Court Issues Opinion in Red Flags Rule Lawyers Case That May Have Broader Applicability to Other Businesses

By William T. Koustas –

We previously reported that the United States District Court for the District of Columbia ruled in favor of the American Bar Association and prevented the Federal Trade Commission ("FTC") from enforcing its Red Flags Rule (“the Rule”) on attorneys.  On December 1, 2009, Judge Walton issued a written Opinion, explaining why the FTC’s application of the Red Flags Rule to attorneys violates the Administrative Procedure Act, 5 U.S.C. § 706(2)(C), because the Rule is in excess of the Government's statutory jurisdiction and authority.  American Bar Ass'n. v. FTC, No. 09-1636 at 1 (D.D.C. Dec. 1, 2009).  Although the ruling is in a case that relates specifically to the Rule's coverage of lawyers, there is language in the Opinion that may be highly beneficial to other businesses.

The Judge ruled that the Fair and Accurate Credit Transactions Act of 2003 (“FACT Act”),  on which the Rule is based, does not bring attorneys within the purview of the FACT Act and thus subject them to regulation by the Rule.  The Court also found that the lack of clarity in the FACT Act regarding its applicability to attorneys cannot be interpreted as authority for the FTC to regulate a profession that is traditionally regulated by the states.  Decision at 14.  As the Court explained, the FACT Act seems to contemplate the regulation of financial businesses.  It also concluded that another statute, the Equal Credit Opportunity Act (“ECO Act”),  which defines some of the terms used in the FACT Act such as "creditor" and "credit",  is targeted at credit applicants, but not lawyers. 

The Court also determined that the FTC’s “application of the Red Flags Rule to attorneys who invoice their clients is not reasonable,” and thus not entitled to "deference" by the Court.  Decision at 31.  The FTC argued that the definition of creditor under the ECO Act, as incorporated into the FACT Act, covers attorneys because they bill their clients for services rendered at the end of the month, rather than collect compensation for those services at the time the services are performed.  The Court, however, declined to permit such a broad interpretation of the term creditor and noted that “[t]o invoice [a] client at the end of each month is not delaying payment or giving a client a right to postpone payment.  As a practical matter in the legal context, legal services are not the type of services that can in many instances be billed and payment received simultaneously with the occurrence of the services . . . .”  Decision at 32-33. 

Although couched in terms of the typical arrangement between lawyers and their clients, this aspect of the Court's holding would appear to have much broader applicability to many other businesses.  It is quite common that companies sell goods or services to a customer and then send that customer a bill, expecting to be paid within a fairly short period of time.  The FTC has taken the position that this type of payment arrangement means that the company selling the goods and services has extended "credit" and has become a "creditor" subject to the Rule.  That position has been soundly rejected by the Court in the context of lawyers.  There does not appear to be any logical reason why a court would render a different analysis for businesses other than lawyers that simply send their suppliers a bill, expecting that payment will be made soon.

The Court found other reasons to rule that attorneys are not covered by the Rule.  For instance, the FTC never indicated that its definition of a creditor for the purposes of the Red Flags Rule would include attorneys during the rulemaking process.  Rather, that interpretation was only disclosed a year and a half after the Red Flags Rule was issued.  Therefore, the Court ruled that the FTC’s interpretation of the Red Flags Rule as applied to attorneys was “both plainly erroneous and inconsistent with the purpose underlying the enactment of the FACT Act.”  Decision at 40.

Procedurally, the Court's Decision resulted in the Court granting the ABA's Motion for Partial Summary Judgment.  It is quite noteworthy that the FTC has not issued any public statements regarding whether it intends to reissue the Rule, appeal the Court's ruling, seek further review from Judge Walton, or take some other action.