with these chartered flights, and the issuer,

respondent PHH, learned of the dispute. Schley incurred

$89,025.87 in connection with third party charters prior to

the cancellation of the card in August 1988.

PHH claimed the full amount of all charges incurred on

the account both before and after it was notified that

unauthorized use may have occurred. The District Court

granted PHH summary judgment and the Court of Appeals

affirmed. The Court of Appeals held that Towers had raised

no defense to the issuer’s summary judgment motion by

8

contending that the issuer was on notice that the credit card

was being used in an unauthorized manner.

The Court of Appeals reasoned that because the third-

party card user was properly in possession of the credit card

— Towers had voluntarily entrusted the card to Schley — the

cardholder could not avail itself of any of the limitations of

liability found in the Truth in Lending Act for unauthorized

use, even for use that occurred after the issuer became aware

of the claimed unauthorized use. The Act defines

“unauthorized use” as use made without "actual, implied or

apparent authority.” The Court of Appeals reasoned that any

use of a credit card by a formerly authorized user — even use

that occurred after the cardholder informed the issuer that the

user’s authority had been limited or withdrawn — should be

deemed to be use made with the “apparent authority” of the

cardholder and thus outside the protection of the Act. The

Court of Appeals also held that the user’s “apparent

authority” could not be limited by notification of the

limitation to the card issuer.

REASONS FOR GRANTING THE WRIT

The credit card is an essential part of economic life in

modern America. In 1987, some 105.5 million people owned

801.7 million credit and charge cards. The outstanding

balances on revolving credit totalled $142 billion as of

September 30, 1987.' A great proportion of credit cards are

issued to more than one user — to spouses, to other family

1 S. Rep. No. 259;°-100th Cong., 2d Sess. 1 (Fair Credit And Charge

Card Disclosure Act of 1988), reprinted in 1988 U.S. Code Cong. &

Admin. News, 3936, 3937.

9

members, and to employees. These third-party users have no

direct contractual relationship with the card issuers. This

case involves the allocation of risk for improper credit card

use by third-party credit card users who have been given

authority to use the card by the cardholder.

All credit card agreements are subject to the Truth in

Lending Act, 15 U.S.C. § 1601 et seg., and Federal Reserve

Board Regulation Z, 12 C.F.R. § 226 et seg. Congress

adopted the provisions pertaining to credit cards in 1970 in

response to widespread concern about the proliferation of

credit cards and the reported attempts of some card issuers to

hold their customers responsible for charges incurred by

thieves or others acting without the cardholder’s

authorization. One part of the legislative response was to ban

the unsolicited issuance of credit cards. Another was the

enactment of criminal sanctions for credit card fraud.’

However, the most important part of that legislative

response was to set explicit limitations on a customer’s

liability for unauthorized credit card use. Specifically, the Act

places a $50 upper limit on the cardhoider’s liability for

unauthorized use. 15 U.S.C. § 1643(a)(1).

The Court of Appeals’ decision in the case at hand

carves a major exception out of this statutory limit to

cardholder liability. It construes the Act so as to totally

eliminate the limitations of liability found in the Act for

unauthorized charges incurred by spouses, employees, or

other users who have been given a card for temporary or

limited purposes.

2 Act of Oct. 26, 1970, Pub. L. No. 91-508, tit. V, 84 Stat. 1126,

amending Truth in Lending Act, 15 U.S.C. § 1601-81(t) (1970).

10

In view of conflicting opinions among federal regulatory

agencies, state courts and federal courts, this case presents a

timely opportunity for the Court to consider and define the

limits of liability for unauthorized use of credit cards by

persons other than the cardholder.

The Act generally provides that the risk of unauthorized

use be placed on the credit card issuer, not the cardholder.

15 U.S.C. § 1643. The Court of Appeals creates a major

gap in the congressional policy of protecting the consumer

from unauthorized use. Under its opinion, a cardholder

cannot trigger the limitations of liability found in the Act by

notifying the issuer that the authority of a third-party user to

use a card has been limited or terminated.

The Court of Appeals based its limitation of the statutory

protection to cardholders in reliance on an intensely factual

(and essentially unsupportable) communication difficulty

between issuers and merchants of the limitations placed on

particular types of card use. It stated that "it is totally

unrealistic to burden the card issuer with the obligation to

convey tO numerous merchants whatever limitations the

cardholder has placed on the card user’s authority" (11a) (fn.

omitted). But most credit card issuers, with dial-in or other

on-line computer networks to their merchants, now possess

the technological ability to instantaneously convey to

merchants the fact that a card has been canceled or otherwise

restricted. Indeed Congress intended to place the risk of

credit card fraud on issuers in part to encourage the

development of this type of technology.’

3 See Note, Credit Cards: Distributing Fraud Loss, 77 Yale L.J. 1418,

1424-26 (1968).

T:\DOCS\WP51\FIRM\0400\9935.FS2 73816-0081497 (824) 06/25/91 10:06am

11

It is particularly germane that the Federal Reserve Board

and the Federal Trade Commission — each of which has

regulatory authority under 15 U.S.C. § 1607 to implement

the provisions of the Act — and various state courts have

taken positions contrary to that taken by the Court of Appeals

in this case.* As credit card use, and, in particular, third-

party credit card use, becomes even more important to the

economy, th.s conflict in interpreting the Truth in Lending

Act should be resolved.

A. The Court of Appeals restricted the limitations of

cardholder liability for unauthorized card use by third-party

users by employing reasoning that is contrary to the thrust of

the limitation of liability provisions of the Act and its

implementing regulations. In particular, the Court rejected

the defense that notice to the issuer of unauthorized use was

sufficient to make a previously authorized third-party’s use of

a card unauthorized.

The Court of Appeals reasoned that it is “totally

unrealistic to burden the card issuer with the obligation to

convey to numerous merchants whatever limitations the

cardholder has placed on the card user’s authority.” (11a).

The Court of Appeals’ analysis overlooks the fact that a

merchant’s lack of knowledge that a particular use is

unauthorized has no relevance in determining whether the

limitation of liability provisions of the Act apply. For even

if a third-party user validly possesses a card and has apparent

authority (from a merchant’s perspective) to use it, the Act

and the regulations explicitly provide that actual notice to the

4 See Appendix C and cases cited at p. 14-15, infra. Other state courts

have taken a position similar to that adopted by the Court of Appeals

below. Id.

12

issuer that the authority has been terminated precludes

imposition of liability upon the cardholder.

In particular, in allocating risk and responsibility for

unauthorized use in 15 U.S.C. § 1643(a)(1)(E), Congress has

provided that a cardholder may be held liable only if “the

unauthorized use occurs before the card issuer has been

notified that an unauthorized use of the credit card has

occurred or may occur as the result of loss, theft, or

otherwise."

Similarly, Regulation Z limits a cardholder’s liability to

no more than $50 “before notification to a card issuer" that

contains “pertinent information about the loss, theft, or

possible unauthorized use of a credit card" (emphasis added).

12 C.F.R. § 226.12(b)(1) and (3). The Federal Reserve

Board Official Staff Commentary on section 12(b)(3) of

Regulation Z states that notice to the card issuer needed to

trigger the protection of § 12(b) is “sufficient so long as it

gives the ‘pertinent information,’ which would include the

name or card number of the cardholder and an indication that

unauthorized use has or may have occurred" (emphasis

added). 1 Consumer Cred. Guide (CCH), ¢ 3302 (1990).

As one commentator has written:

It might seem self-evident that any continued

use of the card is unauthorized once the

cardholder so notifies the issuer. One could

read the regulation [12 C.F.R. § 226.12(b)(1)

and (3)] to mean that once the cardholder

notifies the issuer of ‘loss, theft, or possible

unauthorized use,’ this terminates the

cardholder’s liability for any further use of the

card (fn. omitted).

13

R. Rohner, F. Miller, J. Mancuso, The Law of Truth in

Lending, { 10.03 (Supp. 1989) at $10-8.

The Court of Appeals may have believed that it was

unrealistic to require an issuer to cancel an account (or bear

the risk of unauthorized use) once the issuer has been

informed that the card user believes a third-party user is

engaging in credit card fraud. Under the statutory scheme

adopted by Congress and as administered by the regulatory

agencies, this concern is misplaced.

Once the issuer receives notice, the Act enjoins the issuer

to act promptly and responsibly. If the issuer determines that

cancellation of the card is the only feasible means of

protecting itself, the issuer may condition continuation of the

card’s use upon the cardholder’s express assumption of the

risk of unauthorized use. If the issuer considers that it is too

draconian to cancel an entire account in the situation of

improper third-party card use, issuers can take technological

steps to code individual cards so that only the problematic

cards, and not the entire account, are canceled upon

notification of improper use. What the issuer cannot do, as

PHH did here, is absolutely nothing and then attempt to hold

the cardholder liable.

B. The two regulatory agencies with authority to

implement the provisions of the Act have taken a position

contrary to that of the Court of Appeals — a divergence of

view not acknowledged by the Court of Appeals. The

Federal Trade Commission, with the concurrence of the staff

of the Federal Reserve Board, has explicitly stated that the

limitations on cardholder liability found in the Act do extend

to use by third-party card users after the issuer has been

notified of unauthorized use.

14

In Matter of Shell Oil Co., 95 F.T.C. 357 (1980), the

Commission entered a consent decree requiring a card issuer

to limit the liability of a cardholder to $50.00 after receiving

notice that the authorized use of the card by a third-party user

had been revoked. The proposed consent decree was widely

published and commented on by the credit card industry

whose views were considered and rejected by the Federal

Trade Commission. In a letter from the Commission to the

president of the Consumer Bankers Association (18a), the

Commission, with the concurrence of the staff of the Federal

Reserve Board, wrote:

With respect to the definition of ‘unauthorized

use’ in Regulation Z, the Commission believes

that previously authorized use by a third

person becomes ‘unauthorized’ when the

cardholder revokes the authorization and so

notifies the card issuer. This position is

consistent with the definition of ‘unauthorized

use’ because the third person no longer has

apparent authority to use the card after

notification of revocation. Notification to the

card issuer is sufficient, not only to terminate

the third person’s apparent authority with

respect to the card issuer, but also with respect

to merchants that are the agents of the issuer

in the use and acceptance of the issuer’s credit

cards.

C. Various state courts have taken the same position to

that adopted by the Federal Trade Commission. For

example, in Cities Serv. Co. v. Pailet, 452 So.2d 319 (La.

Ct. App. 1984), the Louisiana Court of Appeals held that a

cardholder was not liable for uses that occurred after the

15

issuer was notified of possible unauthorized use by the

cardholder’s employee, even though the employee’s prior use

had been authorized. Accord, Standard Oil Co. v. Steele, 22

Ohio Misc. 2d 27, 489 N.E.2d 842 (Mun. Ct. Akron Co.

1985). Other state courts have taken the opposite view.

Walker Bank & Trust Co. v. Jones, 672 P.2d 73 (Utah 1983),

cert. denied, 466 U.S. 937 (1984); Martin v. American

Express, Inc., 361 So.2d 597 (Ala. Civ. App. 1978).

D. The Court of Appeals’ decision will adversely effect

a wide array of consumer interests. For example, the

congressional policy of limiting consumer liability for

unauthorized use is particularly important to separated and

divorced spouses. Frequently the non-cardholder spouse

incurs charges on a card after divorce or separation with no

intent of paying the cardholder, issuer or merchant for the

merchandise or services procured. The card issuer, upon

notice, can take precautions preventing this type of fraud

from occurring.

The congressional policy limiting cardholder liability for

unauthorized use is also important to small businesses, which

have cards issued for their employees’ use. The Court of

Appeals’ decision affords the employer no protection for an

employee’s improper card use. There is no policy or other

reason to place the responsibility for unauthorized charges on

the employer once it has notified the issuer that card use

should be limited or terminated.

The explicit policy of Congress was to place the risk of

fraudulent and unauthorized credit card use upon the issuer

since it is the issuer that is most likely to take efficient steps

16

to minimize fraud and unauthorized use.* The industry has

responded and taken many such steps. The industry’s

incentive to make innovations should not be reduced by

carving out a wholesale exception to the protection from

credit card fraud for usage by once-authorized third party

card users.

CONCLUSION

The petition for a writ of certiorari should be granted.

Respectfully submitted,

8 k coxalert ~

“Wd. Pf ? hh Lee (=

DALE A. SCHREIBER

STEPHEN P. KRAMER

Counsel of Record for

Petitioners

PROSKAUER ROSE GOETZ

& MENDELSOHN

1585 BROADWAY

NEW YORK, NEW YORK 10036

212 969-3000

June 25, 1991

5 See also, Weistart, Consumer Protection In The Credit Card Industry:

Federal Legislative Control, 70 Mich. L. Rev. 1476 1509-13 (1972).

APPENDIX

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UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

+

No. 1041—August Term 1990

Argued: February 7, 1991 Decided: May 17, 1991

Docket No. 90-7909

TOWERS WORLD AIRWAYS, INC., THE TOWERS

ORGANIZATION, INC. and TOWERS FINANCIAL

CORPORATION,

Plaintiffs-Appellants,

aaa ke

PHH AVIATION SYSTEMS, INC. and PHH GROUP, INC.,

Defendants-Appellees.

4

Before:

LUMBARD, NEWMAN, and ALTIMARI,

Circuit Judges.

*

Appeal from the June 19, 1990, judgment of the District

Court for the Southern District of New York (Kevin Thomas

Duffy, Judge) requiring credit cardholder to pay credit card

issuer for charges incurred by person given credit card,

despite defense that use of card was "unauthorized" within

acta iia eit ati nai teat

2a

meaning of Truth in Lending Act, 15 U.S.C. § 1643(a)

(1988).

Affirmed.

%

JAY D. FISCHER, New York, N.Y. (Jeffrey

D. Marks, Alexander H. Schmidt,

Proskauer Rose Goetz & Mendelsohn,

New York, N.Y., on the brief), for

plaintiffs-appellants.

JAMES P. O’NEILL, New York, N.Y.

(Stephenie J. Lannigan, Victor Rivera,

Townley & Updike, New York, N.Y., on

the brief), for defendants-appellees.

s

JON O. NEWMAN, Circuit Judge:

The Truth-in-Lending Act, 15 U.S.C. § 1643(a) (1988),

places a limit of $50 on the liability of a credit cardholder for

charges incurred by an “unauthorized” user. This appeal

concerns the applicability of this provision to a card bearer

who was given permission by the cardholder to make a

limited range of purchases but who subsequently made

substantial additional charges on the card. The appeal is

brought by Towers World Airways, Inc. ("Towers"), a credit

cardholder, and two related corporations from the June 19,

1990, judgment of the District Court for the Southern District

of New York (Kevin Thomas Duffy, Judge) denying their

request for a declaratory judgment to absolve them of liability

' |

3a

for the sums charged and granting judgment for the card

issuer, PHH Aviations Systems ("PHH"), on its counterclaim

for the amounts charged. We conclude that the person

incurring the charges was not an “unauthorized” user within

the meaning of section 1643(a) and therefore affirm.

Background

In February 1988, PHH issued a credit card to Towers to

purchase fuel and other aircraft-related goods and services for

a corporate jet leased by Towers from PHH. World Jet

Corporation, a subsidiary of United Air Fleet, was

responsible for maintaining the aircraft. An officer of

Towers designated Fred Jay Schley, an employee of World

Jet, as the chief pilot of the leased jet and gave him

permission to make purchases with the PHH credit card at

least in connection with non-charter flights, which were used

exclusively by Towers executives. Notwithstanding United

Air Fleet’s agreement to pay the cost of fuel on chartered

flights, which provided service for other clients, Schley used

the credit card to charge $89,025.87 to Towers in connection

with such flights, prior to the cancellation of the card in

August 1988.

Towers filed a complaint in state court seeking a

declaratory judgment (i) absolving it of liability for any

charges incurred in connection with fuel purchases for

chartered flights, (ii) holding PHH responsible for knowingly

permitting these purchases and consequently for breaching the

credit agreement issued in connection with the PHH credit

card, and (iii) requiring an accounting and disgorgement of

all improperly charged amounts. After removing to federal

court, PHH moved for summary judgment on _ its

counterclaims seeking recovery for the $89,025.97 in unpaid

charges.

4a

The District Court granted PHH’s motion, denied

Towers’ prayer for declaratory relief, and entered judgment

for the full amount in dispute. Judge Duffy held Towers

liable under the terms of the credit agreement between

Towers and PHH, which provided that “[the] Aircraft

Operator shall be responsible for all purchases made with a

Card from the date of its issuance until the Aircraft Operator

reports that a card is lost, stolen, misplaced or cancelled by

calling PHH.” Judge Duffy further held that the Truth-in-

Lending Act, which limits a cardholder’s liability for

“unauthorized” uses, was inapplicable to charges incurred by

one to whom the cardholder has "voluntarily and knowingly

allow[ed]" access for another, limited purpose.

On appeal, Towers concedes liability under its credit

agreement with PHH but contends that summary judgment

was improperly granted on the question of whether the Truth-

in-Lending Act limits its liability to $50. The issues on

appeal are whether Schley’s use of the card to incur the

$89,025.97 in connection with chartered flights was

"unauthorized" within the meaning of the Truth-in-Lending

Act and whether that question was properly decided on

summary judgment.

Discussion

Congress enacted the 1970 Amendments to the Truth-in-

Lending Act, 15 U.S.C. §§ 1602(j)-(0), 1642-44 (1988), in

large measure to protect credit cardholders from unauthorized

use perpetrated by those able to obtain possession of a card

from its original owner. In addition to imposing criminal

sanctions for the most egregious cases, those involving fraud,

15 U.S.C. § 1644 (1988), the amendments enacted a scheme

for limiting the liability of cardholders for all charges by

ee

Sa

third parties made without “actual, implied or apparent

authority" and “from which the cardholder receives no

benefit." 15 U.S.C. §§ 1602(0), 1643 (1988). Where an

unauthorized use has occurred, the cardholder can be held

liable only up to a limit of $50 for the amount charged on the

card, if certain conditions are satisfied.' 15 U.S.C.

§ 1643(a)(1)(B) (1988); Credit Card Service Corp. v. FTC,

495 F.2d 1004, 1006 (D.C. Cir. 1974). Except as provided

in section 1643, "a cardholder incurs no liability from the

unauthorized use of a credit card.” 15 U.S.C. § 1643(d).

By defining “unauthorized use” as that lacking in “actual,

implied, or apparent authority,” Congress apparently

contemplated, and courts have accepted, primary reliance on

background principles of agency law in determining the

liability of cardholders for charges incurred by third-party

card bearers. See, e.g., Fifth Third Bank/VISA v. Gilbert, 17

1 15 U.S.C. § 1643(a)(1) (1988) provides:

A cardholder shall be liable for the unauthorized use of a credit card

only if —

(A) the card is an accepted credit card;

(B) the liability is not in excess of $50;

(C) the card issuer gives adequate notice to the cardholder of the

potential liability;

(D) the card issuer has provided the cardholder with a description of

a means by which the card issuer may be notified of loss or theft of

the card, which description may be provided on the face or reverse

side of the statement required by section 1637(b) of this title or on a

separate notice accompanying such statement;

(E) the unauthorized use occurs before the card issuer has been

notified that an unauthorized use of the credit card has occurred or

may occur as the result of loss, theft, or otherwise; and

(F) the card issuer has provided a method whereby the user of such

card can be identified as the person authorized to use it.

6a

Ohio Misc. 2d 14, 478 N.E.2d 1324, 1326 (1984); Walker

Bank & Trust Co. v. Jones, 672 P.2d 73, 75-76 (Utah 1983),

cert. denied, 466 U.S. 937 (1984); see also 12 C.F.R.

§ 266.12 n.22 (1990). Under the parameters established by

Congress, the inquiry into “unauthorized use” properly

focuses on whether the user acted as the cardholder’s agert

in incurring the debt in dispute. A cardholder, as principal,

can create express and implied authority only through

manifestations to the user of consent to the particular

transactions into which the user has entered. See Restatement

(Second) of Agency § 7 (1958).

In the pending case, there remains an unresolved issue of

fact as to whether Steven Hoffenberg, the Towers officer who

dealt with Schley, expressly or impliedly authorized Schley

to purchase fuel on chartered flights. Hoffenberg’s testimony

that he instructed Schley to limit his use of the card to

purchases “benefit[ting] . . . Towers’ use of the airplance”

supports the inference that Schley lacked both express and

implied authority to make the disputed purchases. Whether

Schley’s testimony to the contrary should be credited can be

resolved only by a factfinder. Accordingly, we cannot affirm

the grant of summary judgment on the theory that Schley

possessed express or implied authority.

A. Did the Card User Have Apparent Authority?

Unlike express or implied authority, however, apparent

authority exists entirely apart from the principal’s

manifestations of consent to the agent. Rather, the

cardholder, as principal, creates apparent authority through

words or conduct that, reasonably interpreted by a third party

from whom the card bearer makes purchases, indicate that the

card user acts with the cardholder’s consent. See Restatement

(Second) of Agency §§ 8, 27 (1958). Though a cardholder’s

Ta

relinquishment of possession may create in another the

appearance of authority to use the card, the statute clearly

precludes a finding of apparent authority where the transfer

of the card was without the cardholder’s consent, as in cases

involving theft, loss, or fraud. However elastic the principle

of apparent authority may be in theory, the language of the

1970 Amendments demonstrates Congress’s intent that the

category of cases involving charges incurred as a result of

involuntary card transfers are to be regarded as unauthorized

under sections 1602(0) and 1643. The description in section

1643 of the conditions precedent to an issuer’s recovery of up

to $50 from the cardholder for unauthorized uses clearly

assumes that cases of loss or theft fall within the definition of

unauthorized uses, see 15 U.S.C. § 1643(a)(1)(D) (1988)

(requiring that "the card issuer has provided the cardholder

with a description of a means by which the card issuer may

be notified of loss or theft of the card"); id. § 1643(a)(1)(E)

(unauthorized use must occur before the “card issuer has been

notified that an unauthorized use of the credit card has

occurred or may occur as the result of loss, theft, or

otherwise"), while section 1644’s imposition of criminal

penalties for "[f]raudulent use of credit cards" makes a

similar assumption with respect to fraudulently induced

transfers, id. § 1644 (1988).

Because the statute provides no guidance as to uses

arising from the voluntary transfer of credit cards, the general

principles of agency law, incorporated by reference in section

1602(0), govern disputes over whether a resulting use was

unauthorized. These disputes frequently involve, as in this

case, a cardholder’s claim that the card bearer was given

permission to use a card for only a limited purpose and that

subsequent charges exceeded the consent originally given by

the cardholder. Acknowledging the absence of express or

8a

implied authority for the additional charges, several state

courts have adopted the analysis of the Court of Civil

Appeals of Alabama in Martin vy. American Express, Inc..,

361 So. 2d 597, 600 (Ala. Civ. App. 1978), and declined to

apply the Truth-in-Lending Act to limit the cardholder’s

liability, reasoning that the cardholder’s voluntary relin-

quishment of the card for one purpose gives the bearer

apparent authority to make additional charges. See Cities

Service Co. v. Pallet, 452 So. 2d 319, 321-22 (La. Ct. App.

1984); Standard Oil Co. v. Steele, 22 Ohio Misc. 2d 27, 489

N.E.2d 842, 843-44 (1985); Michigan National Bank v.

Olson, 44 Wash. App. 898, 723 P.2d 438, 441 (1986);

Mastercard v. Town of Newport, 133 Wis. 2d 328, 396

N.W.2d 345, 348 (Wis. App. 1986).

Though we agree that a cardholder, in lending or giving

his card for one purpose, acts in a way that significantly

contributes to the appearance of authority, at least as

perceived by the third-party merchant, to make other

purchases, we need not decide whether voluntary

relinquishment for one purpose creates in every case apparent

authority to incur other charges. In the pending case, the

appearance of authority for Schley to purchase fuel on

chartered flights was established not only by Towers’ consent

to Schley’s unrestricted access to the PHH card but by other

conduct and circumstances as well.

Nothing about the PHH card or the circumstances

surrounding the purchases gave fuel sellers reason to dis-

tinguish the clearly .authorized fuel purchases made in

connection with non-charter flights from the purchases for

chartered flights. It was the industry custom to entrust credit

cards used to make airplane-related purchases to the pilot of

the plane. By designating Schley as the pilot and

subsequently giving him the card, Towers thereby imbued

9a

him with more apparent authority than might arise from

voluntary relinquishment of a credit card in other contexts.

In addition, with Towers’ blessing Schley had used the card,

which was inscribed with the registration number of the

Gulfstream jet, to purchase fuel on non-charter flights for the

seme plane. The only difference between these uses

expressly authorized and those now claimed to be

unauthorized—the identity of the passengers—was insufficient

to provide notice to those who sold the fuel that Schley

lacked authority for the charter flight purchases.

B. Was Apparent Authority Limited by Notice to the Card

Issuer?

Towers contends that, despite its own failure to have the

card cancelled, once PHH, as the card issuer, learned, either

through Towers or a third party, that Schley lacked authority

to make certain charges, any such transaction that Schley

entered into becomes an unauthorized use even if fuel sellers

reasonably perceived that Schley had apparent authority to

charge fuel purchases. Whether notifying the card issuer that

some uses (or users) of a card are unauthorized makes them

so has divided those courts that have considered the issue.

Compare Cities Service Co., 452 So. 2d at 320-22 (authority

terminated), and Standard Oil Co., 489 N.E.2d at 844

(same), with Martin, 361 So. 2d at 600-01 (notice to card

issuer ineffective), and Walker Bank, 672 P.2d at 75 (same).

With respect to this claim as well, the agency principles

incorporated in section 1602(0) remains Congress’s chosen

vehicle for establishing a card bearer’s authority, and whether

a cardholder can limit a card bearer’s authority by notifying

the card issuer must be resolved by looking first to these

principles and then to other indicia of Congressional intent

that might qualify the application of agency principles to

10a

credit card transactions. Under well-established principles of

agency law, codified in Restatement (Second) of Agency

§ 166 (1958), notice to a third party of limitations on an

agent’s authority qualifies the agent’s apparent authority to

act on the principal’s behalf. See Warner v. Central Trust

Co., 798 F.2d 167, 171 (6th Cir. 1986); Cox v. Pabst

Brewing Co., 128 F.2d 468, 472 (10th Cir. 1942);

H. Reuschlein & W. Gregory, Agency and Partnership 164

(1979). However, in making a purchase with a third-party

credit card, where the card issuer and the selling merchant

are distinct entities, a card bearer not only reaches an

agreement with one third party, the merchant, but also

indirectly deals with a different third party, the card issuer.

Use of a third-party credit card by its bearer is made possible

by arrangements, previously entered into by both the

merchant and the card issuer, that simultaneously obligate the

cardholder and the issuer to the merchant and the cardholder

to the card issuer each time the card is used to charge pur-

chases.”

The rule of agency law contained in section 166 of the

Restatement would permit the principal to qualify the

authority of an agent to make purchases from a merchant by

giving the merchant notice of the limitation. The limitation

would surely be effective in an ordinary three-party

arrangement in which an agent charges purchases on a

2 As compared to the other set of third parties, the selling merchants,

PHH would have been aware of different facts bearing on Schley’s

authority, not all of which could be attributed to Towers as the princi-

pal. Towers has not questioned and we therefore need not decide

whether an issuer seeking recovery for credit card charges under a

theory of apparent authority must establish that it, as well as the mer-

chant, reasonably believed the agent to have apparent authority.

lla

principal’s running account with a merchant. It is more

doubtful whether a principal can similarly avoid liability by

notifying the merchant of limitations on an agent’s authority

when an agent makes purchases using a credit card. Both

cardholders and merchants normally regard anyone

voluntarily entrusted with a credit card as having the right to

make any purchases within the card’s contractually specified

limits. But to whatever extent a cardholder can limit the

authority of a card user by giving notice to a merchant, we

do not believe he can accomplish a similar limitation by

giving notice to a card issuer. In four-party arrangements of

this sort, it is totally unrealistic to burden the card issuer with

the obligation to convey to numerous merchants whatever

limitations the cardholder has placed on the card user’s

authority.’

Finally, there is no substance to the argument that our

construction of the 1970 Amendments inadequately protects

cardholders against liability for charges made without their

consent. Admittedly, third-party credit cards ordinarily

permit the bearer to charge purchases made from a vast

number of merchants, and cardholders, who typically do not

know which merchants have contracted to accept the card,

cannot contact each merchant to selectively revoke a card

bearer’s authority. However, a cardholder need not do so to

prevent unauthorized use by one entrusted with the card. In

many cases, the cardholder can avoid unwanted charges

3 As framed by the Restatement, the notice rule is subject to certain

restrictions, such as the requirement that the principal’s communica-

tion of the limits on the agent’s authority must be clear. But the exist-

ence of these restrictions does not necessarily mean that the notive

rule itself is applicable in all contexts where those restrictions are

satisfied. See Restatement of Agency (Second) at § 166, comment e.

12a

simply by repossessing the card. Where a card issuer permits

a cardholder to cancel the card, and thereby any contractual

obligation to pay, a cardholder can limit his liability even if

unable to regain possession by cancelling his card. Even

where the card issuer also requires return of the card prior to

cancellation of the agreement, a cardholder who has tried and

failed to recover a card from an “estranged spouse, a

dishonest employee, or a disappeared ‘friend,’” R.J. Rohner,

F.H. Miller, J.H. Mancuso, The Law of Truth-in-Lending

{ 10.03[2][a], at S10-9 (Supp. 1989), likely can prevail on

the claim that the card user has stolen the card and that any

subsequent charges are for that reason unauthorized. Finally,

we note that by foreclosing card issuers from recovering

unauthorized charges from cardholders, section 1643(a)(1)

undoubtedly encourages card issuers to facilitate the

cancellation of cards once a possible unauthorized use has

been reported.

Because the disputed charges were not unauthorized

within the meaning of 15 U.S.C. §§ 160Z(0) and 1643(a)(1),

PHH was entitled to recover their full value from Towers

under their credit agreement.

The judgment of the District Court is affirmed.

13a

ENDORSEMENT

Towers World Airways, Inc., The Towers

Organization, Inc. and Towers Financial

Corporation, Plaintiffs, v. PHH Aviation Systems,

Inc., Defendants, and PHH Group, Inc. 88 Civ.

7303 (S.D.N.Y.)

Defendants PHH Aviation Systems, Inc. ("AvSystems”")

and PHH Group, Inc. ("PHH") bring this motion for

summary judgment on their counterclaim, pursuant to Fed. R.

Civ. P. 56(c), against plaintiffs Towers Financial Corporation

("Towers Financial") and Towers World Airways, Inc.

("Towers Airways"), (or together ("Towers"), alleging

Towers failed to repay credit extended by PHH to Towers.

PHH seeks repayment in the amount of $89,025.87 plus

interest. Towers also seeks a declaratory judgment that no

monies are owed and that PHH was unjustly enriched in

amounts Towers already paid PHH.

In 1988, Towers leased an Aircraft from PHH. Sometime

thereafter, AvSystems, PHH’s credit account managers,

issued a PHH credit card jointly to Towers Airways and

Towers Financial for the purchase of aviation fuel and other

goods and maintenance services in connection with the

Aircraft. LaRosa Affid. 44 4-7. The PHH credit card was

then sent to World Jet Corporation ("World Jet"), a

subsidiary of United Air Fleet, Inc. ("UAF"), a company

designated to maintain and oversee the Aircraft. World Jet

then presented the PHH credit card to Fred Jay Schley, its

employee, who had been designated as Chief pilot for the

Aircraft by Steven Hoffenberg, Towers Financial’s President

and Chairman of the Board. Schley Depo. at 11.

Authorization was extended by Hoffenberg to Schléy, on

l4a

behalf of World Jet and UAF, for use of the PHH credit card

in connection with and for the benefit of the Aircraft on non-

charter flights, pursuant to a Towers-UAF agreement.

Specifically, the Towers’ management agreement with

UAF permitted UAF to charter the Aircraft for use by third

persons when the plane was not being used for the

transportation of Towers’. executives. The agreement

provided that the Aircraft was to be chartered "dry," which

apparently meant that fuel costs for charter flights were to be

borne by UAF rather than Towers. Hoffenberg Depo. at

22-23, 27-28. Schley, a UAF pilot, evidently used the PHH

credit card to purchase fuel and other services for the Aircraft

on chartered flights, in direct contravention of the Towers’

management agreement with UAF. By August 1988, before

the PHH credit line with Towers was terminated, Schley

charged $89,025.87 in unauthorized fuel costs. Hoffenberg

Depo. at 47-49; O’Neil Affid. 4 3. Towers claims that it

cannot be held accountable for Schley’s charges because such

charges were prohibited by Towers’ internal company policy

and Schley knew that use of the PHH card in connection with

charter flights was unauthorized. Because Schley purportedly

used the credit card while outside the scope of his

employment with Towers, Towers argues that it is thus not

liable for amounts still due and owing, traceable to Schley’s

allegedly private use.

I find otherwise. Towers knew or should have known of

the express conditions and terms for use of the PHH credit

card. In order to use the credit card, Towers, and by

extension its employees, agreed to be bound by certain terms

and conditions including that:

[the] Aircraft Operator shall be responsible for

all purchases made with a Card from the date

15a

of its issuance until the Aircraft Operator

reports that a Card is lost, stolen, misplaced or

cancelled by calling PHH.

LaRosa Affid., Exh. A.

Schley, as the Aircraft’s pilot, was given by Towers

unfettered access and use of the PHH credit card. Absent

Hoffenberg having reported either that the card was stolen or

used in contravention of the agreement, PHH is not

chargeable with knowledge of any unauthorized use of its

card. Furthermore, by the clear language of the agreement,

Towers agreed to be responsible for fuel charged to PHH by

one of its authorized employees, unless the card was reported

lost, stolen, misplaced, or cancelled.

It is of no moment that Schley was not actually authorized

to charge fuel on chartered flights. Schley’s daily trip sheets

did or should have provided ample notification to Towers that

Schley was inappropriately charging charter flights to

Towers’ PHH credit line and that Hoffenberg was obligated

to sever Schley’s use of the card. Neither Hoffenberg nor

Towers notified PHH of Schley’s unauthorized credit card use

before Schley incurred, over several months, almost $90,000

in fuel charges. Indeed, Schley’s unauthorized use was

brought to light in August, 1988, well after Schiey charged

significant amounts on the PHH credit card. Allied Stores of

New York, Inc. v. Funderburke, 52 Misc. 2d 872, 277

N.Y.S.2d 8 (N.Y. Civ. Ct. 1967) (authorizing agent of the

credit card assumes risk of loss for theft or unauthorized use

after receipt of notice of the theft or unauthorized use). And

although Hoffenberg claims to have paid the charges "with

reservation,” purportedly indicating concern over Schley’s

possible unauthorized use of the PHH credit card, I find that

16a

such did not provide notice to PHH that Schley was abusing

his privileged use of the PHH credit card.

In business and commerce, holders and issuers of credit

cards are protected from sustaining losses occasioned by

improper use of such cards. Assumption of liability,

however, is on the cardholder who, voluntarily and

knowingly allowing another to abuse the privileges attendant

to its use, was in the best position to have foreseen losses

sustained the cardholder by foreseen misuses by the agent.

Id.; see Martin v. American Express, Inc., 361 So.2d 597

(Ala. Civ. App. 1978); see also TransAmerica Ins. Co. v.

Standard Oil Co., 325 N.W.2d 210 (N.D. 1982) (cardholder

is charged with its own negligence in paying for charges

while failing to adequately examine statements such that it

could rectify a fraudulent misuse of employer’s credit by an

employee entrusted with the card). Because the PHH credit

card was entrusted to Schley by Towers, the cardholder,

Schley overused the PHH card for six months, and Towers

paid Schley’s charges during a six-month period that Schley

was alleged to have abused his privilege in overusing the

PHH credit card, Towers was in the best position to have

discovered the misuse. Losses sustained pursuant to Schley’s

overuse of the PHH credit card must therefore be sustained

by Towers. See Compania Anomima Venezolana De

Navegacion yv. American Express International Banking

Corp., No. 84 Civ. 2047 (S.D.N.Y. July 12, 1985)(damages

for loss must be borne by bank customer who was in “best

position to prevent such losses, by avoiding last minute

transfers, by confirming receipt of the intended funds or by

purchasing insurance) (citing Kerr Steamship Co. v. Radio

Corp. of America, 245 N.Y. 284, 291-92, cert. denied, 275

U.S. 557 (1927) (Cardozo, J.).

17a

For the foregoing reasons, summary judgment is granted

the defendants, plaintiffs prayer for declaratory relief is

denied, and the complaint is dismissed. Defendants are

hereby directed to submit judgment on 5 days notice within

10 days of the date of this order.

SO ORDERED.

DATED: New York, New York

May 30, 1990

/signed/

Kevin Thomas Duffy, U.S.D.J.

18a

[Letterhead of Federal Trade Commission]

March 19, 1980

Mr. Leslie R. Butler, President

The Consumer Bankers Association

1725 K Street, N.W.

Washington, D.C. 20006

Re: Shell Oil Company

File No.: 792-3260

Dear Mr. Butler:

Thank you for your recent letter commenting on the

Federal Trade Commission’s consent order in the Shell Oil

proceeding. Your letter was placed on the public record

pursuant to Section 2.34 of the Commission’s Rules and was

given serious consideration. After carefully evaluating all the

comments received, including yours, the Commission has

decided to issue the order contained in the agreement. The

following is a reply to the points you raised in your letter.

With respect to the definition of “unauthorized use" in

Regulation Z, the Commission believes that previously

authorized use by a third person becomes “unauthorized"

19a

when the cardholder revokes the authorization and so notifies

the card issuer. This position is consistent with the definition

of “unauthorized use" because the third person no longer has

apparent authority to use the card after notification of

revocation. Notification to the card issuer is sufficient, not

only to terminate the third-person’s apparent authority with

respect to the card issuer, but also with respect to merchants

that are the agents of the issuer in the use and acceptance of

the issuer’s credit cards. This position is consistent with the

statutory theory of Regulation Z, as shown by § 226.13(e),

that notice to the issuer is also notice to the issuer’s agents

for purposes of the safeguards set forth in § 226.13.

The case of Martin v. American Express, Inc., 361 So.2d

597 (Ala. Civ. App. 1978), cited in your comment, involved

a different factual situation from the facts alleged in the Shell

complaint. In Martin there was not an absolute revocation

but instead an attempt by the cardholder to set a maximum

limit on the holder’s liability for third-party use. Without

either implying concurrence or disagreement with the Martin

holding, the Commission notes that the facts in that case are

different from the unconditional and complete revocation as

alleged in Shell.

Your letter states that this order, if generally followed in

the credit card industry, would place too great a burden on

the credit card issuer as opposed to the cardholder. Congress

through the Truth in Lending Act and Regulation Z has made

a public policy determination that, after notification to the

issuer of loss, theft, or other unauthorized use, the risk of

loss for the third-party use is placed on the issuer. After

notification it is the responsibility of the issuer to take

whatever steps it deems appropriate to minimize or eliminate

any loss. As shown by this order, The Commission

interprets Regulation Z to place this burden after notification

20a

on the credit card company rather than on the cardholder

regardless of whether the unauthorized use was a result of

loss, theft, or revocation of previously-authorized use.

It is in the public interest that the cardholder be relieved

of liability for third-party use after notification to the issuer

of revocation of previously-authorized use rather than to

continue to hold the cardholder liable until the card is

returned to the issuer. In many instances, as with lost or

stolen cards, it may be impractical or impossible for the

holder to retrieve the card and return it to the issuer, and

continuing to hold the cardholder liable would subject the

holder to possibly unlimited charges by the third person that

the holder is powerless to control. The card issuer, on the

other hand, can protect itself through merchant notification

and other loss-prevention measures. Further, the order

specifically does not aid the cardholder if the cardholder has

committed fraud or received benefit from the third-person

use, thus protecting the card issuer from unscrupulous

holders. Finally, nothing in this order prohibits the issuer

from attempting to hold the third party liable for these

charges.

Finally, you suggest that consideration of this order be

deferred until a formal Federal Reserve Board interpretation

can be obtained. However, this matter was referred to the

Commission from the Board staff, and the Commission has

been informed by Board staff that the Commission’s legal

interpretations of this matter is correct. Thus, the

Commission believes that nothing would be gained by such

a delay for formal interpretation.

Your other points raised in your comment have been

considered. However, for the reasons stated in this letter, the

2la

Commission believes this order is appropriate and is based

upon a correct interpretation of Regulation Z.

In sum, the Commission has decided that it is in the

public interest to issue the agreed-upon order.

Your interest in bringing your comments to the attention

of the Commission is appreciated.

By direction of the Commission.

/signed/

Carol M. Thomas

Secretary