Fighting for the Consumer

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%, apply for 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 who 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 are 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 (or even $1000) “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. Until recently, the consumer would be required to provide one or two checks for the amount of the loan plus a fee of 15-20%, and the lender promised not to deposit the check or checks for 14 days, or after the next payday, and only if the consumer failed to pay off the full amount or fails at least to pay the fee and to roll over the loan. Now, payday lenders usually obtain authorization to debit the consumer’s checking account if no cash payment is made by the due date. 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 is deposited or a debit is made, 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 or committed theft, because the lender knows when it receives the check or the debit authorization that there will be insufficient funds in the account at the time the transaction is done. See Jones v. Kunin, 2000 U.S. Dist. LEXIS 6380, *3-4 (S.D. Ill. 2000); Turner v. E-Z Check Cashing, 35 F.Supp.2d 1042, 1051-1052 (M.D. Tenn. 1999); Hartke v. Ill. Payday Loans, Inc., 1999 U.S. Dist. LEXIS 14937, *9 (C.D. Ill. 1999). Otherwise, why would a consumer be seeking the loan? Likewise, there can be no presumption of criminal intent if the check is post-dated and probably not if it is undated. In practical terms, I have not heard of a criminal hot check or theft prosecution arising out of a payday loan transaction 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

Until recently, the most difficult payday loan transactions to attack were 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 purported to act as brokers of payday loans and arranged for loans from banks, such as the County Bank of Rehoboth Beach, that were located in states in states with no usury limits. Since federal banking law allowed the exporting of rates permitted in the jurisdiction where banks were located, these loans facially appeared to be immune to attack for usury, even though the disclosed APR exceeded 500%. Nevertheless, a number of public and private suits were filed, arguing that the payday lender chains were carrying all of the risk, being required to buy back all notes in default, and that, in substance, the true lender was the purported local broker. In effect, these suits argued that the banks whose names were on the notes were only renting their charters to permit the purported brokers to evade local usury laws. 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 certified and settlement approved). While Congress has not acted on this issue, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the FDIC issued policies to discourage such arrangements. When the FDIC issued its policy directive in 2005, all of the lenders using this model in Texas switched to a new model, relying on the Texas Credit Services Organizations Act (“CSOA”).

b. Use of the CSOA as a dodge

When the rent-a-charter model failed in 2005 due to policy directives from federal bank regulatory authorities, all of the payday lenders using this model had some time to find a new model. In Texas, all of the larger payday lending operations switched to a CSOA model. Entities like Advance America, Cash America and Ace Cash Express all follow this model. Under this model, the company with local offices registers as a “credit services organization” (“CSO”) with the Texas Secretary of State and provides the disclosures required by the CSOA, Tex. Fin. Code § 393.001 et seq., and lists a separate entity as the lender on the actual loan documents. Since there is no limit on the fees that can be charged by CSO’s for acting as loan brokers, the theory is that the passage of the CSOA in the early 1980's constituted an implied repeal of a portion of the usury laws that would permit broker fees to be treated as interest when the broker was a “general agent” of the lender. In effect, the payday loan operations argue that the CSOA was passed in part to serve as a tort reform measure. While I strongly disagree with this theory, I lost in the one case in which this theory was challenged. See Lovick v. Ritemoney, Ltd., 378 F.3d 433 (5th Cir. 2004).

Practice Pointer: While the CSOA usury defense theory is subject to attack in state court, an action can only be filed in state court if the omni-present arbitration clauses are invalid and unenforceable. Since courts in Texas are loath to refuse enforcement of arbitration agreements, there may be no practical means of attacking this theory of usury avoidance by any means other than a public enforcement action by the State of Texas. Unfortunately, I doubt that any such action will ever be filed. If there is a claim in these cases, it is most likely to involve the payday loan brokers’ collection activity. Since the big operators are all registering as CSO’s and claiming to be loan brokers, they are clearly third-party debt collectors who are subject to the FDCPA as well as the Texas Debt Collection Act. Thus, for example, explicit threats of criminal prosecution or arrest could be subject to attack under those statutes. See section A.1.c. below.

c. 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, State of North Carolina v. NCCS Loans, Inc., 620 S.E.2d 697 (N.C. App. 2005), Department of Financial Institutions v. Mega Net Services, 833 N.E.2d 477 (Ind. App. 2005) and 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). See also Austin v. Alabama Check Cashers Ass’n, 2005 Ala. LEXIS 197 (Ala. 2005)(covering catalog gift certificate and telephone calling card schemes). 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), it has been undisputed 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.).