For three centuries or more, the common law has prohibited contract provisions that impose a penalty greater than the amount of damages caused by a breach of the contract. When those damages are difficult to determine, the common law permits “liquidated damages” provisions that are reasonably related to the actual damages sustained by the party. However, provisions that impose a penalty above a reasonable estimate of those damages are prohibited. This doctrine has thrived for centuries and is codified as part of the Uniform Commercial Code. The anti‐penalty rule continues to be applied to this date, with the exception of a critical area –consumer financial services.
Ironically, consumer financial services is the market in which the anti‐penalty doctrine is most needed. Even critics of the anti‐penalty doctrine have recognized that penalty provisions should not be enforced when there is the presence of unequal bargaining power or unconscionability. Yet consumer financial services is a market in which the bargaining power of the parties is not only unequal, it is grossly disproportionate.
This article explores the relationship of the anti‐penalty provision with one particularly controversial damages provision in consumer financial services – the overdraft fee. The article provides background on both overdraft fee practices and the anti‐penalty doctrine. It discusses how it came to be that the anti‐penalty doctrine is not applied to overdraft fees. This article shows how the failure to apply the anti‐penalty doctrine has led banks to turn overdraft fees into a profit center, and to engage in many unfair, deceptive, and abusive tactics to induce more overdrafts in order to generate more fees. It documents how the doctrine was partially revived in the context of credit card penalty fees with the establishment of a “reasonable and proportional” standard in the Credit CARD Act.
The article discusses how this same standard could be applied to regulate overdraft fees, so that they once again meet the anti‐penalty doctrine’s standard of a reasonable relationship to actual damages. Finally, it discusses another alternative that can be used to require that overdraft fees be reasonable and proportional, by treating fees that do not meet this standard as “unfair” or “abusive” under the Dodd‐Frank Act.