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A lawsuit in federal court in Utah may determine whether a loan service for online purchases owned by eBay and touted as an upstart challenger to credit card companies passes legal muster.

Forbes in a website headline once touted Bill Me Later as a "credit card killer" out to displace the likes of Visa and Mastercard as a way for consumers to pay for online purchases. Then eBay bought the company to complement its PayPal subsidiary as it moved aggressively into online and mobile payment services.

But a lawsuit that has wound its way into federal court in Salt Lake City is challenging Bill Me Later's business model as a "financial shell game" in which it "rents" a charter from Utah's WebBank in order to avoid having to comply with consumer protection laws in other states.

"Bill Me Later's business model is structured to evade laws by passing its loan accounts through a chartered bank, while keeping almost all the rewards — and risks — for itself," the lawsuit says.

By cloaking itself as a Utah-chartered bank, Bill Me Later believes it can charge excessive interest and exorbitant penalty fees to consumers who use the service to make purchases but fail to pay off their accounts on time, according to the proposed class-action lawsuit.

California-based eBay denies that its relationship with WebBank in Salt Lake City is superficial. WebBank argues that it is doing nothing that is not allowed under Utah consumer regulations and federal banking laws.

Under federal law, a state-chartered bank can operate nationally under the auspices of the laws of the state where it is chartered. Utah law contains no restrictions on the amount of interest and fees a bank can charge, said Jeff Friedman, an attorney with the Berkeley, Calif., law firm that originally filed the lawsuit in federal court in San Francisco.

"The purpose of renting a Utah charter is that the defendants want to borrow the law of Utah in terms of no cap on interest rates," he said. "That way, Bill Me Later is free to charge whatever interest rate it wants to, as well as any late fees it wants to."

In its latest annual report to the Securities and Exchange Commission, eBay acknowledges the area of law on which the lawsuit is based is unsettled.

"This area of law is uncertain, and if the lawsuit is successful, Bill Me Later may be required to change its methods of operations, pay substantial damages and reduce some of its charges and fees, which would likely adversely affect our business," the company warned.

Kyle Sawyer, a resident of Torrance, Calif., is the only plaintiff so far in the suit that was filed in January 2010.

Sawyer bought a computer online in October 2008 from Cyberpower Inc. with a loan from Bill Me Later for $1,068.08. He failed to pay off that amount on time and subsequently was charged an annual interest rate of 19.99 percent and monthly late fees of $39.

The lawsuit suit says the high interest rate and late fees are not allowed under California law.

Parent company eBay, Bill Me Later and WebBank deny the allegations in the lawsuit and say their relationship with the Utah chartered banks is legitimate under federal and state laws, and applicable court decisions.

"Mr. Sawyer has never disputed that the loan was legal under Utah law," Amanda Christine Miller, an eBay spokeswoman, said in an email. "In order to avoid his obligation to pay interest and late fees, he now wants to apply California law to that loan through his lawsuit. We are confident that we will ultimately prevail."

Federal law allows banks to sell loans and contact with other parties to service them, just like WebBank does with Bill Me Later, the companies said in their pending motion to dismiss the lawsuit.

WebBank attorney Mark Haddad of Los Angeles said that the WebBank-Bill Me Later operation is what Congress envisioned when it passed the Federal Deposit Insurance Act of 1950 and a 1980 amendment.

"Congress made a clear policy choice to bring state-charted banks under the FDIA to allow them to export interest rates and fees," Haddad told U.S. District Judge Clark Waddoups during a recent hearing. "This is critical. Congress did this because state-charted banks were disadvantaged versus national banks."

But the lawsuit contends Bill Me Later is the real lender because its proprietary software is used to vet the loans and its contract with the bank requires it within two days to buy the loans that WebBank extends to consumers. Bill Me Later then collects the payments and any interest and fees from consumers, while WebBank gets a small fee for the transaction, according to the suit.

"To avoid state law, defendants engage in a financial shell game — which in truth if just a form of money laundering," according to the lawsuit that asks the court to approve it as a class action to include all California Bill Me Later consumers who were charged interest or a late fee.

If the fees paid by Sawyer for the loan on his computer were calculated as an annual percentage rate, he was charged more than 70 percent interest, the lawsuit says. It also cites an online complaint where a woman says she was assessed a late fee of $19 and a $2 finance charge for an outstanding balance of $20.87.

California laws limit the amount of fees to the actual damages a lender suffers as a result of failing to pay on time, and the interest rate for these types of consumer transactions can be no more than 10 percent, according to the lawsuit.

Gary Marino, formerly of Citibank and First USA, started Bill Me Later in about 2000 with $100 million in venture capital, according to the lawsuit. Bill Me Later was acquired by eBay in 2008 for $820 million so the latter could enhance its payment services that already included PayPal, the company that facilities online transactions by providing easy-to-use payments through participants' bank cards or accounts.

According to eBay's 2011 annual report to the Securities and Exchange Commission, Bill Me Later last year bought $585.5 million worth of consumer loans from WebBank.

Bill Me Later is offered by 1,000 online stores, catalogs and travel partners, including Borders, Blue Nile, Bluefly, Continental Airlines, eLUXURY, Fujitsu, JetBlue, Overstock, QVC, Toshiba, Toys R Us, U.S. Airways, and Zappos, according to the lawsuit.

The suit asks the court enjoin Bill Me Later from violating California unfair-competition laws, order restitution to consumers and assess punitive damages, costs and fees.

Twitter: @TomHarveySltrib

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