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February 18, 2005


The benefits of CAFA: one example

The recent Seventh Circuit decision in In the Matter of A.G. Financial Service Center, Inc. provides an excellent case study for abusive class actions and why they resemble Russian roulette to corporations. AG Financial issued private-label credit cards, which consumers could use to purchase products from single merchants. Some of AG Financial merchants were distributors of satellite television systems (presumably the big C-band dishes). This ended up being a money-losing line for AG Financial, but, worse, they found themselves ensconced in fraud claims. Why? A typical system sold for $2,354 at 19% interest; AG Financial's merchant offered a financing deal whereby customers could pay $40/month, about what they would pay for cable. As anyone with a calculator can figure out, it would take 13 years to pay off the financing. Some customers chose negative amortization--paying minimum amounts for less than the amount of interest accumulated, meaning the debts grew over time.

Objectively, for most people, this is not a great deal. On the other hand, some people prefer satellite to cable, and wanted a 19% loan to get it. In today's world, anyone offering a not-great-deal that consumers actually want is subject to consumer fraud suits. (If it's a not-great-deal that no one purchases, then there's no "injury".) As the Seventh Circuit wrote: "A.G. Financial contested the 500 or so suits filed against it and appears to have prevailed or settled the rest for small sums, though the single loss was a doozy." A Mississippi court issued a judgment for $167 million, mostly in punitive damages. (Actual damages are clearly miniscule, if existent at all.) A.G. Financial filed for bankruptcy.

Perhaps we as a society want to be paternalistic and forbid negative amortization or high-interest loans, even though some people want these financing arrangements for themselves. But shouldn't that be a decision for the legislature rather than one judge out of hundreds who didn't find it problematic? As a society, we would be justifiably outraged if a single person were charged and exonerated hundreds of times for the same alleged crime until a court could be found who would pronounce execution. But that's what happened here--and why so many magnet jurisdiction class actions result in immediate settlements before they can get to the point where a company is rolling the dice on whether it will survive the suit. (Troubled Company Reporter, "A.G. Financial: Files For Bankruptcy Protection", Aug. 30, 1999).

Posted by Ted Frank at 08:47 AM | TrackBack (1)



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Published by the Manhattan Institute

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