be driven out of business, but that is a result which may, in fact, be desirable.

The basic point is that I don't foresee banks and other issuers operating as a regulatory body over merchants. Rather, the impersonal charge back provides a mechanism for directing the costs of shoddy merchandise back to the source of those goods.

Senator PROXMIRE. Could that work to discriminate against small business or simply against small business that may have standards which are too low, and merchandise which and practices which are indefensible?

Professor WEISTART. The premise of that argument—which has been made by the banking industry-is, in effect, that our retailing system must tolerate a little fraud in order to keep the small businessman in operation. I would, of course, reject the notion that we ought to allow some businessmen to insulate themselves from shoddy mechandise and fraudulent selling tactics.

Senator PROXMIRE. That is very well put. Many States have abolished or restricted the holder-in-due-course doctrine. Do you see any difference between installment credit and open-end credit that would justify retaining the doctrine in three-party credit card transactions? Professor WEISTART. The thrust of my prepared remarks actually goes the other way. From the perspective of the consumer, a number of arguments can be made against the holder-in-due-course doctrine in both areas, irrespective of the type of credit involved. First, the consumer's liquidity problem is much the same in the traditional installment area as it is in the credit card areas. Moreover, the consumer's expectation about not having to pay for goods which have no utility for him is essentially the same in both areas.

One might decide to leave open the question of the application of the holder-in-due-course doctrine in traditional retail installment financing transactions since existing commercial relationship are premised on the existence of that doctrine.

My feeling is that we cannot make that same argument with respect to credit card transactions. We cannot say that, as a result of evolution of the market, we have arrived at a situation in which credit card holders have agreed that issuers can insulate themselves from cardholder defenses. I would suggest that the present state of affairs-in which issuers have insulated status-is not the result of a natural market operation. It is rather the result of efforts by issuers to include the waiver-of-defense language in small type, nonnegotiable cardholder agreements.

Senator PROXMIRE. Do you think the provisions of S. 914 with respect to holder-in-due-course would in any way impede development of the bank credit card system?

Professor WEISTART. It is undeniable that there will be costs involved with implementation of the system. The question comes down to whether one considers those costs to be so excessive as to impede development of the bank card or other credit card systems. Since the industry has not produced any reliable cost projections, my feeling is that we should put the system into operation as an experiment to see whether the costs are excessive. I would expect that they would not be, because in the credit card area the opportunity for cost spreading is great. There are large numbers of cardholders involved, as well as

large numbers of merchants. It is likely that the additional cost for each cardholder would be quite small.

Senator PROXMIRE. Do you think most customers are aware of the fact that when they accept a bank credit card they waive any claim or defense they may have against the bank or, if they are aware, they appreciate the legal significance?

Professor WEISTART. The credit card area is another case study of one of the major vices of the holder-in-due-course doctrine as it is applied in practice. One reason why the doctrine is so firmly established in the retail installment area is that consumers are never made aware, in advance, of the practical implications of an application of the doctrine. That lack of awareness is epitomized with respect to credit cards because the waiver-of-defense language is hidden in fine print and typically in legalistic language, which it is unlikely that consumers would understand.

Senator PROXMIRE. I am asking Mr. McLean to give you a credit card issued in Virginia. Do you see anything in there to indicate that a cardholder waives any defenses against the bank?

Professor WEISTART. There is certainly nothing specific. In fact, we have another indication of the sort of deceptive, indirect disclosure that is often made. At the bottom of the card, it says that an authorized user of the card is responsible for all credit extended. The bank might argue that that language provides authority for it to hold you responsible for all credit received on the card, irrespective of the details of the particular transaction.

Senator PROXMIRE. That's right, and the card indicates that the bank is bound by the customer agreement. So you have to go to the agreement which most people throw away. Why do you suppose the bank neglects to mention the waiver-of-defense clause on the card?

Professor WEISTART. The industry might use that question as the occasion to decry the effect of Government regulation and say that the Government requires them to put so much on the card that there is no room for other information.

Senator PROXMIRE. I think it is significant that you are not only a trained lawyer, you are a very fine lawyer and an outstanding professor and expert on this subject, and you were unable to pick it up, so that the chances that the typical customer who would give less attention than you gave, to pick it up, is literally infinitesimal.

Professor WEISTART. I'll accept that as a reasonable illustration of issuer tactics. [Laughter.]

The point I tried to make a moment ago was that even if the customer has read the language to the effect that he promised to "waive and release the bank from all defenses arising from the claims holder may have against any merchant honoring the card." I am not sure he would appreciate the full import of that language. "Waiver" and "release" are not familiar terms for the average consumer. Also, most people do not fully anticipate at the time they receive their cards that they may enter into transactions with which they will have difficulty. It is difficult to make the consumer aware of what he is giving up in these cases. If we were to ask the average consumer at the time he discovered defective merchandise, whether he knew he had waived his right to withhold payment, we would most likely get a universal reaction of surprise.

Senator PROXMIRE. Thank you very, very much, Professor Weistart. You have been most helpful. We do appreciate it.

[The complete statement of Professor Weistart follows:]

STATEMENT OF JOHN C. WEISTART, PROFESSOR OF LAW, DUKE UNIVERSITY Senate Bill 914 is a laudable attempt to deal with several problems which consumers face in their increasing use of credit for the purchase of goods and services. The solution for many consumer credit problems requires such complex regulations that the task of the legislative drafter is a formidable one. S. 914 is noteable in this regard, for it confronts some of the most difficult questions in this area and provides reasonable solutions.

While the bill covers a variety of important topics, I shall address only onethe provision in section 172 permitting credit card holders to assert against the card issuer claims and defenses which arise from transactions between the card holder and a merchant who has accepted the credit card. The background for my comments on this provision comes from a teaching and professional interest in commercial law generally and the law as it affects credit card relationships in particular. (See Weistart, Consumer Protection in the Credit Card Industry: Federal Legislative Controls, 70 Mich. L. Rev. 1475 [1972].) I am in basic agreement with the operation of section 172, although, as suggested below, some of the language of the section may warrant reconsideration.

1. THE RATIONALE FOR OPENING ISSUES TO CARDHOLDER CLAIMS

The justification for the provision opening issuers to cardholder claims and defenses can be seen when the section is viewed in the context of recent developments with respect to the holder in due course (HIDC) doctrine and the related matter of waiver of defenses clauses in consumer contracts. As applied in the typical non-credit card installment sales transaction, these doctrines permit banks and financial institutions to provide financing for transactions between consumers and merchants without accepting responsibility for defective merchandise or fraudulent selling tactics. The financing institution is able to achieve this insulated status despite the fact that it often plays an essential, and typically prearranged, role in the consummation of the arrangement. The net effect of this holder in due course concept is that consumers may be required to continue to pay the third-party creditor on a long-term installment obligation even though the consumer has not received what he bargain for in the underlying transaction with the merchant.

Dissatisfaction with the holder in due course notion has been evidenced at a number of levels. FTC rule-making proposals, recommendations of the National Commission on Consumer Finance, and a wide range of recent state statutes and decisions have had the object of limiting the operation of the doctrine. The cumulative effect of these developments is to leave little doubt that our legal institutions are prepared to question continued use of the doctrine as a means for diminishing the consumer's bargaining power. Many difficult questions must be dealt with before the optimal level of readjustment of the HIDC doctrine is reached. Nonetheless, it seems clear that we should be prepared to say that whatever may happen to the doctrine in traditional retail installment sales, it should not be lightly extended to new areas, such as credit card transactions. To do so is to fail to give credence to the general trend of developments in the consumer credit area.

A credit card issuer cannot be a holder in due course as such, since there is no negotiable instrument involved. Issuers have, however, attempted to claim the same degree of insulation by the use of language in the cardholder's agreement immunizing the credit card company from the cardholder's defenses. Section 172 can be viewed as an effort to confront the issue of whether issuers should be allowed to extend to the HIDC concept to the credit card area. In light of the sever impact of the doctrine on cardholder rights, Congress may reasonably conclude that protection of the interests of consumers requires that the credit-providing issuers not be permitted to assume a position of disinterest with respect to transactions between cardholders and merchants.

Thus, properly viewed, the purpose of the legislation is to prevent the HIDCrelated doctrine from growing beyond those transactions in which it has been historically applied. Credit card relationships are of relative recent origin, and it is appropriate that the legislature play an active role in influencing the manner in which they develop.

II. OBJECTIONS TO IMMUNIZING ISSUERS FROM CARDHOLDER CLAIMS

Even apart from general policy considerations, the case for opening issuers to consumer defenses can be stated more affirmatively. In considering the impact of the HIDC doctrine, its critics have raised a number of objections. The two most telling complaints concern, first, the potential frustration of the consumer's expectations and, second, the strain which the doctrine may place on the consumer's financial resources. Each of these concerns for the consumer position have application in the credit card area.

With respect to the first, it probably goes without saying that a consumer who enters a transaction for the purchase of goods expects that that which he purchases will be serviceable. Where the burden of payment is extended over a longterm, a relationship develops between the consumer's quality expectations and the obligation to continue paying on the goods. Where big-ticket items are involved the consumer is willing to make a long-term financial commitment because he believes that the financial burden is at least equal to the utility to be derived from the goods. Hence when goods prove to be defective, the consumer may reasonably believe that since he did not get what he paid for, his payment obligation should not continue. When he is forced to continue payments after the transaction has lost its anticipated utility, the consumer rightly feels that he was misled upon being induced into the purchase. The regulation in section 172 can be seen as an effort to make legal relationships in the credit card area comport with this reality of consumer expectations.

It will be noted that the section generally applies only to big-ticket purchasesthose over $50. These are likely to be the transactions in which the consumer perceives the long-term nature of the repayment burden. As has been adequately argued by others, small credit card transactions more closely resemble cash purchases. While a consumer, of course, has quality-expectations in cash purchases, the relationship arising from such a transaction is not as likely to be perceived as a continuing one. The consumer who uses his credit card to purchase a $200 television, for example, is likely to expect the product to last beyond the period of payment. In order to insure that this perception is not undermined, it is necessary to subject the financing agency-the card issuer-to complaints which arise as a result of the frustration of the consumer's quality-expectations.

The second objection to insulating third-party creditors from consumer defenses applies with equal force to credit card transactions. When the holder in due course doctrine is invoked, the creditor often points out that even though the consumer must pay for defective merchandise, he has a cause of action against the seller of the goods. This response overlooks the reality of the consumer's financial situation. Where a defective automobile is involved, for example, the consumer's budget often will not enable him to pay for the defective car while financing both alternative transportation and a law suit against the seller. While automobile purchases present the clearest examples of this liquidity problem, it is also present whenever a big-ticket item is involved, And where the item is one of necessity-major household appliances, for example the burden is most severe.

The effect of section 172 is to insure that this problem of liquidity-which has been a major source of concern in the traditional application of the HIDC doctrine is not allowed to develop with respect to credit card transactions. When the section is viewed in this perspective, the exemption for small transactions takes on particular significance. Since individual transactions involving small amounts do not represent the same degree of budgetary commitment, consistent adherence to the above policy requires that they be excluded.

Where the traditional methods of retail installment financing are involved, the holder in due course doctrine is often justified on the basis that the doctrine represents a long accepted commercial practice. Because the doctrine has become an ingrained attribute of the trade, it is suggested, its removal would seriously disrupt relationships established through years of operation of the credit market. A similar claim cannot be made in the area of credit card financing. Rather, the industry should be regarded as still very much in its infancy, particularly insofar as bank credit cards are concerned. While the practice of insulating the issuer from defenses appears to be quite standard in the industry, this can hardly be regarded as the result of the natural evolution of the market. Indeed, the issuer's claim to immunity shares the attribute which taints the HIDC doctrine in many traditional transactions: waiver of defense clauses have typically been hidden in fine print, non-negotiable credit card agreements. The widespread use of these devices hardly stands as unequivocal evidence of consumer acceptance of them.

III. COMMENTS ON THE TEXT OF SECTION 172

The basic operation of section 172 represents a reasonable legislative policy choice. Particular language in the section deserves comment, however. As suggested below, reconsideration and clarification of some language may be appropriate is some instances.

(a) Tort Claims.- Under the proposed section, card issuers would be subject to "all claims (other than tort claims)." A question can be raised as to whether the exception for tort claims does not unduly complicate the operation statute without achieving any clearly defined legislative purpose. The basic difficulty with the exception lies in the fact that the distinction between tort and contract claims is quite imprecise in many important respects. For example, fraud and misrepresentation in the sale of goods have both tort and contract aspects in many states. Thus, in the proper circumstances, a defrauded consumer could have separate actions in tort and contract. The statute would not bar the claim since it could stand as an independent non-tort action. In these states the exception adds confusion but accomplishes little. There is a risk, however, that some states might regard a particular claim of fraud or misrepresentation as essentially a tort claim. The effect of the statute in these jurisdictions would be to prevent the cardholder from raising his claim. But it is precisely this sort of defect-active misrepresentation in the sale of goodsfor which the statute should provide the cardholder a remedy.

Perhaps the tort exception was intended to preclude the cardholder from raising claims for personal injury, since "tort" claims are popularly thought to be of this sort. However, the exception will in fact not preclude personal injury claims in most cases. If defective goods produce an injury, the resulting claim will normally be remediable under a breach of warranty theory, which is regarded as contractual in nature. The basis for the warranty action can be found in sections 2-313, 2-314, and 2-315 of the Uniform Commercial Code. While claims framed in terms of strict tort liability doctrine might be barred, a careful choice of legal theories can avoid this result. But surely the statute is not intended to place a premium on technical forms of pleading.

The controversies which might arise over whether a particular claim is of a tortious or contractual nature do not promote any clear legislative policy, and to forestall these diversions, the tort exception should be eliminated.

(b) Cardholder's Good Faith Obligation.-The statute also requires that the consumer make a good faith effort to settle his complaint directly with the merchant who accepted the card. One might have doubts about how this requirement will operate in practice. Given the superior bargaining position of the card issuer, there might be situations in which the issuer rejects a cardenough in seeking restitution from the merchant. In addition, it is probably holder's claim by an arbitrary assertion that the cardholder had not done true that even without this provision most consumers would naturally go to the merchant first; this is the procedure which is generally understood as the normal method for registering complaints. If this is a correct perception of consumer behavior, then the exception is unnecessary for what will surely be the overwhelming majority of cases. The remaining cases may be so statistically insignificant that the countervailing concern for issuer abuse would justify elimination of the exception.

Nonetheless, the Committee can reasonably conclude that the exception should be retained. First, it serves to remove the force of the issuer's objection that the section will give rise to widespread cardholder abuses. While I regard this as a very dubious argument, the language of the statute disposes of it with finality. If it later develops that issuers are interpreting the requirement too stringently, I assume that the rule-making authority of the Federal Reserve Board under the Truth-in-Lending Act can be invoked to set specific requirements for a "good faith" effort. The Board might, for example, build on the approach of the California statute (Calif. Civil Code § 1747.90) and provide that the consumer has met his burden if he has asked the merchant in writing to make an appropriate adjustment.

(c) Exemption for Small Transactions.-As indicated above, I regard the exemption for small transactions in section 172(2) as of critical importance to the development of a sound regulatory scheme. In my testimony before the FTC. I left open the possibility that a dollar exemption greater than $50 might be appropriate. If one accepts the consumer's liquidity problem as providing the justification for the regulation, a limit of $75 or more might be considered. On the other hand, if the justification for the statute is seen in its protection