The Kentucky Supreme Court offered a new interpretation of Kentucky’s usury statute, KRS 360.010, in a collection case involving a credit-card receivable. Unfortunately, SCOKY interpreted a statute that did not apply.

Harrell, a consumer, had a credit card agreement with Citibank, N.A., a national bank with headquarters in South Dakota. The interest rate was 27.24%. Harrell defaulted, and Citibank charged off the debt, but later sold the account to a “debt buyer,” Pilot who later sold to Unifund. Unifund filed a collection action, seeking payment of the debt, and prejudgment interest at 8%, the statutory rate under KRS 360.010.

Harrell counterclaimed, arguing that when Citibank charged off the account, it waived its right to collect ANY prejudgment interest after charge-off. Harrell alleged that Unifund’s attempt to collect interest that it wasn’t entitled to was a violation of the Fair Debt Collection Practices Act.

SCOKY held that Citibank extinguished its right to statutory interest when it contracted with Harrell for an interest rate in excess of 8%. And it held that Citibank waived its right to prejudgment interest when it charged off the account.

First, Citibank is a national bank with headquarters in South Dakota. Under well-established law, a national bank may “export” the interest rate permitted in its headquarters state. South Dakota does not have a usury limit; hence the 27% interest rate for the credit card complied with applicable law. The credit card agreement had a South Dakota choice of law provision—Unifund’s problem was that it failed to produce the agreement. And prejudgment interest is a substantive legal right that parties can control by a choice of law provision. Unifund’s invocation of KRS 360.010 was bad strategy, and led SCOKY down a path it didn’t need to follow. The 27% interest rate would have been permitted for prejudgment interest under the applicable South Dakota law.

Second, SCOKY believed that Citibank, by charging off, “waived” its right to interest. Following the Sixth Circuit in Stratton, SCOKY interpreted Citibank’s action as a “knowing and voluntary relinquishment of a known right.” SCOKY believed that Citibank took to the action to avail itself of a tax deduction for bad debt. But in fact, Citibank was required to charge-off. Federal banking regulations require banks to charge-off debts that are unlikely to be collected, in order to ensure that the banks’ books accurately reflect their assets. Ignoring these rules risks a write-up by the bank examiner. There is nothing “voluntary” about it. Even the National Consumer Law Center has recognized that “charge-off” is an accounting function that does not affect the ultimate collectability of the debt.

Unfortunately, there is a developing split in the courts on this issue, and there is no guarantee the Sixth Circuit and SCOKY will get it right anytime soon. Certainly, debt-buyers are not the most sympathetic defendants, and the lure of lucrative FDCPA class actions is drawing the attention of consumer lawyers.