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The share of purchased paper has dropped from 65.3% to 60.2%. How much of this is due to aggressive bank advertising, and the desire to save the percentage of the finance charge exacted by the automobile dealer as a condition for funnelling his paper to the ban'z, we can only speculate. If the abolition of holder in due course had a significant impact, we believe the shift would have been far more drastic.
It is note worthy that the National Commission on Consumer Finance recommends the continued abolition of holder in due course, and the use of waiver of defense clauses. It also recommends subjecting a “related-lender" to the same defenses. Similar rules should apply in the credit-card situation.
PROBLEMS ON "READY CASH" AND OTHER CHECK-CREDIT PLANS
We would be derelict if we failed to add a few remarks about a new and rapidly growing species of consumer credit. Banks are currently offering two variations of checking account credit. For both varieties, a credit application must be approved, with a maximum potential credit extension. The first type of checking credit operates as an automatic line of credit extended on one's checking account. Regular checks are honored beyond the balance outstanding in the account; overdrafts are treated as loans on which interest is charged until the balance is repaid. We will refer these as "overdraft-loan" accounts.
The other type of checking credit is called a "revolving-cash" account; it operates as a separate account, distinct from the consumer's ordinary checking account. Separate checks are furnished which operate as loans when written. Bills are sent monthly by the bank for the amount due, much as a retail store revolving credit account operates, and repayment is made by the customer drawing a check on the regular account.
The rapidity of growth in this area of the credit market is indicated by a few figures. At the end of March, 1973 Federal Reserve Board Reports show a total of $1.835 billion in consumer check installment credit, up from $1.207 billion since June, 1971. This represents a growth of 52% in a period of less than two years, while total consumer installment credit increased only 27%.
There are certain features of these new accounts which lend themselves to abuse by creditors. The abuses are akin those addressed in S. 914 for other kinds of credit, but the provisions of S. 914 do not reach these new credit arrangements at all.
The banks are very reassuring to customers regarding three aspects of these new accounts: first, that the customer pays interest only on what he or she actually borrows; second, that interest must be paid on any outstanding debts ; and third, that you can repay at any time. There all seem properly protective of the consumer. However, certain problems arise. As to the first point, in overdraft-loan accounts, money is added to the consumer's account only in stated increments. Some banks use $25, others $50 and still others use $100, thus forcing the consumer to "borrow" more than he has in fact intended to borrow or actually needs to get the service. While perhaps not creating a real hardship in any individual case, if only small amounts are involved, the abuse potential here can be significant in the overall credit picture.
Furthermore, a far more serious abuse with the overdraft-loan accounts is encountered. This is the feature shared by most plans, that while payment in full can be made at any time, the customer's deposits to the checking account are not automatically credited to the outstanding debt, and unless a special deposit slip is used, only the minimum monthly principal payments and the full interest charges are deducted by the bank from the consumer's account. The affect of this is that a consumer will be paying interest on an “overdraft-loan" even though his checking balance is more than sufficient to repay the loan in full.
Perhaps an example will clarify. Consider the resemblance of the underlying transaction to the abuses which are to be curbed by S. 914 in § 164 on Prompt Crediting of Payments and in $ 167 on Retroactive Finance Charges.
Suppose that a consumer has an overdraft-loan account, into which his salary of $750 a month is deposited. Let us further assume that the consumer's checks are paid by the bank at the even rate of $25 a day over the course of the month. The consumer purchases an item for $500 using a “loan" on his account. Unless he finds out about the special deposit slip the bank will automatically make repayments in ten monthly installments of $50 plus interest.
At present, he is treated as having $500 outstanding on which he pays interest throughout the month. Computing the repayment at the bank's fixed rate of $50 a month, let us look at the true debit balance position. When the $750 salary is deposited in the account, a new positive balance in the account is created for the first ten days of the month, after which, as the consumer continues to spend at the rate of $25 per day, the debt climbs until it finally reaches $500, but only the last day of the month. So, while the consumer is charged interest as if he had borrowed $500 for one month, in fact nothing was borrowed for ten days, and, the loan really increased at the cumulative rate of $25 a day for only the last 20 days of the month or an average borrowing of only $177 for the month, not the $500 on which interest is charged. He pays approximately three times the disclosed rate of interest.
During the fifth month the customer will have only $300 outstanding, the $750 put in the bank on the first of the month will repay the loan and leave $450 in the account which, at the rate of $25 a day gives the consumer 18 days of new balance in his account. Only after this does he in fact use the overdraft-loan. He is charged one month's interest on a loan of $300, whereas in fact he has 18 days with no loan outstanding and only 12 days with any loan, or an average through the month of $100 outstanding.
The device of requiring a special deposit slip to charge the $50 a month reduction in effect permits banks to multiply permissible interest rates far beyond that permitted by the law, raising questions of violations of usury statutes.
Even if only a single account is involved, it appears unjust to permit this to go unchecked. The bank does have the depositor's money but it fails to credit it to his loan. This abuse has some relation to $ 164 requiring prompt crediting to accounts, and some similarity to the retroactive charges considered by $ 167, however it appears that these charges are more in the nature of prospective charges, i.e., interest on loans which in fact are not yet made by the bank
We urge that S. 914 be revised to curb these practices, or at the least to require specific and repeated disclosure of how the extra repayments can be made to be conspicuously sent with each monthly bank statement. Furthermore, forms with which this can be done should be furnished when the loan application is approved.
The separate revolving cash accounts do not lend themselves so openly to these abuses, because there is no net balance in the same account. However, it would be unfortunate if the consequence of action to meet the overdraftloan abuse were merely to separate the customers account into two portions. It would therefore seem advisable if action is to be taken on this matter to prohibit separation of the customers account for the purpose of increasing the interest collectible on these so-called "ready credit" loans.
We are aware that where one borrows money from a bank on a demand note, for example, interest must be paid on the amount borrowed even though the loan proceeds may be deposited in the same bank. But the "overdraftloan" is sold to the consumer as if it were a temporary accommodation for a temporary shortage and not as a permanent loan. Once the basic arrangements are made, since it is the overdraft that triggers the loan without a special request the deposit should trigger the repayment, equally without a special request.
PROHIBITION OF OFFSETS The prohibition against offsets is the same in both S-914 and S-1630. As worded, it is doubtful if the section will accomplish any useful purpose. The normal bank right of set-off can be exercised to charge the credit card account against the card holder's deposit account under this statute if “such action was previously authorized by the card holder in writing.” The issue should be not only "previously” to the time of the charge-off, but the authorization should come after something has happened. Otherwise all that the bill will accomplish is to add one line of fine print in the card holder's form contract with the issuing bank.
Consider the analogy of the note drawn payable at a bank presented for payment on behalf of the payor who is not the bank. In large segments of the country, the bank may not charge the account without an independent authorization. If this is the thrust of the section, the written authorization should be valid only if given after a failure to pay.
We doubt, however, that this is the intended thrust. We believe the real issue to be whether the card holder understands that the bank can exercise a right of set-off. This should be a matter for a clear disclosure when the contract is made with the card holder. We also feel that the card holder should be notified before the setoff is exercised, whether by letter, telegram, or phone is immaterial. Finally, we believe that no set-off should include any amount which has been reported to the card-issuer as being in dispute before the set-off is exercised. The card holder should not have his checks bouncing while he sends the "please recredit” notice mentioned in item (2) of section 171 (a).
Only one possible card-holder defense is included in the definition of billing error in Section 161 of each bill, namely Section 161(b)(3) that the goods have not been delivered, or if delivery was attempted, the goods were rejected. Apparently this rule applies equally to the two party and to the three party credit card transaction whether or not the bill will prohibit other waivers of defenses.
If Section 172 of 8–194 is adopted in some form there will be other grounds of dispute besides a total lack of delivery. The prohibition against set-off of disputed items should apply to all disputes which the card holder is entitled to raise. Where defenses are permitted to be asserted against the card issuer the remedy of set-off should be prohibited whenever the consumer asserts, in good faith, a claim or defense. The remedy should be by action where all parties, the vendor, the card-issuer, and the card holder will be bound by the result. In these cases the bank does not need the protection of set-off as against the card-holder. It can protect itself by exercising a right of change-back as against the merchant.
If the disputed item was what the bank card people call an "incoming interchange" it can be charged back through channels to the originating bank in the same way a check paid on a forged endorsement is charged back, and will end up as a charge against what the originating bank calls its "own merchant.”
We urge the committee to redraft Section 168 of S-1630 or Section 171 of S-914 so as to require.
(a) A full disclosure of the bank's right of set-off at the time the card is issued and at each time it is renewed;
(b) Prompt notification of each intent to exercise before the set-off is made; and
(c) No set-off at all in the case of disputed items of which the card issuer has been notified.
RELATION TO STATE LAWS It is suggested that Section 169 of S-1630 and Section 173 of S-914 should be clarified to cover a technical point, The Section first pre-empts state laws to the extent that they are inconsistent with the provisions of this bill. Then a final sentence provides
"No state law which provides greater protection for consumers than the protection provided by this law shall be preempted by this law to the extent
of the greater protection.” The construction of the Section could be that the non-pre-emption sentence applies only to greater protections that are not inconsistent. We submit the last sentence of the section should have added, at the end thereof, tho words “notwithstanding any inconsistency."
Generally the provisions of the Truth in Lending Act cannot be varied by agreement. But since Section 167 of S-1630 and Section 170 of S-914 start with the words "Notwithstanding any agreement to the contrary an implication may arise that all other sections are subject to agreement otherwise. This will be an unfortunate result. We hope that other language can be used in these sections, or that the legislative history will make it clear that there should be no implication that agreement of the parties can control other sections.
CREDIT CARDS ISSUED TO BUSINESSES
The basis Truth in Lending Act is transactional in its application. Thus the exclusion of industrial or business credit is transactional in nature. With respect to credit cards, however, and issues such as waiver of defenses, prohibition of offsets and the like, we believe the general transactional exemption will be difficult to apply unless our suggestion as to food, drink, lodging and entertainment is adopted. Even so, there will be difficulties in the case of credit cards issued to professional people and to some corporations, but used for personal purposes by, for example, the sole shareholder. The solution lies in drafting an exemption which will enable card issuers to classify their accounts as business or consumer accounts. There the consumer rules would not be applicable to business accounts no matter what the particular transaction was in which the card was used.
REPORT ON INTEREST RATES Section 206 of S-1630 has no counterpart in S-914. With slight modifications it can be a most important section. Traditionally ates have been laboratories for studying the effect of changes in law. With the present variegated pattern of state law as to creditors remedies in consumer finance, it is important that there be knowledge as to the impact of changes in creditors remedies on the cost of consumer credit. We have urged the Federal Reserve Board to give some geographical break-down to its reports to the Committee on Interest and Dividends on interest rates. We have so far not been successful. The report should have a state by state breakdown of interest costs and finance charges and amounts of credit extended in the following categories A. Installment Credit 1. Automobile Paper
(i) New Cars--purchased paper
(vi) Used Cars—4-6 years old—direct loans
(i) New-purchased paper
(iv) Used—under 5 years old—direct loans 4. Home Repair and Modernization Loans
5. Other Personal Installment Loans B. Non-Installment Credit
1. Single Payment Loans
2. Check Credit The distinction between “purchased paper" and "direct loans” is valuable in determining the effect of an abolition of "holder in due course" and "waiver of defense” rules. For example Federal Reserve Board Statistical Release G-18 dated May 4, 1973 shows that of $2.609 billion dollars of automobile credit extended in March 1973 by commercial banks 58.5% was purchased paper. In March 1972 the percentage of purchased paper was 57.9%, and for June 1971 the figure was 59.4. Again we have no state by state breakdown.
Both bills modify the civil liability sections of the Truth in Lending Act without change in the language with respect to the award of attorneys fees to the successful consumer plaintiff since the language refers to a successful action “to enforce the foregoing liability." But what of the consumer who successfully interposes a defense to a creditor's action. Shouldn't attorney's fees be recovered in this situation, too? We believe so.
The language "a reasonable attorney's fee” should be broadened to make it clear, as it was to the judge in the Ratner case [Ratner v. Chemical Bank, N.Y., 54 F.R.D. 412 (S.D.N.Y. 1972)] that the dollar amount of any recovery should not be a limiting factor, hence the sentence should now end with the words “at reasonable hourly rates based on time reasonably spent without regard to the amount in controversy." Consideration must also be given to the fact that representation of consumer interests is necessarily of a contingent nature. If not successful the attorney is just not paid, unless he is on salary with some group legal services organization. Hence there should be legislative history to show that the “reasonable hourly rate" should reflect the contingent nature of a consumer attorney's representation.
An element that should be added is the fee of an expert witness or an economics experts in the preparation of a brief. As matters become more complex, expert witnesses will become more and more necessary to enable consumer actions to be successful. We also suspect that expert witnesses will become more and more expensive. Under existing rules of law, experts may not be subpoenaed to give expert testimony where fee arrangements have not been made, particularly where the testimony is in the nature of expert opinion. The creditors have easy and mutual access to this type of witness. An example is found in the parade of witnesses for the defense in Messenger v. Sandy Motors (195 A. 2d 402 (N.J. Super Ct., Chanc., 1972)) in New Jersey, or the economic appendix to a brief amicus in Adams v. Egley, 338 F. Supp. 614 (S.D. Calif. 1972) appeal Docketed No. 72–1484 9th Cir. Mar. 1972 prepared by Dr. Robert Johnson of the Krannert School of Business Administration of Purdue University.
Thirdly, there is the problem of compensating an individual plaintiff or two or more participating plaintiffs for time taken from gainful employment to consult with counsel, locate documents and other data desired by counsel, submit to opposition depositions and discovery, wait at the courthouse when his case is listed for trial until the proceeding is actually started, and for days or hours spent at trial. We suggest that this is the function of the fixed dollar figures, but at today's prices the spread should be from $160 (4 days at $10) to $2,000 (20 days at $100).
The business defendant has these costs too, but they can be included in overall costs of operation where the burden will be spread, mostly in the cost of the product or service or credit, and in part absorbed by reducing profit. If we take almost any one of the Fortune's 500, very sizeable awards in dollar amounts appear miniscule in comparison with net profit or cost of sales. So too with the purveyors of finance. Bank of America has a new worth of over $1.2 billion. An award of $100,000 is roughly 842 thousands of 1% of that figure. Given a bank one hundredth the size of Bank of America, the award of $100,000 would be eight-tenths of 1% of that figure.
Hence, we can conclude that, in individual suits, the recovery of the items of cost and expense we have suggested will not impose any serious burden on credit grantors. We would, therefore change the proposed rules of damages for individual suits so that they would read, from line 19 on page 18 of S-914 as follows:
"any person is liable to such person in the case of a successful action or defense based upon a violation of or a failure to follow the provisions of this act, for an amount equal to the sum of
“(A) in an individual action.
"(1) twice the amount of any finance charges imposed in connection with the transaction ;
“(2) any actual damages, including consequential and incidental damages, caused such person by the failure ;
“(3) a sum to compensate the person for time and effort consumed in the case, but the liability under this subparagraph shall be not less than $100 nor greater than $2,000 as determined by the court; and
“(4) the cost of the action including reasonable fees and expenses of expert witnesses and economic or other experts reasonably employed in connection with the case, together with a reasonable attorney's fee based on compensatory hourly rates for the hours reasonably expended, all as determined by the court.
“(B) in a class or other group action:... At this point we would like to pass, for, in the time since we were requested to prepare our testimony, we have not been able to reach any conclusion except that we are not in favor of the class action language in either S-914 or, even more so, in S-1630. There are some rather novel suggestions under discussion in various quarters, and, if we may, we would like to submit a written memorandum on this aspect at a later date when we have reviewed more thoroughly the qui tam and declaratory judgment proposals which we understand will be proposed.
We thank the Committee for this opportunity to present our individual views on this important legislation.
SECTION 172. RIGHTS OF CREDIT CARD CUSTOMERS
(a) A credit card issuer shall be subject to all claims and defenses of the card holder arising out of any transaction in which the credit card is used
(1) in any sales, lease or service transaction in which the seller, lessor or person rendering the service is the card issuer or any person under direct or