Attorneys representing debtors in bankruptcy court are probably more exposed to a wider gamut of consumer law issues than any other sub-set of attorneys. Bankruptcy debtors are often a desperate and yet unsophisticated lot that are subject to many abuses not visited upon sophisticated, middle class consumers with prime credit ratings.
Being short of money and convinced that conventional lending sources are unavailable, debtors who file for bankruptcy protection are more likely, in my experience, to seek payday loans with interest rates that commonly exceed 500%, auto title loans with interest rates in excess of 100% and to be subject to yo-yo spot deliveries of automobiles. Likewise, such debtors are often treated, both before and after bankruptcy, as “second chance finance” customers are more likely to be sold automobiles with odometer rollbacks and undisclosed wreck damage and to be sold products on the “back end” such as credit life insurance, credit disability insurance and third-party extended warranties which are usually over-priced and rarely provide the promised benefits without litigation. In addition, this class of consumers is more vulnerable to wrongful repossessions, improper attempts at foreclosure, deceptive attempts at credit repair and outrageous debt collection tactics.
What follows are my ruminations on a number of practical consumer and debtor issues that can be addressed by consumer protection laws.
A. Abusive or Predatory Lending
1. Payday Loans
Payday loans are the modern version of salary-buying. Typically, a company advertises that it offers personal loans of $100 to $500 “without a credit check.” Assuming the loan applicant has worked for the same employer, lived at the same residence and maintained a checking account for a minimum period of time without any pending hot check charges, these lenders will make loans without actually pulling any credit report. Usually, the consumer is required to provide one or two checks for the amount of the loan plus a fee of 15-20%, and the lender promises not to deposit the check or checks for 14 days, or after the next payday, and only if the consumer fails to pay off the full amount or fails at least to pay the fee and to roll over the loan. In effect, these are one-payment term loans that are secured by postdated or undated checks (or by an authorization to seek electronic payments from the consumer’s bank account). Many consumers are unable to pay off the full amount of the loan in 14 days, so they “renew” the loan and pay the fee repeatedly until they are able to come up with the full amount or they tire of paying and simply cease their payments. A number of surveys have shown that consumers renew these loans, due to an inability to pay off the loan in full, 10 to 12 times. At 15% every two weeks, the annualized cost of this credit is 26 X 15 or about 390%. At 20% every two weeks, the annualized cost of this credit is 26 X 20 or about 520%.
Given the high rate of interest, the absence of any reduction of the principal amount owed unless the full sum is repaid and the financial tight wire walked by many consumers who take out these loans, many of these loans eventually fall into default. To induce payment, payday lenders explicitly state, or at least implicitly suggest, that if a check or checks are deposited, the practice when no other payment is received, and then bounces, the consumer has committed a criminal offense and could be arrested on the job. In fact, however, the consumer has not passed a hot check, because the lender knows when it receives the check that it will not be good. Otherwise, why would a consumer be seeking the loan? Likewise, there can be no presumption of criminal intent if the check is postdated and probably not if it is undated. In practical terms, I have not heard of a criminal hot check prosecution brought against a consumer in the Houston area, even in J.P. Court, in over 10 years. In effect, the explicit or implicit threat of criminal prosecution which induces many consumers to renew loans and to pay fees has no teeth.
What can be done about such loans? In the best of all worlds, all of these transactions would be considered usurious, any failure to give credit disclosures would be treated as a Truth-in-Lending Act (TILA) violation and much of the efforts at collection would be viewed as violations of the Fair Debt Collection Practices Act (FDCPA) and/or the Texas Debt Collection Act (TDCA). Every loan transaction has to be reviewed differently. The validity of potential claims varies a great deal, depending upon the business model utilized by the lender. See § 7.5.5 of the 2004 Supplement to The Cost of Credit (NCLC 2004).
a. Rent-a-charter transactions
At this time, the most difficult payday loan transactions to attack are those involving a purported principal-agent relationship between the actual lender, usually a state bank in Delaware, South Dakota, Illinois or Kentucky, and companies with local offices that purport to be acting as loan brokers. Many of the larger payday loan operations purport to act as brokers of payday loans and arrange for loans from banks, such as the County Bank of Rehoboth Beach, that are located in states in states with no usury limits. Since federal banking law allows the exporting of rates permitted in the jurisdiction where banks are located, these loans facially appear to be immune to attack for usury, even though the disclosed APR exceeds 500%. Nevertheless, a number of public and private suits have been filed, arguing that the payday lender chains are carrying all of the risk, being required to buy back all notes in default, and that, in substance, the true lender is the purported local broker. In effect, these suits argue that the banks whose names are on the notes are only renting their charters to permit the purported brokers to evade local usury laws. See The Cost of Credit § 3.4.6.5 (NCLC, 2004 Supplement). The one case in which the plaintiffs prevailed involved a settlement. Purdie v. Ace Cash Express, 2002 U.S. Dist. LEXIS 20910, 2002 WL 31730967 (N.D. Tex. 2002)(case dismissed), 2003 WL 21447854 (N.D. Tex. 2003)(dismissal vacated), 2003 U.S. Dist. LEXIS 22547, 2003 WL 22976611 (N.D. Tex. 2003)(class certifies and settlement approved). While Congress has not acted on this issue, the Office of the Comptroller of the Currency and the Office of Thrift Supervision have issued policies to discourage such arrangements, leaving only institutions regulated solely by the FDIC to engage in such arrangements. See The Cost of Credit § 3.4.6.5. These are difficult usury cases, involving undecided law and significant resources.
Practice Pointer: If there is a claim in these cases, it is usually usury and possibly RICO (based on a claim that the interest being charged exceeds the allowable limit by more than two times). These payday lenders are much more likely to comply with the Truth-in-Lending Act in their written disclosures and the Texas Debt Collection Act in their direct collection activity.
b. Lenders pretending not to be lenders
Another sub-set of payday lenders pretend to be selling a product or a service when, in fact, they are only making a loan. For example, some payday lenders have unsuccessfully claimed to be selling catalog gift certificates, Cashback Catalog Sales, Inc. v. Price, 102 F.Supp.2d 1375 (S.D. Ga. 2000) and Upshaw v. Ga. Catalog Sales, 206 F.R.D. 694 (M.D. Ga. 2002)(class certification granted), advertisements, Henry v. Cash Today, Inc., 199 F.R.D. 566 (S.D. Tex. 2000)(class certification granted), and internet service, Short on Cash.Net of New Castle, Inc. v. Department of Financial Institutions, 811 N.E.2d 819, 2004 Ind. App. LEXIS 1210 (Ind. App. 2004). The issue in all of these cases is whether, in substance, the transactions are loans or sales or, in other words, whether the form of the transaction as a sale is merely a guise or sham to evade the usury laws. See Tex. Fin. Code §§ 342.008 and 342.051. Since § 342.008 explicitly states that “[c]haraterization of a required fee as a purchase of a good or service in connection with a deferred presentment transaction is a device, subterfuge or pretense” to evade the law, there may be no factual issue when such transactions are completed in Texas.
For a long time in Houston, many payday lenders engaged in sale-leaseback transactions whereby they would purchase a consumer’s television or refrigerator, e.g., for $200 and then agree to lease the property back for 2 weeks in return for a “rental” fee of 20-25% with an option price of $200. With amendments to the Finance Code effective September 1, 2001, however, the Legislature specifically declared that these transactions were to be treated as loans and the rentals as interest. See Tex. Fin. Code § 341.001(10). That led many of the sale-leaseback operations to change their business model.
Besides usury, payday lenders that pretend to be sellers often violate the Truth-in-Lending Act as well. Since the Federal Reserve Board’s issuance of an official interpretation on March 24, 2000, 65 Fed. Reg. 17129 (2000), there has no been issue that TILA applied to deferred presentment transactions as extensions of credit. Arrington v. Colleen, 2000 U.S. Dist. LEXIS 20651 (D. Md. 2000). Even if this official interpretation need not be followed until October 1, 2000, Clement v. Amscot Corp., 176 F.Supp.2d 1292 (M.D. Fla. 2001), there is no doubt that all payday loan transactions consummated on or after that date must comply with TILA. Nevertheless, it has been my experience that those businesses pretending to be sellers instead of being lenders fail to give any TILA disclosures, exposing themselves to federal jurisdiction and statutory damages equal to twice the finance charge not to exceed $1000 and not less than $100. Koons Buick Pontiac GMC, Inc. v. Nigh, 2004 U.S. LEXIS 7979 (2004).
The operations pretending to be sellers may also violate the Texas Debt Collection Act by threatening hot check arrest or criminal prosecution when the check or checks, serving as security, are deposited and then bounce. See, e.g., Turner v. E-Z Check Cashing, 35 F.Supp.2d 1042 (M.D. Tenn. 1999). Such threats by a third-party, such as an attorney, violate the federal Fair Debt Collection Practices Act, assuming the third party meets the statutory definition of a “debt collector.” Nance v. Ulferts, 282 F.Supp. 2d 912 (S.D. Ind. 2003). At least one payday lender based in a foreign country has attempted to threaten defaulting Texas borrowers with wage garnishment, and that is the subject of a private lawsuit in Harris County District Court.
Practice pointer: One way for payday lenders to discourage claims is to place an arbitration agreement in the loan documents. These arbitration agreements, however, are not always enforced, particularly in bankruptcy court when there is a core proceeding involving the payday loan. See The Cost of Credit § 10.6.10 (NCLC, 2004 Supplement); Consumer Arbitration Agreements § 5.2.3 (NCLC, 4th ed.).
2. Car Title Loans
These transactions work much like payday loans, but the security is a lien on a paidoff vehicle (instead of a check), the amount being lent is usually at least $1000 (instead of $100 to $300), the interest rate is usually around 100% (instead of 400% or more) and the term is usually at least 6 months with multiple payments (instead of a 2-week term with one payment). Like the case of many payday lenders, title lenders often try to evade the usury laws through the use of form, but these efforts at evasion usually are unsuccessful. See Sal Leasing, Inc. v. State ex rel. Napolitano, 10 P.3d 1221 (Ariz. App. 2000)(saleleaseback of automobiles actually car title loans); Aple Auto Cash Express Inc. of Okla. v. State ex rel. Oklahoma Dep’t of Consumer Credit, 78 P.3d 1231 (Okla. 2003)(transactions in form rent-to-own deals but, in reality, were car title loans).
One local group of businesses have attempted to avoid usury liability for such transactions by having one business act as a broker, register under the Credit Services Organizations Act, do all the work, place the loan with a lender. Specifically, they have disclosed in their paperwork that the finance charge for TILA purposes was over 100%, but they argued that the 75% fee paid to the broker could not be treated as interest even in the face of allegations that there was a principal-agent relationship between the lender and the broker. So far, a panel of the Fifth Circuit Court of Appeals has accepted the lenders and brokers’ argument in affirming a Rule 12(b)(6) dismissal, although petitions for rehearing are pending. See Lovick v. Ritemoney Ltd., 378 F.3d 433 (5th Cir. 2004). Should the Lovick opinion remain in place, form will be more important than substance and successful usury cases will be few and far between.
3. High-interest, high-fee loans
One other form of predatory loan is the home equity, home improvement or re-fi loan secured by a homestead with very high fees or interest that is subject to the Home Ownership Equity Protection Act (HOEPA), a part of TILA. Money Mortgage used to broker a number of HOEPA loans every year, but I have not seen many of these type of loans since Money Mortgage failed and filed for bankruptcy protection back in September of 2001. If you find one of these loans with fees in excess of 8% or an interest rate 8% in excess of the T-bill rate for notes with similar terms, see 15 U.S.C. § 1602(aa), then the lender is required to comply with a number of mandates set forth in 15 U.S.C. § 1639, such as a required written notice before closing, limitations on prepayment penalties, a partial ban of balloon payments, a complete ban on negative amortization and a prohibition on the making of loans without regard to the borrower’s ability to repay (in other words, the loan was made solely on the basis of the borrower’s equity in his home). When HOEPA applies, it is often violated, and it provides a special penalty equal to all payments to date for interest and fees. 15 U.S.C. § 1640(a)(4). Moreover, HOEPA provides unlimited assignee liability. 15 U.S.C. § 1641(d). In short, HOEPA provides the plaintiff’s counsel with a substantial weapon, even where federal law has preempted all state usury regulation in the context of residential construction mortgages.
While such loans are much more common in other states, I have been referred a number of consumers in the past 18 months who have HOEPA-covered loans.
B. Yo-Yo/Spot Delivery Transactions
A yo-yo or spot delivery is a very common sales practice with both new and used car dealers, and it is probably the most insidious practice affecting consumers with poor credit histories. This is how it works. In response to advertising offering “second chance financing,” a consumer with a less than sterling credit history appears at a dealership seeking to buy an automobile. After choosing a particular car to purchase and permitting his trade-in vehicle to be appraised, the consumer will be asked to provide a substantial cash downpayment, and sometimes a trade-in, and sign all of the usual paperwork, including a buyer’s order, a retail installment contract, a title application, a promise to obtain insurance sheet and odometer disclosure documents, and, in addition, the consumer will be asked to sign a document usually referred to as a “bailment agreement” or “courtesy delivery agreement.”
In the bailment agreement, the dealer typically promises to seek financing on the terms set forth in the other documents, but, if the dealer is unable to obtain financing on those terms, then the consumer is obligated to return the vehicle upon request and the dealer can apply daily and mileage use charges against any cash downpayment provided by the consumer. Many of these bailment agreements even provide that the trade-in may be sold immediately, even if the dealer later claims the deal was not completed due to the failure to “obtain financing.” Leaving his trade-in, if any, with the dealer, the consumer then drives away, often with a temporary dealer plate stating that a sale occurred that day, but often the consumer is only allowed to retain a copy of one document, the bailment agreement. Frequently, consumers in these transactions are told that they will receive a copy of the retail installment contract in the mail or when they come to pick up their permanent license plates. Most of these consumers drive away assuming that the deal is final.
After driving off in a new vehicle, the dealer attempts to sell the retail installment contract, and the right to receive the monthly payments, to a sub-prime finance company. If the dealer is unable for any reason to sell the contract or at least not on the terms set forth in the contract, the dealer will usually call the consumer and ask for either the car to be returned or the consumer to sign a new retail installment contract, frequently back-dated to the date of delivery, with terms less favorable to the consumer, such as a higher downpayment, a higher interest rate and consequently higher monthly payments, or the addition of a co-signor. In fact, sometimes dealers ask consumers to return and sign several different retail installment contracts. When the retail installment contract is not sold or renegotiated and sold, the dealer takes the position that no sale was ever consummated, as it has not transferred title (which only occurs when the dealer is paid in full by a finance company). Instead, because no financing has occurred, the argument goes that the transaction was merely a form of rental and an objecting consumer will have daily and mileage rental charges assessed against their downpayment. When such a deal goes south and a consumer demands the return of the trade-in and cash downpayment, the dealer frequently says the trade-in has already been sold and that the consumer is not entitled to any refund due to significant use, relying on the “bailment agreement.” (Marvin Zindler calls this process “dehorsing” when consumers are denied the return of their tradein.) To avoid arguments over the existence of a sale on specific terms, dealers have alternated between providing no copies of the retail installment contract until after funding at the time of assignment and providing a copy of the retail installment contract with no dealer signature (based on the feeble argument that it was not a final agreement without such a signature).
Not surprisingly, the dealer will typically assert that the retail installment contract was consummated on the day the consumer signed when it is able to sell that contract and obtain funding from a finance company, but, on the other hand, the dealer will assert that no sales transaction was ever consummated if it was not able to sell the finance contract even though the consumer has already signed. Talk about a one-sided agreement! This is one of the best examples of a “tails I win/heads you lose” transaction.
For ways to obtain for injured consumers in these transactions, see the attached paper presented to a State Bar CLE in November of 2004. Please note as well that the Office of the Consumer Credit Commissioner has proposed a rule to regulate these transactions, based on the Commissioner’s licensing authority over dealers that enter into retail installment transactions.
C. Car Title Disputes Arising out of Sales out of Trust
In the typical automobile sales transaction, there are a number of parties that serve particular roles. First, whether the transaction involves a new or used vehicle, there is a floorplanner which provides financing for the dealer to put the automobile on the lot for sale, secured by a purchase money security interest (PMSI) in the dealer’s inventory. Second, there is the dealer that is offering to sell the vehicle. Third, there is the consumer who agrees to purchase the vehicle off the lot of the dealer. Finally, there is the retail finance source which ultimately provides the funding for the purchase of the automobile from the dealer by the consumer, secured by a PMSI in the vehicle which is the subject of the sale. This retail financing usually comes in one of two forms. A retail lender can provide direct financing to consumers who seek their own funding or indirect financing by purchasing a retail installment contract executed by the dealer and the consumer.
What happens when a vehicle is sold by a dealer without payment of the inventory lender’s PMSI? This is commonly known as a “sale out of trust.” Such sales out of trust are very common, especially with failing used car dealers who must steal from Peter to pay Paul. The law must determine who must suffer or share the risk of loss when such a sale out of trust occurs. Attorneys representing consumers can make at least modestly decent money in such cases, as long as careful case selection analysis is conducted before offering to be retained. On the one hand, consumers in these cases are sympathetic even to very conservative judges and jurors, because they are often truly innocent and yet have suffered a loss of title or even possession of a vehicle that they had purchased. On the other hand, there can be substantial risk in these cases as well, however, because there may be no deep pocket defendant that can afford to pay damages or afford other relief. Before agreeing to represent a consumer in a sale out of trust case, consumer attorneys must be sure that their prospective consumer is innocent and that there is a target defendant with the resources to pay damages. With the right facts, the right client and the right defendant, an attorney representing an innocent consumer can do well for his client and himself. An attached paper endeavors to survey how the law has addressed the burden of risk in sales out of trust and, thereby, to give attorneys the tools to identify those cases which are worth handling.
D. Outrageous collection tactics
Besides threats of criminal prosecution related to payday loan collections, bankruptcy attorneys should be alert to other debt collection practices that can be attacked under the federal Fair Debt Collection Practices Act or the Texas Debt Collection Act. For example, you should recognize that attorneys can be liable under the FDCPA for failing to provide validation and Miranda notices within 5 days of their first contact, by filing suit to collect consumer debts in a distant forum and by permitting non-attorneys to utilize their signed letterhead without any direct involvement in the process of collection. For a discussion of these issues, see the attached paper on the FDCPA and the TDCA.
E. Deceptive Auto Sales: Odometer Rollbacks and Undisclosed Wrecks
In my experience, odometer rollbacks and undisclosed wrecks are the most common consumer complaints about automobiles after failed yo-yo transactions. For a discussion of the law in this area, see the attached paper on deceptive auto sales.
F. Conclusion
I urge bankruptcy practitioners who represent debtors to become familiar with the consumer laws applicable to their clients, partly because I want to encourage more lawyers to handle consumer claims and partly to encourage lawyers to recognize consumer issues and to refer their clients when necessary to attorneys with consumer law experience.
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