In recent decades, the Supreme Court has held that excessive punitive damage awards in tort suits violate the Due Process Clause.1 Consumer advocates have invoked the Court’s punitive damages decisions to challenge contractual credit card penalty fees as similarly violative of due process.2 Recently, in In re Late Fee and Over-Limit Fee Litigation,3 the Ninth Circuit rejected such a claim as unsupported by precedent, but a majority of the panel encouraged the Supreme Court to extend the tort cases’ reasoning to contract cases involving credit card agreements.4 The state action requirement, however, poses a principal difficulty to this extension. Revitalizing the public function theory of state action,5 despite its current dormancy, would be one means of protecting consumers in an age in which many traditional contract law protections have been supplanted by boilerplate terms, narrowed by courts, or abrogated by positive law. Public function theory, while absent from both the briefing and opinions, is the only theory of state action that captures an important feature of why punitive credit card fees are objectionable: they entail card issuers exercising state-like power over consumers.
Provisions allowing card issuers to impose penalty fees, including fees for late payments or over-limit use, are included in the contracts necessary for obtaining credit cards.6 Although recent federal legislation has resulted in limits on the amount of some credit card fees,7 fees still constitute more than one-third of issuers’ annual revenue.8 A slightly late payment or slightly over-limit use imposes only de minimis marginal costs on issuers,9 and card issuers recoup any costs through raising cardholders’ interest rates.10 As a result, the fees are best understood not as compensatory, but rather as either driven by profit motives or as “purely punitive.”11 Such fees are forbidden under the common law of contracts,12 which has traditionally been particularly suspicious of late fees on the grounds that they are often punitive rather than compensatory.13 Credit card penalty fees have been permitted, however, by positive law abrogating the common law of contracts.14
In January 2007, cardholders sued card issuers in the Northern District of California, alleging, inter alia, that contractual penalty fees violate due process limits on punitive damages.15 In an opinion by Judge Armstrong, the district court dismissed the complaint,16 rejecting all of the plaintiffs’ claims, including their attempt to apply the Due Process Clause to credit card penalty fees.17 It reasoned that credit card fees are not subject to the Due Process Clause because they are merely “paid by one party to another pursuant to private contract,”18 do not advance “governmental objectives,”19 and do not impose the risks, present in the jury awards context, of “arbitrariness, uncertainty, and lack of notice.”20 Additionally, it found that credit card fees — “even if [they] could be regarded as some kind of private ‘punitive damages’” — do not implicate state action and therefore do not violate the Due Process Clause.21 The Court distinguished fees set by government mandate from those resulting from private contract, and rejected the plaintiffs’ argument that contractual penalty fees are state action when affirmatively permitted by a federal regulatory framework.22
The Ninth Circuit affirmed.23 Writing for the panel, Judge Nelson24 noted that the “similarities and differences between liquidated [compensatory] damages and punitive damages . . . govern the outcome of this case,”25 and enumerated the various features of punitive damages, in particular their goals of retribution and deterrence.26 Yet she decided the case not based on these features, but rather based on the fees’ origin: because they originate from private contracts, she concluded, they are distinct from jury-imposed punitive damages and, consequently, the Due Process Clause does not apply.27
Judge Reinhardt concurred in the judgment.28 He did so “reluctantly,”29 conceding that the Supreme Court has not extended the reasoning of punitive damages cases to the contract context, but forcefully arguing that it should — at least for contracts of adhesion.30 He focused on the ubiquity of adhesive contracts,31 the asymmetry of current doctrine in protecting corporate tort defendants but not consumers,32 and the importance of “[c]onstitutional evolution . . . to ensure that changes occur within the framework of fairness and equality.”33 He noted that contractual fees could constitute state action by dint of judicial enforcement.34 He acknowledged, but neither endorsed nor rejected, the plaintiffs’ theory of state action, which maintained that statutory and regulatory provisions abrogating the common law bar on penalty clauses constitute state action by allowing “imposition of . . . disproportionate penalties in violation of the Constitution.”35
Extending the logic of punitive damages tort cases to the contract context requires an account of an issue only briefly discussed in the opinions: how the fees at issue implicate state action.36 In addition to the theories advanced by Judge Reinhardt and the plaintiffs, public function theory could justify a finding of state action, given that punitive credit card fees allow private firms to exercise the power to punish — traditionally an exclusive state function. Though applying public function theory would require a substantial doctrinal change relative to current law, which has long rejected new public function claims, public function theory is nonetheless a normatively attractive means of finding state action. It would effectively capture the fact that the fees at issue are objectionable not only because of their amount or their having been authorized by the state, but also by virtue of the type of power that they allow card issuers to exercise.
The state action requirement stipulates that the Fourteenth Amendment applies only to government conduct37 — namely statutes, regulations, actions by government employees, and a narrow range of private actions enabled by government.38 Under the public function theory of state action, courts consider “the predominant character and purpose” of an activity in determining whether it should “be treated as a public institution subject to the command of the Fourteenth Amendment.”39 Public function cases of the mid-twentieth century treated some activities as “governmental in nature”40 and therefore state action even when performed by private parties.41 Later decisions found that public function theory applied only when private entities exercised powers that are “traditionally the exclusive prerogative of the State.”42 While described as a “significant curtailment of the public function theory,”43 this exclusivity requirement was in fact the theory’s death knell — since imposing the exclusivity requirement, the Court has never classified a new function as exclusively public.44
Yet if the public function theory were still doctrinally robust, it could be applied to credit card fees by treating those fees as a form of punishment. Legal theorists have long viewed punishment as an exclusive government function.45 Punitive damages, which can be understood as a form of punishment, have “throughout the legal history of England and the United States, been seated exclusively within the capacity of the state.”46 A theory of punitive damages as the exclusive province of the state accords with at least some Supreme Court dicta, most notably the view that punitive damages “serve the same purpose as criminal penalties”47 — the imposition of which is the paradigmatic exclusive government function. Moreover, courts could treat punishment as an exclusive public function even under a narrowed public function theory, given that punishment is — even more so than public goods provision — a traditional, exclusive, and constitutive state power.
The rules of contract law implicitly recognize the exclusivity of state control over punishment. In rejecting punitive contract provisions, the Restatement (Second) of Contracts notes that the “central objective behind the system of contract remedies is compensatory, not punitive.”48 As a result, contract law bars punitive damages, defined as those that are not “reasonable” relative to “the anticipated or actual loss caused by the breach.”49 While scholars do not know for certain the reason for contract law’s longstanding bar on punitive damages,50 discomfort with a privately structured system of punishment provides one possible reason. Indeed, observers have noted that because “failure to perform . . . self-imposed responsibilities is only a breach of a private duty,” breach of contract “does not technically contravene social norms” and is therefore incompatible with punitive damages.51
The Supreme Court has not expressly defined what renders sanctions punitive, but treating credit card late fees as punitive is in accord with at least some of the criteria it has set out. The Court has long understood punishment to be defined by the nature of the sanction, noting, in another context, that a sanction’s “character is not changed by the mode in which it is inflicted.”52 Insofar as sanctions are punitive when they are disproportionate relative to actual damages,53 credit card fees are almost certainly punitive.54 Yet if sanctions are punitive only when “imposed for purposes of retribution and deterrence,”55 the status of the fees at issue is more ambiguous. Card issuers impose fees with the intent of generating profits, not of punishing cardholders.56 The primary effect of the fees on cardholders, however, remains retribution (because the fees convey a message of fault) and deterrence (because of fees’ effects on cardholder incentives).57 The Court has not addressed whether punishment, in the context of punitive fees, is defined more by intent or effect.58 Yet the noncompensatory nature of the fees, coupled with their retributive and deterrent effects, is enough to render colorable the proposition that they are punitive — thereby opening the door to the application of public function theory.
Public function theory is the only approach to state action that captures one of the normatively objectionable features of the fees at issue: the power of card issuers to exercise state-like power over cardholders without due process constraints. Contractual penalty clauses are more similar to positive law imposed by the state than to terms negotiated by contracting parties: cardholders do not author contract terms, are largely unaware of those terms,59 and consent to them only in the most attenuated fashion.60 In each of these respects, adhesive contracts diverge from the classical contract model of bargained-for exchange. The power exercised by firms authoring adhesive contracts, particularly when those contracts grant firms the power to punish, is thus analogous — normatively, even if not under current doctrine — to state power.61
The firm-state analogy is challenged by the fact that, at least in theory, punitive fee provisions are avoidable by simply declining to obtain a credit card, or by declining to obtain one with certain terms. An application of public function theory to private contracts could thus find state action only when the relevant contract terms are de facto unavoidable.62 Credit card penalty fee provisions may meet that high threshold — credit cards, unlike most consumer goods, are a “practical necessit[y] of modern life,”63 and the vast majority of credit card contracts contain comparable penalty fee provisions64 — but additional facts about the market structure would be necessary to establish unavoidability.
Requiring that a particular type of fee be unavoidable before applying the public function theory would have several benefits. First, and most significantly, it would severely limit the effects of a new rule, thereby preserving private ordering in nearly all contract law cases, even those involving contracts of adhesion.65 Second, a rule turning on unavoidability could draw on jurisprudence that courts have developed in several other areas of law.66 Finally, requiring a determination of unavoidability, while not directly rooted in precedent, would follow from the Court’s invitation, albeit in an earlier era, to make fact-specific determinations in state action cases.67
Though novel and counter to strong doctrinal trends, relying on the public function theory to impose restraints on firms that wield state-like power over consumers would be consistent with one of the Court’s longstanding commitments: interpreting the Fourteenth Amendment to protect those who are structurally disadvantaged by the political process.68 In the credit card context, the government abrogated the generally applicable bar on punitive contractual damages in response to interest group pressures.69 Applying the Due Process Clause to credit card fees would thus serve as a firewall to protect consumers from firms that, because of that successful advocacy, now exercise state-like power in their ability to introduce punitive fee provisions into adhesive contracts. Public function analysis highlights that, though far from exercising the full complement of sovereign powers, private firms can at times look more like state actors than is commonly realized.