# Appendix — American Financial Services Ass'n v. Federal Trade Commission

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1986
- **Citation:** 475 U.S. 1011

## Text

e

BS i vf 96 ‘a Supreme Court, U.S,
FILED
No. 85- NOVY g (985
JOSEPH F. SPANMOL, JR.
IN THE CLERK

Supreme Court of the United States

OCTOBER TERM, 1985

AMERICAN FINANCIAL SERVICES ASSOCIATION,

y. Petitioner,
FEDERAL TRADE COMMISSION, et al.,
Respondents.
PETITIONER’S APPENDIX
On Petition for a Writ of Certiorari to
the United States Court of Appeals
for the District of Columbia Circuit
ROBERT B. EVANS WILLIAM H. ALLEN*
FRANK M. SALINGER DAVID H. REMES
American Financial Covington & Burling
Services Association 1201 Pennsylvania Ave., N.W.
1101 Fourteenth St., N.W. P.O. Box 7566
Washington, D.C. 20005 Washington, D.C. 20044
(202) 662-6000
Attorneys for American Financial
Services Association
November 8, 1985 *Counsel of Record

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TABLE OF CONTENTS

APPENDIX A —
Opinion of Court of Appeals:
IID \inicsasanenonidbinnedecuistammnahaasataneniambnailel

ENE NI ee cee Ge RUN EA TR ETT

APPENDIX B —
Credit Practices Rule, 16 C.F.R. Part 444 ............

APPENDIX C —

Statement of Basis and Purpose of Credit
Practices Rule, 49 Fed. Reg. 7740 (1984)!...........

APPENDIX D —

Letter from FTC to Senators Ford and Danferth,
Dec. 17, 1980 (1980 Policy Statement)?...............

APPENDIX E —

Letter from FTC to Senators Packwood and
Be, TAR B,, BI viccecsnanccnnccccrccsacncavcccnccsess

Page

la
66a

82a

87a

! Obvious typographical errors have been corrected. Citations to the
corresponding pages in the Federal Register are provided in brackets.

Citations to the corresponding pages in the original letter are provided in

brackets.

APPENDIX A

la
Notice: This opinion is subject to formal revision before publication
in the Federal Reporter or U.S.App.D.C. Reports. Users are requested

to notify the Clerk of any formal errors in order that corrections may be
made before the bound volumes go to press.

United States Cot of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

No. 84-1081

AMERICAN FINANCIAL SERVICES ASSOCIATION, PETITIONER
Vv.
FEDERAL TRADE COMMISSION, RESPONDENT
SILAS BROWN, et al.,

AMERICAN CONFERENCE OF
UNIFORM CONSUMER CREDIT CODE STATES, INTERVENORS

No. 84-1167

THE SOUTH CAROLINA DEPARTMENT OF
CONSUMER AFFAIRS, PETITIONER

Vv.
FEDERAL TRADE COMMISSION, RESPONDENT

AMERICAN CONFERENCE OF
UNIFORM CONSUMER CREDIT CODE STATES,
AMERICAN FINANCIAL SERVICES ASSOCIATION,
DEPARTMENT OF COMMERCE OF THE STATE OF MONTANA,
INTERVENORS

Petitions for Review of an Order of the
Federal Trade Commission

Bills of costs must be filed within 14 days after entry of judgment. The
court looks with disfavor upon motions to file bills of costs out of time.

2a

Argued February 22, 1985
Decided July 12, 1985

David H. Remes, with whom William H. Allen was on
the brief, for petitioner/intervenor American Financial
Services Association in Nos. 84-1081 and 84-1167.

Steven W. Hamm, with whom Philip S. Porter and
J.M. Edouard Mille were on the brief, for petitioner
South Carolina Department of Consumer Affairs in No.
84-1167. Philip S. Porter and J.M. Edouard Mille were
also on the brief for intervenor American Conference of
Uniform Consumer Credit Code States in Nos. 84-1081
and 84-1167.

Ernest J. isenstadt, Assistant General Counsel, Fed-
eral Trade Commission, with whom Howard E. Shapiro,
Deputy General Counsel, Federal Trade Commission was
on the brief, for respondent in Nos. 84-1081 and 84-1167.

J. Alan Galbraith, for intervenors Silas Brown, et ai.
in No. 84-1081. Charles Hill entered an appearance for
intervenors.

Francis X. Bellotti was on the brief, for Commonwealth
of Massachusetts, et al., amicus curiae, in Nos. 84-1081
and 84-1167. Rex Butler entered an appearance for
amicus curiae in No. 84-1081.

Edwin Lloyd Pittman was on the brief for the Com-
missioner of Banking and Consumer Finance of the State
of Mississippi, amicus curiae, in Nos. 84-1081 and 84-
1167.

R. Stuart Broom was on the brief for National Asso-
ciation of Consumer Credit Administrators, amicus
curiae, in Nos. 84-1081 and 84-1167.

Before: TAMM, WALD and EDWARDS, Circuit Judges.
Opinion for the Court filed by Circuit Judge Waxp.
Dissenting opinion filed by Circuit Judge TAMM.

3a

WALD, Circuit Judge: In these consolidated cases, the
petitioners, American Financial Services Association
(AFSA) and South Carolina Department of Consumer
Affairs (SCDCA) seek review of the Federal Trade Com-
mission’s (“the FTC” or “the Commission”) Trade Regu-
lation Rule on Credit Practices (“the Credit Practices
Rule” or “the Rule”), pursuant to section 18(e) of the
Federal Trade Commission Act (“the FTC Act”), 15
U.S.C. § 57a(e)(1)(A).1 After thorough consideration
of the record, we find the promulgation of the Credit
Practices Rule was within the Commission’s authority
wnder sections 5(a)(1) and 18(a)(1)(B) of the FTC
Act, that the Rule is supported by substantial evidence
in the record, and that the Rule does not effect an un-
lawful preemption of state law.

I. THE RULEMAKING AND PETITIONERS’ CHALLENGE

The “Sommission’s rulemaking on creditor remedies
originated as a result of two national studies of consumer
credit transactions. As part of the Consumer Credit Pro-
tection Act of 1968, Congress established the National
Commission on Consumer Finance and charged it with
conducting a study of consumer credit transactions in-
cluding an assessment of existing regulatory measures to
protect against unfair practices and to ensure the in-
formed use of consumer credit. The National Commis-

1 Petitioner AFSA is an association of over 550 consumer
finance and small-loan companies. Additional briefs in sup-
port of the petitioners were filed by intervenor Ameri-
can Conference of Uniform Consumer Credit Code States
(ACUCCS) and amici the National Association of Consunier
Credit Administrators and the Commissioner of Banking and
Consumer Finance of the State of Mississippi. Additional briefs
in support of the respondent were filed by intervenors Silas
Brown, Community Thrift Clubs, Inc. and the National Con-
sumer Law Center and amici the Attorneys General of Arkan-
sas, Illinois, Kentucky, Maine, Massachusetts, Michigan, Min-
nesota, New Mexico, New York, North Carolina, Ohio, Okla-
homa, Oregon, Rhode Island, Tennessee and Wisconsin.

4a

sion on Consumer Finance’s final report, based on an
extensive survey, identified a number of abusive prac-
tices and recommended curtailment of a variety of boiler-
plate provisions commonly found in consumer credit con-
tracts. See Consumer Credit in the United States, Re
port of the National Commission on Consumer Finance
(1972), Joint Appendix (“J.A.”) at 3 [hereinafter cited
as NCCF study]. Between 1972 and 1974, the FTC’s
Bureau of Consumer Protection also conducted an inves-
tigation of the consumer finance inaustry to determine
whether the use of certain collection remedies was an un-
fair practice within the meaning of section 5 of the FTC
Act. As a result of this investigation, the Bureau of Con-
sumer Protection recommended that the FTC propose a
trade regulation rule branding certain creditor remedies
as unfair trade practices. See Memorandum to Commis-
sion from Division of Special Projects, Bureau of Con-
sumer Protection, Creditor Remedies Project (April
1974), J.A. at 74 [hereinafter cited as Creditor Reme-
dies Project].

On April 11, 1975, the Commission published its initial
notice of rulemaking on consumer credit practices.
Credit Practices Rule, 40 Fed. Reg. 16,347 (1975). The
initial notice of rulemaking proposed a rule proscribing
or restricting the use of eleven creditor practices or rem-
edies: confessions of judgment; waivers of exemptivn;
wage assignments; security interests in household goods;
cross-collateralization; blanket security interests; resale
of repossessed collateral; imposition of attorneys’ fees in
connection with debt collection; pyramiding of late
charges; third party contacts; and co-signer liability.
Following the comment and hearing stages of the rule-
making,? reports were prepared and submitted to the

2 Numerous written comments were received through Au-
gust 5, 1977. Included among the commenters were banks,
finance companies, retailers, credit unions, savings and loan
associations, various trade associations, legal aid attorneys,

OO

5a

Commission by the Presiding Officer, see Report of the
Presiding Offcer on Proposed Trade Regulation Rule:
Credit Practices (August 1978), J.A. at 330 [herein-
after cited as P.O. Report], and by the Commission staff,
see Credit Practices: Staff Report and Recommendation
on Proposed Trade Regulation Rule (August 1980), J.A.
at 704 [hereinafter cited as Staff Report}. The publica-
tion of the Staff Report triggered a 60-day comment
period, see 16 C.F.R. §1.18(h) (1985), which was ex-
tended until January 16, 1981. On April 14, 1983, the
rulemaking staff’s memorandum recommending a final
modified proposed rule and memoranda from the Com-
mission’s Bureau of Economics and Bureau of Consumer
Protection were placed on the public record.* Prior rule-

consumer groups, governmental entities, and consumers.
Banks and saving and loan institutions while not subject to
the FTC’s regulatory jurisdiction, nonetheless submitted com-
ments because they are affected by the Credit Practices Rule.
The Federal Reserve Beard and the Federal Home Loan Bank
Board are required to promulgate rules applicable to banks
and saving and loan associations that are “substantially
similar” to the FTC’s rule within 60 days after the FTC’s rule
takes effect unless the Boards affirmatively find that the
covered practices are not unfair or deceptive, or find that the
rule would “seriously conflict with essential monetary and
payments systems policies.” See 15 U.S.C. § 57a(f) (1). The
Federal Reserve Board published a “substantially similar”
credit practices rule on May 8, 1985. See 50 Fed. Reg. 19,325
(1985) (to be codified at 12 C.F.R. pt 535).

A final notice of rulemaking was published on June 24, 1977,
42 Fed. Reg. 32,259 (1977), setting forth a schedule of public
hearings and enumerating 14 issues for consideration desig-
nated by the Presiding Officer pursuant to 16 C.F.R. § 1.138
(d) (1) (1985). The hearings were conducted between Sep-
tember 12, 1977, and January 30, 1978, in Dallas, Texas,
Chicago, Illinois, San Francisco, California, and Washington,
D.C. Rebuttal submissions were then received until May 1,
1978.

’ See Memorandum to the Commission from Division of
Credit Practices (July 20, 1981) (Staff’s Final Recommenda-
tions on the Proposed Credit Practices Trade Regulation Rule),

alse

6a

making participants were invited to present their views
orally directly to the Commission on June 6 and 7, 1983.
On June 13, 1983, the Commission met to consider
whether to promulgate a rule and what form the rule
should take. The Commission rejected several provisions
of the rule and modified others.* On July 20, 1983, the
Commission tentatively adopted, by unanimous vote, the
revised proposed rule. The final rule was published on
March 1, 1984, to become effective March 1, 1985. Credit
Practices Rule, 49 Fed. Reg. 7740 (1984) (codified at 16

J.A. at 1581 [hereinafter cited as Staff’s Final Recommenda-
tions]; Memorandum to Commission from Timothy Muris,
Director of Bureau of Consumer Protection (April 4, 1983)
(“Muris Memorandum’), J.A. at 1823; Memorandum to Com-
mission from Richard Higgins, Deputy Director of Bureau of
Economics (April 5, 1983) (“Higgins Memorandum’), J.A.
at 1876; Memorandum to Commission from Division of Con-
sumer Protection, Bureau of Economics (April 7, 1983), J.A.
at 1892 [hereinafter cited as Bureau of Economics Finai
Recommendations] ; Memorandum to Commission from Wendy
Lee Gramm, Director of Bureau of Economics (April 7, 1983)
(“Gramm Memorandum”’), J.A. at 1932.

* The Commission rejected draft provisions governing the
resale of repossessed collateral, the imposition of attorneys’
fees in connection with debt coilection, a practice known as
cross collateralization, and creditor contacts with third parties.
See 40 Fed. Reg. 16,347 (April 11, 1975) (originally proposed
rule, relevant sections to be codified at 16 C.F.R. § 444.2(a) (5),
(7), (8), (10) ); see also 49 Fed. Reg. at 7783-87 (explaining
rejection of provisions relating to resale of repossessed col-
lateral and third party contacts) ; Staff Report, J.A. at 965-
1182, 1195-1237 (discussing objections tc proposed provisions
ultimately rejected). The household goods provision was
substantially modified to provide a narrow definition of house-
hold goods covering only “common household necessities’ and
to make clear that the provision only applied to non-possessory
security interests. See 49 Fed. Reg. at 7767-68. The scope of
the original wage assignment provision was similarly nar-
rowed to exclude from its coverage revocable wage assign-
ments, preauthorized payroll deduction plans, and already
earned wages. In addition a definition of “earnings” was
added. See 49 Fed. Reg. at 7760-61.

Ta

C.F.R. pt 444). In sum, the Credit Practices Rule was
painstakingly considered and significantly modified in re-
sponse to the extensive comments and recommendations
received during this long rulemaking proceeding.

The Credit Practices Rule as finally promulgated con-
tains provisions relating to the following creditor rem-
edies: confessions of judgment; wage assignments; secu-
rity interests in household goods; waivers of exemption;
pyramiding of late charges; and cosigner liability. Peti-
tioners, as a whole, specifically challenge the provisions
relating to wage assignments and security interests in
household goods. The challenged provisions read in perti-
nent part:

(a) In connection with the extension of credit to
consumers in or affecting commerce, as commerce is
defined in the Federal Trade Commission Act, it is
an unfair act or practice within the meaning of Sec-
tion 5 of that Act for a lender or retail installment
seller directly or indirectly to take or receive from
a consumer an obligation that:

(3) Constitutes or contains an assignment of
wages or other earnings unless:

(i) The assignment by its terms is revocable at
the will of the debtor, or

(ii) The assignment is a payroll deduction plan
or preauthorized payment plan, commencing at the
time of the transaction, in which the consumer au-
thorizes a series of wage deductions as a method
of making each payment, or

(iii) The assignment applies only to wages or
other earnings already earned at the time of the
assignment.

(4) Constitutes or contains a nonpossessory se-
curity interest in household goods other than a pur-
chase money security interest.

8a

16 C.F.R. §$ 444.2(a) (3)-(4). Household goods are de
fined as:

(i) ... Clothing, furniture, appliances, one radio
and one television, linens, china, crockery, kitchen-
ware, and personal effects (including wedding rings)
of the consumer and his or her dependents, provided
that the following are not included within the scope
of the term “household goods”:

(1) Works of art;

(2) Electronic entertainment equipment (except
one television and one radio) ;

(3) Items acquired as antiques; and
(4) Jewelry (except wedding rings).

(j) Antique. Any item over one hundred years
of age, including such items that have been re
paired or renovated without changing their original
form or character.

16 C.F.R. § 444.1 (i)-(j).

A non-purchase, non-possessory security interest in
household goods (“HHG security interest”) allows the
creditor to seize and sell the debtor’s household goods
upon default without a judgment or court order. Sim-
ilarly, a wage assignment allows the creditor to file the
assignment with the debtor’s employer and receive all
or part of the debtor’s wages until the debt is satisfied
without first obtaining a court judgment. The Commis-
sion found that both these creditor remedies were “un-
fair’ because they cause substantial and unavoidable
injury to consumers which is not outweighed by counter-
vailing benefits to consumers or competition. Petitioners
argue that the Rule is beyond the Commission’s section
5 authority to proscribe unfair practices because in the
absence of seller overreaching in the form of deceit,
coercion or nondisclosure of material information, the
FTC may not intercede in the market as an “invisible
hand” to obtain “better bargains” for consumers.

9a

&

The petitioners’ challenges to the household goods and
wage assignment provisions of the Credit Practices Rule
raise the following issues °:

5 Petitioner AFSA argues that even if the challenged pro-
visions of the Rule are found ’» be valid exercises of, FTC
authority, the court should still remand the Rule for further
consideration in light of changes which have occurred in the
consumer credit market since the bulk of the rulemaking
record was compiled. AFSA Brief at 71-74 (citing the enact-
ment of the Bankruptcy Reform Act of 1978; the increase
in use of second mortgages for ncn-housing related loans; the
emergence of banks as a stronger competitor in the consumer
credit market; and the deregulation of state interest rate
ceilings). Courts generally are reluctant to base a remand on
the ground that the evidence has grown stale. American
Optometric Ass’n v. FTC, 626 F.2d 896, 906-07 (D.C. Cir.
1980) (remand warranted due to intervening Supreme Court
decision while judicial review of rule was pending). In Ameri-
can Optometric, this court recognized that the equities of a
situation may militate in favor of a remand “ ‘where there
has been a change in circumstances .. . that is not merely
“material” but rises to the level of a change in “‘core” circum-
stances, the kind of change that goes to the very heart of the
case.’” 626 F.2d at 907 (quoting Greater Boston Television
Corp. v. FCC, 463 F.2d 268, 283 (D.C. Cir. 1971), cert. denied,
406 U.S. 950 (1972)). AFSA has cited no “core” change in
circumstances which go to “the very heart of the case.” In
fact, AFSA acknowledges that none of the intervening develop-
ments cited provide any “decisive answers” to the Commis-
sion’s stated justifications for the Rule. ‘FSA Brief at 73.
AFSA merely asserts that if the purporteu effects of the new
developments were confirmed as true then certain portions of
the FTC’s reasoning may be undercut. On the other hand,
the effects of the new developments cited may bolster the Com-
mission’s reasoning. See FTC Brief at 70-71. Moreover, th that “the rule is not intended to occupy
the field of creuit regulation or to preempt state law in
the absence of requirements that are inconsistent with
the rule.” 49 Fed. Reg. at 7783.

In the Statement of Basis and Purpose for the Credit
Practices Rule the Commission states:

The rule has been drafted to be as consistent with
existing state laws as possible. Indeed, state laws
served as the model for several rule provisions. The
rule prohibits practices that are authorized by stat-
ute or common law in at least some states. However,
none of the rule provisions preempts state law by
creating an irreconcilable conflict. That is, creditors

64a

will be able to comply with both state law and this
rule.

Id. at 7782 (footnote omitted) (emphasis in original).
The Commission further included in the Rule an ex-
emption provision whereby states that offer protections
equal to or greater than the Rule can obtain an exemp-
tion from the Rule. See 16 C.F.R. § 444.5. With respect
to the weight to be given the exemption provision, the
Fourth Circuit, upholding the FTC’s authority to promul-
gate the Funeral Rule despite state regulation of funeral
homes, noted:

Furthermore, Congress explicitly considered this is-
sue, and provided in Section 19(d) of the Federal
Trade Commission Improvements Act of 1980...
that the existence of state regulation was no barrier
to a funeral rule as long as the rule allowed any
state to obtain an exemption for its funeral homes
by adopting laws that provide protection substan-
tially similar toe the federal rule.

Harry and Bryant Co., 726 F.2d at 999. Cf. Peerless
Products, Inc. v. FTC, 284 F.2d 825, 827 (7th Cir. 1960)
(FTC “can restrain unfair business practices in inter-
state commerce even if the activities or industries have
been the subject to legislation by a state or even if the
intrastate conduct is authorized by state law.’’), cert.
dented, 365 U.S. 844 (1961) ).

The Commission in this proceeding considered and
modified the Rule to be as consistent with state laws as
possible, ** explicitly expressed its intent not to occupy the
field, and included a provision which allows states pro-
viding equal or greater protections to obtain an exemp-

“2 For example, the prohibition on the taking of wages as-
signments was modified to exclude wages already earned at
the time of the assignment to eliminate a potential problem in
California where certain creditors must take assignments of
earned wages to qualify as personal property brokers under
state law or to qualify for higher interest rates. See 49 Fed.
Reg. at 7760; see also id. at 7756-57, 7761-62.

65a

tion. Under these circumstances, we cannot agree with
petiticn»rs that the Commission has exceeded its author-
ity.
V. CONCLUSION
After carefully considering each of petitioners’ chal-
lenges, we conclude that the FTC has not exceeded its
authority to promulgate rules proscribing unfair prac-
tices under sections 5(a) and 18(a) of the FTC Act.
We further find upon a thorough consideration of the
record that the Commission’s decision to proscribe the
taking of HHG security interests and wage assignments
is supported by substantial evidence and not arbitrary,
capricious or an abuse of discretion. All other arguments
advanced by the petitioners, intervenors, and amici were
given due consideration and found to be unpersuasive.
Accordingly, AFSA’s and SCDCA’s petitions for review
are
Denied.

66a

TaMM, Circuit Judge, dissenting: The Commission’s
decision to ban security interests in household goods and
future earnings is in excess of its statutory authority
to regulate unfair trade practices. Although rational-
ized in terms of “market imperfection” and “consumer
choice,” the Commission’s action reflects nothing more
than its paternalistic judgment that lenders should not
extend credit to low-income consumers. Such a judgment
not only violates the approach to consumer protection
outlined in the Policy Statement but also will have the
practical effect of forcing needy consumers out of the
credit market. I therefore dissent.

I. INTRODUCTION

Two venerable principles of administrative law con-
trol the determination of whether the Commission has
exceeded its authority in this case. First, the words
“unfair trade practice” set forth a legal standard and
must, therefore, gain their final meaning from judicial
construction. FTC v. R. F. Keppel & Bro., Inc., 291 U.S.
304, 314 (1934). See also Office of Communication of
the United Church of Christ v. FCC, T07 F.2d 1418,
1423 (D.C. Cir. 1983) (“it is the quintessential function
of the reviewing court to interpret legislative delega-
tions of power and to strike down those agency actions
that traverse the limits of statutory authority’). In-
formed judicial construction of the statutory language
depends, however, upon “enlightenment gained from ad-
ministrative experience.” FTC v. Colgate Palmolive Co.,
380 U.S. 374, 385 (1965). Courts therefore traditionally
accord respect to an interpretation of a statute by the
agency charged with its execution. Red Lion Broadcast-
ing Co. v. FCC, 395 U.S. 367, 381 (1969) (such a con-
struction “should be followed unless there are compelling
indications that it is wrong, especially when Congress
has refused to alter the administrative construction”).
Thus, while we “give great weight to the Commission’s
conclusion,” FTC v. Cement Institute, 383 U.S. 688, 720

67a

(1948), “the final word is left to the courts.” Atlantic
Refining Co. v. FTC, 381 U.S. 357, 368 (1965). Cf.
FTC v. Colgate Palmolive Co, 380 U.S. at 385
(“{Whhile informed judic’ \1 determination is dependent
upon enlightenment gained from administrative experi-
ence, in the last analysis the words ‘deceptive practices’
set forth a legal standard and they must get their final
meaning from judicial construction.’’).

Second, for a reviewing court to determine whether
the Commission’s exercise of authority has “warrant in
the record” and “a reasonable basis in law,” Atlantic Re-
fining Co. v. FTC, 381 U.S. at 368, 369, the Commission
must, of course, articulate the reasons for the choices
made. These reasons can be supplied by neither appeli-
late counsel nor the court itself. The Commission’s de
cisionmaking must be tested by the basis upon which it
purports to rest; if the decisions made do not reasonably
conform to the policies expressed, the court may not
affirm. See SEC v. Chenery Corp., 318 U.S. 80, 95
(1948) (“[A]n administrative order cannot be upheld
unless the grounds upon which the agency acted in exer-
cising its powers were those upon which its action can
be sustained.”’).

II. THE DEFINITION OF “UNFAIR” IN THE
PoLicy STATEMENT

Application of these basic principles to this case be
gins with the Commission’s 1980 Policy Statement. Is-
sued in response to congressional concern over the ex-
tent of the Commission’s authority to regulate commerce,
the Statement provides an authoritative interpretation of
what trade practices can properly be regulated as un-
fair. The Statement outlines a market-oriented, non-
paternalistic test, conditioning Commission intervention
in the marketplace upon a finding of a market failure
that prevents consumers’ purchasing decisions from regu-
lating the market. Once a market failure is identified,

68a

the Commission may proseribe practices resulting there-
from that are “injurious in their net effects.”

Contrary to the majority’s suggestion,’ the Statement
can guide the court in resolving the issues raised by pe-
titioners in this case. Although it does not identify what
specific conduct constitutes unfair trade practices, the
Statement does establish limits to the “Commission’s dis-
cretion under its unfairness jurisdiction.” Federal Trade
Commission, Companion Statement to the Commission’s
Consumer Unfairness Jurisdiction 6. As the majority
recognizes, the principle limitation placed upon Commis-
sion authority is that it cannot, consistent with the Pol-
icy Statement, intervene merely because “it believes the
market is not producing the ‘best deal’ for consumers.”
Majority opinion (Maj. op.) at 46. Determining what
“deal” is best for consumers presumes that consumers
are unable, without the benevolent guidance of the fed-
eral bureaucracy, to make purchasing decisions for them-
selves. Such a paternalistic approach to consumer pro-
tection is “fundamentally incompatible with the liberal
assumption that each person is the best judge of his or
her own needs.” R. Reich, Toward a New Consumer
Protection, 128 U. Pa. L. Rev. 1, 14 (1979). The Com-
mission instead must “rely on consumer choice—the abil-
ity of individual consumers to make their own private
purchasing decisions without regulatory intervention—
to govern the market.” Policy Statement at 7. At the
same time, “certain types of seller conduct or market
imperfections may unjustifiably hinder consumers’ free

1The majority displays a remarkable ambivalence toward
the Policy Statement. The Statement, the majority promises
at one point, provides “tangible guideposts for review.”” Ma-
jority opinion (Maj. op.) at 18. It chooses, however, to ignore
these guideposts, finding instead that the Policy Statement
“falls short of providing any concrete guidance to the court in
resolving the issues raised by petitioners in this case,” id.
at 25, and offers no more than “an abstract definition of un-
fairness.” Id. at 24.

69a

market decisions and prevent the forces of supply and
demand from maximizing benefits and minimizing costs.”
Maj. op. at 33. In such instances of market failure, the
Commission may take corrective action “to halt some
form of seller behavior that . . . takes advantage of an
obstacle to the free exercise of consumer decisionmak-
ing.” Policy Statement at 7.

Because no market responds perfectly to consumer
choice, any market could conceivably be subject to whole-
sale Commission regulation. The reviewing court’s first
task, therefore, is to ensure that the Commission’s inter-
vention is a genuine response to a market failure “which
prevents free consumer choice from effectuating a self-
correcting market,” Maj. op. at 44, and not a disguised
attempt to impose a paternalistic purchasing decision
upon consumers. To perform this task adequately, the
court must insist that the Commission sufficiently under-
stand and explain the dynamics of the marketplace.
Furthermore, unless the Commission manifests an under-
standing of how the market responds to consumer choice,
it cannot measure the costs and benefits of Commission
intervention.

If the Commission has identified with sufficient clarity
the impediment that blocks the market’s natural alloca-
tion, it may be appropriate for the Commission to inter-
vene. Whether intervention is appropriate, and if so,
what form it should take, can only be answered by
weighing the costs and benefits of the Commission’s ac-
tion.?

2In reality, two closely related balancing tests must be
made. First, the Commission must determine whether the
specific trade practice involved actually harms consumers,
that is, whether it is “injurious in its net effects.” If the
benefits of the trade practice to the consumer do not outweigh
its costs, the trade practice is unfair. Even the prevention of
an unfair practice, however, may not justify federal interven-
tion. Thus, a second, more general, cost-benefit analysis must
be made: whether the unfair trade practice can be profitably

70a

III. APPLICATION OF THE UNFAIRNESS TEST

A. Market Failure or “Reasonably Avoidable Injury”

The Commission discusses market failure in terms of
what the consumer can “reasonably avoid”; if the con-
sumer can “reasonably avoid” the practice, there is no
market imperfection and, hence, no justification for in-
tervention. The most common example of an injury con-
sumers cannot “reasonably avoid” occurs when a seller
has failed to disclose a risk involved in the exchange.
Although the Commission states that the consumer’s
ability to shop and bargain for credit remedies is con-
stricted by fine print and technical language, it found
not only that consumers generally understand the con-
sequences of default,* but that more information would
not lead to different consumer decisions. 49 Fed. Reg.
at 7746-47. Moreover, while it is true that creditors
present standard form credit contracts on a take-it-or-
leave-it basis, everyone in this proceeding recognizes that
such contracts are the only efficient method of conducting
loan transactions. Jd.; Presiding Officer’s Report at 76,

regulated by the federal government. As the Commission
states in its Policy Statement, this includes an assessment of
the “burdens on society in general in the form of increased
paperwork, increased regulatory burdens on the flow of infor-
mation, reduced incentives to innovation and capital forma-
tion, and similar matters.” Policy Statement at 7. Further-
more, as we stated in American Optometric Ass’n v. FTC,
626 F.2d 896, 910 (D.C. Cir. 1980), “principles of federalism”
dictate deference by the Commission to “states’ exercise of
their police powers.” In measuring the general regulatory
burden, therefore, the disruptive effect federal regulation
would have upon stste regulatory schemes must be considered.

3In almost ninety percent of the loan contracts, the house-
hold goods taken as collateral are listed or the loan contract.
Presiding Officer’s Report at 157, J.A. at 489. In such in-
stances, the Commission notes, there is “little question either
that a security interest has been given or as to the scope of
the coverage.” 49 Fed. Reg. at 7762.

-
jla

J.A. at 410 (“It is, beyond doubt, absolutely necessary to
use form contracts in the interests of both creditors and
consumers. Without such aids the consumer credit mar-
ketplace could not function in a reasonably efficient man-
ner.”). Creditors, therefore, do not unfairly take advan-
tage of a market imperfection by imposing upon con-
sumers hidden risks. Discussion by the Commission and
the majority about standard form contracts and fine
print is thus empty rhetoric, completely irrelevant to the
market analysis.

Lacking any evidence of inadequate or undisclosed in-
formation that would distort consumer choice, the Com-
misison alternatively concludes that consumer choice is
restricted because consumers do not have access to stand-
ard form contracts that do not contain the provisions in
question. This conclusion rests on one of two premises—
one factually incorrect, the other theoretically bankrupt.

First, the Commission could mean that consumers gen-
erally do not have access to loan contracts without these
provisions. This is wrong as a matter of fact. Millians
of consumers acquire credit each year without pledging
any collateral. Millions more, forced to do business with
pawnbrokers or loan sharks, do not even have access to
loan contracts with these provisions. It is not simply
common sense and everyday experience, however, that
refutes the Commission’s finding. The Presiding Officer
found that “[{i]t was generally agreed that consumers
shopping among different classes of creditors would find
differences in terms offered by banks as opposed to
finance companies.” J.A. at 404 (emphasis added).

Second, the Commission could mean that high-risk con-
sumers do not have access to loan contracts that do not
contain these provisions. Some consumers, to be sure,
cannot avoid these provisions in loan contracts, so the
provisions may constitute, for those consumers, an “ob-
stacle to the free exercise of consumer decisionmaking.”
Policy Statement at 7. This phenomenon reflects a mar-

72a

ket failure, however, only if one is willing to accept the
proposition that the high-risk consumer should be free
to choose the same credit as the credit-worthy consumer.
Under the Commission’s reasoning, since not every driver
can choose the lowest insurance premium, by selling more
expensive automobile insurance to the high-risk driver,
the insurer takes advantage of an “obstacle to free
choice.” The only obstacle to free choice identified by
the Commission is the level of risk the borrower, like the
insured, brings to the transaction.

The Commission’s analysis of the credit marketplace
mocks the approach to consumer protection outlined in
the Policy Statement. In the Policy Statement, the Com-
mission asserts that the status quo is presumed to be
the product of a well-functioning market. In the Credit
Practices Rule, the Commission turns this presumption
on its head: it proceeds from an e@ priori vision of
the mix of options that would be available in a “well-
functioning market,” and, with little difficulty, concludes
that the existing market, which does not provide that mix,
is “imperfect.” As the majority recognizes, the Statement
prevents the Commission from intervening whenever “it
believes the market is not producing the ‘best deal’ for
consumers.” Maj. op. at 46. Yet this is precisely what
the Commission has done in this case. It simply identifies
a particular class of consumers (those who cannot avoid
loan contracts without security interests in household
goods and future earnings) and concludes that those con-
sumers ought to have access to credit without pledging
household goods—that is, those consumers ought to have
credit at a better price.

This is not to suggest that the credit marketplace re-
sponds perfectly to consumer choice. To justify its in-
tervention, however, the Commission must at least ration-
ally explain how the market fails to respond to con-
sumer choice. Allowing the Commission to intervene
when it does not know the “obstacle to free choice”

73a

essentially reverses the presumption that each person
is the best judge of his or her own needs. Such a pater-
nalistic approach to consumer protection is fundamentally
incompatible with the limits imposed upon the Commis-
sion’s authority in the Policy Statement.

B. The Cost-Benefit Analysis

The Policy Statement’s definition of “unfairness” pro-
vides that for an unavoidable consumer injury to be
unfair, “the injury must not be outweighed by any off-
setting consumer or competitive benefits that the sales
practice also produces.” Policy Statement at 6. Business
practices entail a mixture of costs and benefits for con-
sumers. Purchase money security agreements in auto-
mobiles, for example, can be a great cost to consumers
because, upon default, consumers must forfeit the auto-
mobile, in many circumstances a vital necessity, or face
costly refinancing agreements. The security agreements
cannot be deemed unfair, however, because the benefits
of the trade practice—making credit available to those
who wish to purchase automobiles—clearly outweigh the
costs.

The Commission makes two fatal errors in its cost-
benefit analysis of security interests in household goods.*
First, in measuring the costs of these security interests,
the Comuinission fails to separate the injury caused by
these creditor practices from the financial and emotional
hardships that inevitably accompany default. Second, in
evaluating the offsetting benefits of these provisions, the
Commission never squarely addresses the single critical
question: the extent to which the intended beneficiaries

* Much of the criticism leveled at the cost-benefit analysis of
household goods security interests also applies to the Com-
mission’s cost-benefit analysis of security interests in future
earnings. I do not specifically address the latter, however,
because the practice is already thoroughly regulated in the
states where it is commonplace. See 49 Fed. Reg. at 7756.

74a

of the Rule depend upon the ability to pledge b usehold
goods and future earnings to acquire credit.

1. Injury Caused by the Credit Practices

The Commission identifies several harms supposedly
“caused by” security interests in household goods. First,
household goods are necessities and forfeit of these neces-
sities causes harm to the consumer and his family. This
consequence of default, however, is not unique to secu-
rity interests in household goods. Household goods—
indeed houses themselves—can and will still be seized
under other permissible credit remedies, such as a home
mortgage or a purchase money security interest. More-
over, the Commission found that relinquishing household
possessions to a pawnbroker in exchange for credit is
not, in fact, “consumer injury.”* Thus, a lender may
hold a borrower’s television set from the time a loan is
made and keep it if the borrower defaults. According
to the Commission, this is not a consumer injury. If
the lender allows the borrower to use the television from
the time the loan is made and, in extremely rare cir-
cumstances,’ picks it up when the borrower defaults, he
engages in an “unfair” trade practice.

Second, the Commission states that the threat of losing
household goods increases the likelihood that debtors will
forego valid defenses. The credit practices still available
to creditors, particularly purchase money security inter-
ests, however, pose a far greater risk that debtors will
forego valid legal defenses. The creditor who sells defec-
tive household goods, for example, is subject to a much

5349 Fed. Reg. at 7767 (“[t]he record furnishes no evidence”
that giving a pawnbroker a possessory security interest
“cause[s} any injury’).

* As the Commission recognizes, defaults occur in only a
fraction of transactions, and actual seizure occurs in but a
“tiny fraction” of defaults. Brief for Respondent at 21; 49
Fed. Reg. at 7768.

75a

greater array of defenses than is the creditor who simply
loans money.

Third, the Commission states that the threat of repos-
session may cause the consumer to default improvidently
on other loans to avoid repossession of his household
goods. Defaulting on another loan, however, could only
be “improvident” if the creditor remedies of that other
loan were more onerous than the remedies threatened
by the creditor. If this other loan has more onerous
credit_. remedies, it is difficult to see the marginal cost
of these less onerous creditor provisions. If, on the other
hand, the creditor remedies under this other loan are
less onerous (a much more likely situation), it is not
unwise to default. Moreover, the recognition that the
threat of repossession may cause the debtor to choose to
default on another loan is fundamentally inconsistent
with the Commission’s entire notion of the causes of
consumer default. In determining whether the trade
practice is unavoidable, the Commission states that de
fault is beyond the debtor’s control. On the other hand,
in assessing the marginal cost of the trade practice, the
Commission assumes that consumers faced with repos-
session will deliberately default on a loan not so secured
to minimize their losses. The Commission cannot have
ic both ways.

Finally, the Commission states that the “unique”
threat of repossession of household goods causes con-
sumers to enter into costly refinance arrangements. The
Commission contends that these horrible agreements
“may reduce or defer monthly payments on a short-term
basis . . . at the cost of increasing the consumer’s total
long-term debt obligation.” Maj. op. at 29. See 49 Fed.
Reg. at 7764-65. A creditor, therefore. unfairly takes
advantage of a market imperfection by refusing to dis-
charge debtors’ contractual obligations unilaterally or by
refusing to lend more money free of charge. Until the
Commission can wish into being a world in which debtors

76a

do not owe money and the use of money is free, the
courts should require, I think, a less fatuous approach
to consumer protection.

The economic hardships that inevitably accompany in-
debtedness and default will remain despite the prohibi-
tion of these creditor remedies. The Commission, there-
fore, grossly exaggerates the beneficial impact of the
Rule. The Rule does not eliminate the need for credit,
does not provide debtors with any more cash with which
to discharge obligations, does not make default a less
likely occurrence, does not relieve the financial and
emotional hardships that accompany default, does not
insulate household necessities from forfeit, does not pro-
tect consumers from unscrupulous lenders intent in any
event upon breaking the law, and does not lessen the
compounding burden unpaid debts place upon debtors.

2. Offsetting Benefits

Security interests in household goods benefit consumers
to the extent that they enable consumers to acquire credit
without resorting to the pawnbroker or the loan shark.
The Commission, however, never squarely addresses
whether any consumers’ access to credit depends upon
their ability to pledge household goods as collateral.’

7 The majority seems to place great weight on the econo-
metric analysis conducted by various participants in the rule-
makings, evidence which “by all accounts, contains deficiencies
which prevent definitive answers.” Maj. op. at 57. In spite of °
these deficiencies, however, the majority insists that the evi-
dence revea!s that the Credit Practices Rule “would have only
a marginal impact on the cost or availability of credit.” Jd.
at 33. What is “marginal” apparently is in the eyes of the
beholder. The econometric studies revealed that the Credit
Practices Rule would cost in 1979 between $623 million and
$10.6 billion in increased interest rates. J.A. at 1528. I would
agree, however, that the Rule has a “marginal” impact on
credit availability: that is, those consumers currently at the
margin will be forced out of the credit marketplace.

77a

Instead, it evaluates the impact of the Rule—not upon
the high-risk consumer it purports to protect—but upon
the credit-worthy consumer who needs no protection from
these “abusive” credit practices in the first instance.

The Presiding Officer considered this question and
came to the following conclusion:

However, this record does support the conclusion
that the ability to take household goods as security
is of very great importance to finance company cred-
itors and that loss of this right would undoubtedly
have a very considerable impact on their operations
and upon the availability of credit to consumers.

Presiding Officer’s Report at 162, J.A. at 494 (emphasis
added). In a feeble attempt to weaken the force of the
Presiding Officer’s conclusions, the Commission states that
the definition of “household goods,” narrowed since the
Officer’s report, would address the problems of availabil-
ity. Thus, the Commission notes, under the new definition
of “household goods,” consumers may still pledge works
of art, antiques, jewelry, video tape recorders, home com-
puters, and the like. Similarly, the Commission puts
great stock in the finding that forty percent of finance
company clients are homeowners and therefore have other
assets to pledge. Furthermore, the Commission states,
banks, which seldom take security interests in household
goods or future earnings, remain available to the ecnsumer.

What happened to the high-risk consumer the Com-
mission so vividly describes when assessing the hardships
caused by the creditor remedies? That consumer owned
household goods of “little or no value.” He had no cash
with which to pay back the loan, no assets to liquidate
to prevent the forfeiture of household necessities or the
imposition of “costly refinancing arrangements.” In as-
sessing the impact of the Rule upon the availability of
credit, the Commission converts the distraught debtor into
a homeowner, able to acquire credit without pledging his

78a

household goods because he can always visit his suburban
bank or pledge his handy Matisse. The problem with the
Commission’s analysis is that the Rule unfortunately does
not make the poor rich, or the high-risk consumer credit
worthy. The Commission proves only that security in-
terests in household goods cost the high-risk consumer
more than they benefit the credit-worthy consumer.

Rather than address the Presiding Officer’s conclusions,
the Commission wishfuily insists that creditors should ex-
tend credit to low-income, high-risk consumers without
requiring from them security interests in household goods.
49 Fed. Reg. at 7766. Such security interests are of no
real value to the creditor, the Commission reasons, be-
cause they do not deter default. Default cannot be de-
terred by security interests because it flows from circum-
stances beyond the debtor’s control. This is nonsense on
stilts. First, according to the record, twenty-five to thirty
percent of defaulting debtors do so because of circum-
stances within their control. Five percent default because
of “debtor irresponsibility”: twenty-five percent because
of “voluntary overextension.” Jd. at 7748. The Com-
mission never considers, however, whether eliminating
these security interests would increase the number of
debtors who default because of “voluntary overextension”’
or “debtor irresponsibility.”

Second, even if every default occurred for reasons be-
yond the debtor’s control, the Commission’s conclusion
that security interests do not deter default is a mammoth
non sequitur. The Commission’s reasoning is this:
household goods security interests do not deter those who
default; therefore, by eliminating the security interest
the rate of default will not increase. By the Commis-
sion’s logic, the existence of criminal laws does not deter
those who violate the law. Can we therefore repeal the
criminal laws and expect no impact upon crime? Of
course not; just as we evaluate the impact of criminal
laws upon those who do not violate the law, so must we

79a

evaluate the impact of security interests upon those who
do not default. As the Commission found, a majority of
consumers face financial trauma that could result in a
default. 49 Fed. Reg. at 7748. Yet only a small number
of consumers actually default. 7d. This disparity is ex-
plained to some extent by the varying degrees of financial
trauma that individual consumers undergo. Unrebutted
evidence in the record and a healthy dose of common
sense also suggest, however, that the more equity a debtor
has in collateral the less likely he is to default. See Bu-
reau of Social Science Research, Federal Trade Commis-
sion Proposals for Credit Contract Regulations and the
Availability of Consumer Credit 129, J.A. at 1518 (the ratio
of the value of collateral to the size of the loan “‘is the
principle determinant of the probability of default”). If,
as common sense and record evidence suggest, security
interests in household goods do deter default, lenders will
rationally refuse to extend credit to at least some con-
sumers who have no other assets to pledge. See Presid-
ing Officer’s Report 162, J.A. at 494 (elimination of house-
hold goods security interests “would undoubtedly have a
very considerable impact . . . upon the availability of
credit”). Derailed by its faulty logic, the Commission
never makes the critical finding of how many low-income
consumers, the intended beneficiaries of the Rule, will be
unable, because of the Credit Practices Rule, to obtain
credit.
IV. CONCLUSION

The flaws in the Commission’s analysis form an in-
triguing pattern, a pattern resulting from the imperfect
superimposition of the “market failure’ and “consumer
choice” rationale upon a simple, paternalistic judgment:
those whose access to credit depends upon the pledge of
meager household goods and future earnings would be
better off if creditors were unable and unwilling to ex-
tend to them credit. If this is the rationale underlying
the Rule, most, if not all, inconsistencies in logic and
shortcomings in evidence disappear. The imperfections

80a

of the marketplace need not be understood because it is
not the obstacle to free choice that the Commission wishes
to prevent but the free exercise thereof. Similarly, the
harms caused by these practices need not be separated
from the harms that inevitably accompany default be-
cause, if excluded from the credit marketplace altogether,
these consumers will avoid not only these security inter-
ests but also all the other attendant hardships of default.
Consumers who do not seek credit will, of course, avoid
“costly refinance agreements” and never default “im-
providently” on other loans. The Commission need not
evaluate the pact of the Rule upon the intended bene-
ficiary because the intended beneficiary, in its benevolent
judgment, should not be seeking credit in the first in-
stance.

The consumer law specialists involved in this case have
at least been forthright in their support of the Credit
Practices Rule. People who must pledge household goods
or future earnings to acquire credit, they testified, would
be better off without credit. Presiding Officer’s Report at
162, J.A. at 484. Although held with genuine compassion,
this belief cannot form the basis for the decision. First,
it assumes that government intervention will eliminate
the need for credit and that these people will not find
credit elsewhere. Credit will be made available to them,
however, by the pawnbroker or, worse, the loan shark,
whose “creditor remedies” are infinitely more severe than
those banned by the decision. Second, “these people’ are
not children. To suggest that “they” are incapable of
making such decisions for themselves replaces healthy re-
spect for the choice of the individual with unwarranted
confidence in the wisdom of those who happen to be in
power. Aware that such an approach to consumer pro-
tection is antagonistic to the basic principles outlined in
the Policy Statement submitted to Congress, the Commis-
sion has couched its purely paternalistic judgment in
terms of the market failure and cost-benefit analysis
with enough skill to sneak past a court anesthetized by

8la

a misplaced deference to agency authority. If judicial
review is to have any meaning, however, agency action
must be tested by the basis upon which it purports to
rest and not by an agenda hidden from the court. See
SEC v. Chenery Corp., 318 U.S. 80, 95 (1943). Tested
against the approach to consumer protection outlined in
the Policy Statement, the Commission’s decisionmaking
must fail. I therefore respectfully dissent.

APPENDIX B

82a

16 C.F.R. PART 444 CREDIT PRACTICES
§ 444.1 Definitions.

(a) Lender. A person who engages in the business of lend-
ing money to consumers within the jurisdiction of the Federal
Trade Commission.

(b) Retail installment seller. A person who sells goods or
services to consumers on a deferred payment basis or pursu-
ant to a lease-purchase arrangement within the jurisdiction of
the Federal Trade Commission.

(c) Person. An individual, corporation, or other business
organization.

(d) Consumer. A natural person who seeks or acquires
goods, services, or money for personal, family, or household
use.

(e) Obligation. An agreement between a consumer and a
lender or retail installment seller.

(f) Creditor. A lender or a retail installment seller.

(g) Debt. Money that is due or alleged to be due from one
to another.

(h) Earnings. Compensation paid or payable to an indi-
vidual or for his or her account for personal services rendered
or to be rendered by him or her, whether denominated as
wages, salary, commission, bonus, or otherwise, including
periodic payments pursuani to a pension, retirement, or disa-
bility program.

(i) Household goods. Clothing, furniture, appliances, one
radio and one television, linens, china, crockery, kitchenware,
and personal effects (including wedding rings) of the con-
sumer and his or her dependents, provided that the following
are not included within the scope of the term “household
goods”:

(1) Works of art;

83a

(2) Electronic entertainment equipment (except one
television and one radio);

(3) Items acquired as antiques; and
(4) Jewelry (except wedding rings).

(j) Antique. Any item over one hundred years of age,
including such items that have been repaired or renovated
without changing their original form or character.

(k) Cosigner. A natural person who renders himself or
herself liable for the obligation of another person without
compensation. The term shall include any person whose sig-
nature is requested as a condition to granting credit to
another person, or as a condition for forbearance on collection
of another person's obligation that is in default. The term
shall not include a spouse whose signature is required on a
credit obligation to perfect a security interest pursuant to
state law. A person who does not receive goods, services, or
money in return for a credit obligation does not receive com-
pensation within the meaning of this definition. A person is a
cosigner within the meaning of this definition whether or not
he or she is designated as such on a credit obligation.

§ 444.2 Unfair credit practices.

(a) In connection with the extension of credit to consumers
in or affecting commerce, as commerce is defined in the Fed-
eral Trade Commission Act, it is an unfair act or practice
within the meaning of Section 5 of that Act for a lender or
retail installment seller directly or indirectly to take or
receive from a consumer an obligation that:

(1) Constitutes or contains a cognovit or confession
of judgment (for purposes other than executory process
in the State of Louisiana), warrant of attorney, or other
waiver of the right to notice and the opportunity to be
heard in the event of suit or process thereon.

(2) Constitutes or contains an executory waiver or a
limitation of exemption from attachment, execution, or

84a

other process on real or personal property held, owned
by, or due to the consumer, unless the waiver applies
solely to property subject to a security interest executed
in connection with the obligation.

(3) Constitutes or contains an assignment of wages or
other earnings unless:

(i) The assignment by its terms is revocable at the
will of the debtor, or

(ii) The assignment is a payroll deduction plan or
preauthorized payment plan, commencing at the time
of the transaction, in which the consumer authorizes a
series of wage deductions as a method of making each
payment, or

(iii) The assignment applies only to wages or other
earnings already earned at the time of the assignment.

(4) Constitutes or contains a nonpossessory security
interest in household goods other than a purchase money
security interest.

§ 444.3 Unfair or deceptive cosigner practices.

(a) In connection with the extension of credit to consumers
in or affecting commerce, as commerce is defined in the Fed-
eral Trade Commission Act, it is:

(1) A deceptive act or practice within the meaning of
Section 5 of that Act for a lender or retail installment
seller, directly or indirectly, to misrepresent the nature
or extent of cosigner liability to any person.

(2) An unfair act or practice within the meaning of
Section 5 of that Act for a lender or retail installment
seller, directly or indirectly, to obligate a cosigner unless
the cosigner is informed prior to becoming obligated,
which in the case of open end credit shall mean prior to
the time that the agreement creating the cosigner’s liabil-
ity for future charges is executed, of the nature of his or
her liability as cosigner.

85a

(b) Any lender or retail installment seller who complies
with the preventive requirements in paragraph (c) of this
section does not violate paragraph (a) of this section.

(c) To prevent these unfair or deceptive acts or practices, a
disclosure, consisting of a separate document that shall con-
tain the following statement and no other, shall be given to
the cosigner prior to becorning obligated, which in the case of
open end credit shall mean prior to the time that the agree-
ment creating the cosigner’s liability for future charges is
executed:

NOTICE TO COSIGNER

You are being asked to guarantee this debt. Think
carefully before you do. If the borrower doesn’t pay
the debt, you wi’ have to. Be sure you can afford to
pay if you have to, and that you want to accept this
responsibility.

You may have to pay up to the full amount of the
debt if the borrower does not pay. You may also have
to pay late fees or collection costs, which increase
this amount.

The Creditor can collect this debt from you with-
out first trying to collect from the borrower. The
creditor can use the same collection methods against
you that can be used against the borrower, such as
suing you, garnishing your wages, etc. If this debt is
ever in default, that fact may become a part of your
credit record.

This notice is not the contract that makes you
liable for the debt.

§ 444.4 Late charges.

(a) In connection with collecting a debt arising out of an
extension of credit to a consumer in or affecting commerce, as
commerce is defined in the Federal Trade Commission Act, it
is an unfair act or practice wihin the meaning of Section 5 of
that Act for a creditor, directly or indirectly, to levy or collect

86a

any deliquency charge on a payment, which payment is other-
wise a full payment for the applicable period and is paid on its
due date or within an applicable grace period, when the only
delinquency is attributabie to late fee(s) or delinquency
charge(s) assessed on earlier installment(s).

(b) For purposes of this section, “collecting a debt’ means
any activity other than the use of judicial process that is
intended to bring about or does bring about repayment of all
or part of a consumer debt.

§ 444.5 State exemptions.

(a) If, upon application to the Federal Trade Commission
by an appropriate state agency, the Federal Trade Commis-
sion determines that:

(1) There is a state requirement or prohibition in
effect that applies to any transaction to which a provision
of this rule applies; and

(2) The state requirement or prohibition affords a
level of protection to consumers that is substantially
equivalent to, or greater than, the protection afforded by
this rule;

Then that provision of the rule will not be in effect in that
state to the extent specified by the Federal Trade Commis-
sion in its determination, for as long as the state administers
and enforces the state requirement or prohibition effectively.

APPENDIX C

87a

FEDERAL TRADE COMMISSION

16 CFR Part 444

Trade Regulation Rule; Credit Practices
AGENCY: Federal Trade Commission.
ACTION: Final trede regulations rule.

SUMMARY: The Federal Trade Commission issues a
final rule, the purpose of which is to restrict certain remedies
used by lenders and retail installment sellers in consumer
credit contracts. The remedies affected by this rule are: Con-
fessions of judgment, waivers of exemption, wage assign-
ments, security interests in household goods, and certain late
charges. The rule further prohibits misrepresentations of
cosigner liability and provides that potential cosigners be
furnished a “Notice to Cosigner” which explains in general
terms their obligations and liabilities.

This notice contains the rule’s Statement of Basis and Pur-
pose, incorporating a Regulatory Analysis, and the text of the
final rule.

EFFECTIVE DATE: March 1, 1985.

ADDRESS: Requests for copies of the rule, the Statement
of Basis and Purpose and Regulatory Analysis should be sent
to Public Reference Branch, Room 130, Federal Trade Com-
mission, 6th Street and Pennsylvania Avenue, N.W., Wash-
ington, D.C. 20580.

FOR FURTHER INFORMATION CONTACT: Christopher
W. Keller, Division of Credit Practices, Bureau of Consumer
Protection, Federal Trade Commission, Washington, D.C.
20580 (202) 724-1580.

SUPPLEMENTARY INFORMATION:

List of Subjects in 16 CFR Part 444

Consumer credit contracts, Cosigner disclosures, Trade
practices, Truth in lending.

By direction of the Commission. Commissioner Calvani did
not participate.

Dated: February 17, 1984.

Benjamin I. Berman,
Acting Secretary.

88a

CREDIT PRACTICES RULE; STATEMENT OF BASIS
AND PURPOSE AND REGULATORY ANALYSIS

I. History of the Proceeding
A. Introduction

This proceeding focuses on the relationship between con-
sumers and the institutions from whom they seek and obtain
credit for purposes other than -.e purchase of real estate. It
originated as a result of: (1) An extensive survey conducted by
the National Commission on Consumer Finance which
examined the consumer credit market and reached a variety
of conclusions based upon empirical data and econometric
analysis;! and (2) an investigation of the consumer finance
industry conducted by the Bureau of Consumer Protection
from the Fall of 1972 until the Spring of 1974, to determine
whether the use of certain collection remedies was an unfair
practice under Section 5 of the FTC Act.?

The Commission published an Initial Notice of Rulemak-
ing in the Federal Register on April 11, 1975. Written com-
ments were received through August 5, 1977. Comments were
received from industry, consumers, legal services, state attor-
neys general, labor unions, consumer organizations and other
interested parties. A Final Notice of Rulemaking was pub-
lished on June 24, 1977, setting forth the time and places for
public hearings on the proposed rule and enumerating 14
issues which the Presiding Officer designated under
§ 1.13(d)(1) of the Commission’s Rules of Practice. Hearings

1 “Consumer Credit in the United States,” Report of the National Com-
mission on Consumer Finance (1972).

2 Memorandum to Commission dated April 19, 1974.

3 40 FR 10347. This Notice contained a Statement of Reason for the
Proposed Rule which set forth the legal theory applied to the acts and
practices at issue in the proceeding, as well as a list of 12 questions which
the Commission deemed particularly pertinent and upon which comment
was specifically invited.

4 42 FR 32281, June 24, 1977.

89a

were conducted in Dallas, Texas; Chicago, Ltilinois; San Fran-
cisco, California; and Washington, D.C., from September 12,
1977, to January 30, 1978. Rebuttal submissions were
received until May 1, 1978.

The written comments, the materials placed on the record
by the Presiding Officer and the Commission staff, the hear-
ing transcripts and exhibits, and the rebuttal statements
comprise the principal evidentiary record of this proceeding.
After the receipt of rebuttal statements, reports to the Com-
mission based on the rulemaking record were prepared by the
Presiding Officer,5 who made findings on designated issues,
and by the Commission staff,® who summarized and analyzed
the record evidence and made recommendations to the Com-
mission for a revised Trade Regulation Rule. The Bureau of
Economics also submitted comments and recommendations
to the Commission for a revised rule.’

Pursuant to § 1.13(h) of the Commission’s Rules of Prac-
tice, publication of the Final Staff Report initiated a sixty-
day comment period which afforded the public an opportu-
nity to comment on the reports of the Presiding Officer and
the staff. This comment period was extended and closed on
January 16, 1981. A summary of post-record comments was
placed on the public record.

On April 14, 1983, the rulemaking staff's memorandum
recommending a final modified proposed rule, and memo-
randa from the staff of the Bureau of Economics, and the
Directors of the Bureaus of Consumer Protection and Eco-
nomics were placed on the public record. On June 6 and 7,
1983, the Commission heard oral presentations from prior

5 Report of the Presiding Officer on Proposed Trade Regulation Rule:
Credit Practices, August 11, 1978 (hereinafter cited as “Presiding Officer’s
Report”’).

6 Credit Practices Staff Report and Recommendation on Proposed
Trade Regulation Rule 16 CFR Part 444, August 1980 (hereinafter cited as
“Staff Report”). .

7 Memorandum by Edward Manfield, Bureau of Economics, August 18,
1980.

90a

rulemaking participants who had been invited to present
their views directly to the Commission as provided in § 1.13(i)
of the Commission’s Rules, 16 CFR 1.13(i).®

On June 13, 1983, the Commission met to consider whether
to adopt a final rule, and if so, what form the rule should take.
Although as to the rule as a whole no final determination was
made during that meeting, the Commission deleted the provi-
sions of the staff proposed rule concerning attorneys’ fees and
deficiency balances and directed the staff to draft proposed
disclosures for the remaining provisions of the rule. The Com-
mission further directed the staff to draft alternative propos-

als for a limitation on household goods security interests and
third party contacts. The staff was instructed to draft a modi-
fied disclosure for cosigners. The Commission indicated ten-
tative support for a ban on confessions of judgment and wage
assignments. The Commission further indicated support for
the late [7741] charges provision subject to clarification of the
language to focus more clearly on the “pyramiding” problem.

On July 20, 1983, the Commission tentatively adopted the
portions of staff’s revised proposed rule banning confessions
of judgment, waivers of statutory property exemptions, wage
assignments, pyramiding late charges and blanket security

8 The participants were Commonwealth of Massachusetts, Department
of the Attorney General; Credit Union National Association, Inc.; the Legal
Aid Society of Cleveland; Professors James Barth and Anthony Yezer,
George Washington University; National Automobile Dealers Association;
American Financial Services Association. (Throughout the major portic
of the proceeding this organization was denominated National Consumer
Finance Association (NCFA) and will be so termed in relevant citations in
this statement); Consumer Federation of America; George Wallace, Rutgers
School of Law; Federal Reserve Board; American Retail Federation and
National Retail Merchants Association; New Orleans Legal Assistance
Corp.; Consumer Bankers Assoc., American Bankers Association, Califor-
nia Bankers Association, and Independent Bankers Association of
America; National Consumer Law Center; and Legal Assistance Founda-
tion of Chicago.

9la

interests in household goods. The Commission also tenta-
tively adopted staff’s revised proposal requiring that poten-
tial cosigners be furnished with a “Notice to Cosigner” which
explains their obligations and liability. The Commission
rejected the provisions of the proposed rule pertaining to
third party contacts and cross collateralization. The Commis-
sion determined that the effective date of the rule is to be one
year from the date of promulgation.

B. Nature of Evidence on the Record

Publication of the proposed Credit Practices Trade Regu-
lation Rule was preceded by a two-year investigation which
culminated in subpoena returns from 12 large national con-
sumer finance companies.? The subpoenaed material consists
of over 7,000 individual files on delinquent debtors"® and offi-
cial company operating manuals and training materials.

In response to the invitation to comment on the proposed
rule’! the Commission received over 1,300 written comments.
The comments are divided as follows by source: Banks (475);
bank trade associations (19); finance companies (169); finance
company trade associations (46); retailers (103); retail trade
associations (8); credit unions (96); credit union trade
associations (9); savings and loan associations (11); savings

° These firms and debtor file record abbreviations are: Associates Finan-
cial Services (ASSOC), AVCO Financial Services (AVCO), Beneficial
Finance Corporation (BEN), CIT Financial Services (CIT), Credit Thrift
of America (CTA), Dial Financial Corporation (DIAL), General Electric
Credit Corp. (GECC), General Finance Corp. (GFC), General Motors
Acceptance Corp. (GMAC), Household Finance Corporation (HFC), Lib-
erty Loan Corporation (LIB) and Transamerica Financial Corporation
(TA).

10 Several tabulations of information from the files were prepared by
FTC staff and placed on the record. Because the staff collected files to
illustrate potential problems with creditors’ remedies, however, for most
statistical purposes other surveys on the record are superior. The primary
value of the files lies in the narrative information they contain.

11 See supra note 3.

92a

and loan trade associations (6); legal aid attorneys (117); con-
sumer groups (23); governmental entities (36); other organ-
ized groups (18); and miscellaneous, including individual
consumers (207). An additional 358 post-record comments
were received during the 1980-81 reopening for comments on
the Presiding Officer and Staff Reports.

Three hundred and nineteen witnesses appeared in ten
weeks of hearings held in Chicago, Dallas, San Francisco and
Washington from September 1977 through January 1978. The
interests they represented were: Finance companies and their
trade associations (95); banks and bank associations (25);
retailers and their associations (12); credit uniors and their
associations (8); legal services attorneys (67); governmental
entities (49); consumers and consumer groups (14); and mis-
cellaneous (15). In ail, 508 hearing exhibits were placed on the
record.

C. Consumer Credit Market

Approximately 70 percent of household indebtedness is in
the form of home mortgages; about 23 percent is in the form
of installment consumer credit.!2 About 5 percent of con-
sumer debt is noninstallment consumer credit, that is, 30 day
charge credit held by retailers, travel and entertainment com-
panies and single-payment loans at commercial banks for
consumer purposes.!* At the end of December 1981 total con-
sumer noninstallment credit amounted to $78.4 billion."

12 “Consumer credit” is defined by the Federal Reserve as “most short
and intermediate-term credit extended to individuals through regular busi-
ness channels, usually to finance the purchase of consumer goods and
services or to refinance debts incurred for such purposes, and scheduled to
be repaid (or with the option of repaying) in two or more installments.”
Board of Governors of the Federal Reserve System, Federal Reserve Statis-
tical Release, G. 19 (Feb. 10, 1978).

13 NCFA 1982 Finance Facts Yearbook at 41.
14 Jd.

93a

At the end of 1981, consumer installment credit totaled
$333.4 billion. Of that amount, 44.8 percent was held by
commercial banks, 26.9 percent by finance companies, 13.8
percent by credit unions, 8.9 percent by retailers, 3.5 percent
by savings and loan associations, 1.3 percent by gasoline com-
panies, and 0.8 percent by mutual savings banks.'®

By type of credit, $126.4 billion, or 37.9 percent of install-
ment credit outstanding at end of 1981, was for the purchase
of automobiles.” Revolving credit outstanding amounted to
$63.0 billion at the end of 1981 (18.9 percent of the total).
Commercial banks held $33.1 billion, retailers $25.5 billion
and gasoline companies $4.4 billion.'®

All other consumer installment financing of $125.4 billion
comprised 37.6 percent of the total outstanding at the end of
1981. Commercial banks held $46.7 billion, finance companies
$40.0 billion, and credit unions $23.5 billion. Retailers
(including the wholly owned finance subsidiaries of chain
stores) held $4.0 billion, savings and loan associations $8.4
billion, and mutual savings banks $2.8 billion. This “other”
category includes installment contract financing of household
goods such as appliances and furniture, as well as all personal
loans.!9

15 During the 1970’s, the increases varied between $4.8 billion in 1970
and $43.1 billion in 1978. The increase in 1980 was only $1.5 billion.

16 Td.

17 Generally the automobile serves as security for installment contracts
which are written by dealers and sold to banks or finance companies, or as
security for auto loans made directly to consumers by banks and credit
unions. Predominant in financing these purchases were commercial banks,
with $59.2 billion outstanding of which $35.1 billion was purchased paper
and $24.1 billion direct loans for the purchase of automobiles. Finance
companies held $45.3 billion, most of which consisted of contracts pur-
chased by the subsidiaries of manufacturers — that is, by General Motors
Acceptance Corporation (GMAC), Ford Motor Credit and Chrysler Finan-
cial Corporation. Credit unions held $22.0 billion in loans made for the
purchase of automobiles.

18 Jd.
19 NCFA 1982 Finance Facts Yearbook at 42.

94a

Il. Legal Basis for the Rule

This proceeding focuses on certain of the terms and condi-
tions that appear in the written contracts that consumers sign
when they obtain credit for reasons other than the acquisition
of real estate.' Its purpose is the evaluation of certain collec-
tion remedies and related practices in light of the require-
ments of Section 5 of the FTC Act. This Chapter of the
Statement discusses the Commission’s mandate to proscribe
unfair or deceptive acts or practices and will serve to place in
perspective subsequent discussions of the specific provisions
of the rule.

The Commission’s authority to promulgate this Trade Reg-
ulation Rule is derived from two sections of the FTC Act:
Section 18(a)(1)(B) and Section 5(a)(1).?

A. Rulemaking Authority

Section 18(a)(1)(B) of the Federal Trade Commission Act
states, in pertinent part, that the Commission may prescribe:

[Rjules which define with specificity acts or prac-
tices which are unfair or deceptive acts or practices
in or affecting commerce * * * [within the meaning
of section 5(a){1) of the FTC Act] * * * Rules under
this subparagraph may include requirements [7742]
prescribed for the purpose cf preventing such acts or
practices.®

The Commission believes that the record should contain a
preponderance of substantial reliable evidence in support of a
proposed rule before that rule is promulgated. This belief is
based partly on the Commission’s perception of its function
and partly on statutory and judicial authority. Any rule
promulgated by the FTC may be challenged in court and may
be set aside if “the court finds that the Commission's action is

1 See Statement of Reason for the Proposed Rule at 40 FR 5346
(April 17, 1975).

2 15 U.S.C. 57(a)(1)(B); 15 U.S.C. 45(a)(1) (Cum. Supp. 1983).

315 U.S.C. 57(a)(1)(B) (Cum. Supp. 1983).

95a

not supported by substantial evidence in the rulemaking rec-
ord * * * taken as a whole,” FTC Act section 18(e)(3)(A), 15
U.S.C. 57(e)(3)(A) (West Supp. 1983). Congress imposed this
high standard as a “ ‘greater procedural safeguard []’”
because of the ‘potentially pervasive and deep effect’” of
FTC rules. American Optometric Ass’n v. FTC, 626 F.2d 896,
905 (D.C. Cir. 1980) (quoting H.R. Rept. No. 1107, 93d Cong.,
2d Sess. 45-46, 1974 United States Code Cong. and Ad. News
7702, 7715.) Therefore, the Commission takes seriously its
responsibility to determine if there is a preponderance of
substantial reliable evidence to support a proposed rule, and
to see that any supporting evidence is clearly recorded.

Initially, the Commission requires substantial evidence for
the factual propositions underlying a determination that an
existing act or practice is legally unfair or deceptive. When
substantial evidence both supports and contradicts such a
finding, the Commission bases its decisions on the preponder-
ance of the evidence. Before promulgating a rule, however,
rather than bringing individual cases, the Commission
believes the public interest requires answers to the following
additional questions: (1) Is the act or practice prevalent? (2)
Does a significant harm exist? (3) Will the proposed rule
reduce that harm? and (4) Will the benefits of the rule exceed
its costs?‘ In analyzing each of these questions, three types of
evidence are frequently brought to bear: Quantitative studies,
expert testimony, and anecdotes. The Commission has the
flexibility to marshall evidence for a rulemaking record that
combines the best mix of these three. However, it has a

* Although the Commission believes that these questions should be
asked and, to the extent possible, answered in every rulemaking, on the
basis of the best evidence reasonably available, it recognizes there is room
for variation in the specific answers that would justify the issuance of a rule,
depending upon the circumstances of each particular rulemaking. Different
| industries lend themselves in varying degrees to answering these questions,
the characteristics of the industry, the ability to reasonably gather informa-
tion, the burdensomeness of the regulation, and the agency’s ability to
address the unfair or deceptive practive by alternative means must be
considered.

. -

96a

responsibility to see that the best evidence reasonably availa-
ble is included.‘

The best evidence will often be surveys or other method-
ologically sound quantitative studies. Carefully prepared
studies can often give a reliable answer to each of the four
questions. First, reliable estimates of the incidence of a prac-
tice are an integral part of an assessment of prevalence and
are frequently well-suited to quantitative methods. Second,
the overall harm caused by a problem is best measured by
determining both the magnitude of consumer injury when it
occurs and the frequency of such an injury. This issue is also
well-suited to quantitative analysis. Third, the effectiveness
of a proposed remedy can often be shown only by quantitative
studies since informally observed changes may be influenced
by other, uncontrolled factors, or may be the result of chance
(i.e., not statistically significant). Finally, quantitative stud-
ies are most helpful when comparing costs with benefits.

In many instances, of course, precise quantitative answers
to these questions are not possible, or could be obtained only
at a prohibitive cost. In such cases, the Commission will seek
alternative ways to conduct a systematic assessment of the
benefits and costs of its regulatory proposals. As in consider-
ing the merits of a rule, the Commission will balance the
benefits and costs of obtaining additional information.
Although carefully structured quantitative studies are gener-
ally preferred as evidence in a rulemaking record, the Com-
mission believes that it is possible in some instances to
support a rule without such studies.

The second type of evidence is expert testimony. The pri-
mary use of expert testimony is in providing underlying tech-
nical details, such as medical or engineering facts or

5 The concept of “reasonably available” takes into account the practical
resource constraints on the ability of the Commission or parties to a
rulemaking to marshal evidence bearing on a particular problem.

97a

information concerning state law and procedures. Expert tes-
timony is also useful to address the methodology of quantita-
tive studies, and its possible effects on the results. Finally,
experts can give their own opinions regarding the issue facing
the Commission. These opinions are usually predictions of
what quantitative studies would show. As such, they are less
satisfactory than an actual study. When an expert’s opinion
conflicts with the conclusions of a study, the study itself is
generally more reliable, unless deficiencies in the methodol-
ogy or execution of the study have been established and a
better study would, in all likelihood, support the expert’s
opinion.

A third type of evidence is anecdotes. Narratives of specific
consumer injuries are helpful in certain ways. They call atten-
tion to a possible problem; they illustrate the contours of a
known problem; and they may suggest areas for further
inquiry. By themselves, anecdotes are generally good ev -
dence that some harm exists. Without thorough exploration
of the details of individual examples, however, anecdotes can-
not establish the cause of a problem. Moreover, anecdotes
give little evidence of the frequency of the harm, they provide
limited evidence for the effectiveness of a proposed rule and
virtuaily no evidence of the balance of benefits and costs.
Therefore, anecdotal evidence is rarely sutiicient to provide
the “substantial evidence” which the Commission requires in
the rulemaking record.

B. The Criteria for Unfairness Under Section Five®

Section 5(a)(1) of the FTC Act, in turn, states:

Unfair methods of competition in or affecting
commerce, and unfair or deceptive acts or practices

® Although a majority of the adopted rule provisions are based on the
Commission's authority to regulate unfair acts or practices, § 444.3(a)(1),
which concerns misrepresentations of the nature or extent of cosigner
liability, is premised on the FTC's jurisdiction over deceptive acts or
practices. A discussion of the Commission's authority to identify and
correct consumer deception is set forth in Chapter IX, infra.

126a

of a consumer credit transaction.!® Other states restrict their
use in specified classes of transactions, such as retail install-
ment saies contracts, but do not impose a general prohibition
on [7750] their use with respect to all consumer transactions.’9
In addition, a significant number of states prohibit small loan

18 See, e.g., Colo. Rev. Stat. sections 5-2-415, 5-3-407 (1973); D.C. Code
Ann. section 28-3804 (1981); Idaho Code section 28-43-305 (Supp. 1983);
Ill. Ann. Stat. ch. 110, section 2-1301 (Smith-Hurd 1983); Ind. Code Ann.
sections 24-4.5-2-415, 24-4.5-3-407 (Burns 1982); Kan. Stat. Ann. section
16a-3-306 (1981); Me. Rev. Stat. Ann. tit. 9-A, section 3.306 (1980); Mass.
Gen. Laws Ann. ch. 231, section 13A (West 1974); N.M. Stat. Ann. sections
39-1-16, 39-1-18 (1981); Ohio Rev. Code Ann. section 2323.13 (Page 1981);
Okla. Stat. tit. 14A, sections 2-415, 3-407 (1983); S.C. Code Ann. sections
37-2-415, 37-3-407 (Law. Co-op. 1976); Utah Code Ann. sections 70B-2-415,
70B-3-407 (1980); Vt. Stat. Ann. tit. 9, section 2455 (1970); W. Va. Code
section 46A-2-117 (1980); Wisc. Stat. Ann. section 806.25 (West 1977),
section 422.405 (West 1974); Wyo. Stat. sections 40-14-249, 40-14-338
(1977).

19 See, e.g., Conn. Gen. Stat. Ann. section 42-86 (1958) (Confession of
judgment void in retail installment contract or installment loan coniract);
Hawaii Rev. Stat. section 476-13 (1976) (void in retail installment con-
tract); Md. Com. Law Code Ann. sections 12-601, 12-607 (1983) (prohibited
in retail installment sales agreements between buyer and seller or sales
finance company); Mich. Comp. Laws Ann. section 445.852 (1976), section
445.864 (Supp. 1983-84)(prohibited in retail installment contract or retail
charge agreement for goods or services); Minn. Stat. Ann. section 325G.16
(West 1981)(prohibited in consumer credit sale for goods or services); N.H.
Rev. Stat. section 361-A:7 (1968)(void in retail installment contract for
purchase of motor vehicle); N.J. Rev Stat. section 17:16C-37 (Supp. 1983-
84)(void in retail installment contract or retail charge account); N.J. Rev.
Stat. section 17:16C-64 (1975)(void in home repair contract); N.Y. Pers.
Prop. section 403 (Consol. 1976)(prohibited in retail Installment con-
tracts); N.Y. Civ. Prac. Law section 3201 (McKinney 1970)(void if executed
before default in connection with the purchase of consumer goods for $1500
or less); N.C. Gen. Stat. sections 25A-2, 25A-18 (Supp. 1983)(void in con-
nection with claim arising out of a consumer credit sale for goods or ser-
vices); N.D. Cent. Code sec:ion 51-13-02.1 (1982)(prohibited in retail
installment contracts); Or. Re.. Stat. section 83.670 (1973) (unenforceable
in retail installment contract for motor vehicle); Tex. Rev. Civ. Stat. Ann.
Art. 5069-6.05 (Vernon Supp. 1982-83)(prohibited in retail installment con-
tract or retail charge agreement).

127a

licensees from utilizing confessions of judgment in loan agree-
ments with consumers.”° The statutory definition of a small
loan licensee varies from state to state, however.”! Thus, the
protection such provisions afford consumers varies accord-
ingly.

Other states authorize confessions of judgment, but only if
they are executed after action on the underlying obligation

20 See, e.g., Ala. Code section 5-18-16 (1975); Ariz. Rev. Stat. Ann. sec-
tion 6-629 (1974); Cal. Fin. Code section 22467 (Deering Supp. 1983); Conn.
Gen. Stat. Ann. section 36-236 (West 1961); Fla. Stat. Ann. section 516.16
(West 1972); Hawaii Rev. Stat. section 409-15 (1978); Ky. Rev. Stat. Ann.
section 288.580 (Bobbs-Merrill Supp. 1982); Md. Com. Law Code Ann.
section 12-311 (1963); Mich. Comp. Laws Ann. section 493.12 (Supp. 1983-
84); Minn. Stat. Ann. section 56.12 (West 1970); Miss. Code Ann. section
75-67-127 (Supp. 1983); Mont. Code Ann. section 32-5-305 (1981); Neb.
Rev. Stat. section 8-447 (1977); Nev. Rev. Stat. section 675.350 (1979); N.H.
Rev. Stat. Ann. section 399-A.5 (1968); N.J. Rev. Stat. section 17:10-15
(Supp. 1983-84); N.Y. Banking Law section 353 (Consul. 1970); N.C. Gen.
Stat. section 53-181 (1982); N.D. Cent. Code section 13-03-15 (1961); R.I.
Gen. Laws section 19-25-24 (1968); Tex. Rev. Civ. Stat. Ann. Art. 5089-3.20
(Vernon 1974); Vt. Stat. Ann. tit. 8, section 2222 (1970); Va. Code section
6.1-283 (1983); Wash. Rev. Code section 31.08.150 (Supp. 1983-84).

The Presiding Officer indicated that 29 states bar the use of confes-
sions of judgment by small loan licensees. Presiding Officer’s Report at 81.
In the interim, six states—Idaho, Indiana, Oklahoma, South Carolina,
Utah, and Wyoming—have replaced such statutes with statutes that pro-
hibit confessions of judgment in all consumer loan transactions. Penn-
sylvania also repealed its statute invalidating confessions of judgment in
small loan transactions. Pennsylvania’s statutory limitations on confes-
sions of judgment are discussed infra at note 33. California and Rhode
Island were not included in the Presiding Officer’s total. These states pro-
hibit confessions of judgment in most small loan transactions, however.

“1 Compare Mont. Code Ann. section 32-5-103 (1961) (licensee is any
person engaged in business of making loans or advances of money on credit
in amounts of $25,000 or less) with Hawaii Rev. Stat. section 409-15
(1976) (licensee is any person engaged in business of making loans of money,
credit, goods, or things in action in the amount or value of $300 or less).

The statutory definition of a licensee typically excludes federal and
state banks, trust companies, savings or building and loan associations and
credit unions. It often also excludes pawn-brokers and retail sellers. See,
e.g., Ariz. Rev. Stat. Ann. section 6-602 (Supp. 1983-84); Mont. Code Ann.
section 32-5-103 (1981).

128a

has been instituted.22 The hallmark of the common law cog-
novit is the waiver of due process rights before the time that
the debtor needs their protection. Because such statutes pro-
hibit waiver of these rights before commencement of an
action against the debtor, in effect they ar the common law
cognovit and the ills traditionally associated with it.?° Before
an action can be commenced the debtor must receive notice,
and the right to a hearing necessarily follows. If at this point
the debtor chooses to confess judgment, the waiver of the
right to a trial on the merits may be assumed to have been
made intelligently and voluntarily. A few other states restrict
confessions of judgment by requiring that they be entered
into after default, rather than after institution of suit,24 or by
requiring that the debtor appear personally in court to con-
fess judgment if he or she chooses.”

Another group of states restricts confessions of judgment
by authorizing their use but requiring that the debtor sign a
verified statement under oath attesting to the existence of the
obligation due or to become due.” Such provisions may help

22 See, e.g., Ala. Code section 8-9-11 (1975); Fla. Stat. Ann. section 53.05
(West 1969); Ga. Code Ann. section 110-801 (1973); Ky. Rev. Stat. Ann.
section 372.140 (Bobbs-Merrill 1970); Miss. Code Ann. section 11-7-187
(1972); Or. R. Civ. P. 73 (1981); Tenn. Code Ann. section 25-2-101 (1980);
Tex. Rev. Civ. Stat. Ann Art. 2224.

23 As a result, confessions of judgment obtained pursuant to such stat-
utes are not prohibited by this rule provision. See infra note 106 and
accompanying text.

24 See, e.g., Ariz. Rev. Stat. Ann. section 44-143 (1962); Iowa Code Ann.
section 537.3306 (West Supp. 1983-84).

25 See, e.g., Ark. Stat. Ann. section 29-301 (1979); Neb. Rev. Stat. section
25-1309 (1979).

26 See, e.g., Alaska Stat. section 9.30.050, Alaska R. Civ. P. 57 (c) (1973);
Cal Civ. Proc. Code sections 1132-1134 (Deering 1981) (confession may be
entered only if an attorney independently representing the debtor signs a
certificate that the attorney has examined the proposed judgment, has
advised the debtor with respect to waiver of rights and defenses, and has
advised the debtor to utilize the procedure); Mo. Rev. Stat. sections
511.070-511.100 (1974); Mont. Code Ann. sections 27-9-101, 27-9-102
(1981); Nev. Rev. Stat. sections 17.090-17.110 (1979); S.D. Codified Laws

129a

to focus the debtor’s attention upon the existence of the cog-
novit clause at the time due process rights are waived. They
do not ensure that the waiver is made intelligently, however,
or at a time that the waiver has meaning for the debtor.’

A few states provide for the entry of a judgment by confes-
sion without requiring verification of the confession under
oath and also without providing the debtor with notice and a
hearing at the time of entry. Instead, these states rely on post-
judgment procedures to alleviate wrongful deprivation that
the debtor may have suffered.?8 The required procedures pro-
vide varying degrees of protection to the debtor. Delaware,
for exam,.e, provides for a hearing on the question of
whether the debtor understood the constitutional rights
waived at the time the judgment was ccnfessed.?9 Before
judgment becomes final the court clerk must send notice to
the debtor by certified mail of the opportunity for such a
hearing. In addition, the debtor may seek to vacate or reopen
the judgment and may present any defenses not deemed to
have been waived, i.e., any defenses of which the debtor had
no knowledge at the time of the confession of judgment or
that arose subsequently.*°

Virginia law provides that any confessed judgment may be
reduced or set aside within twenty-one days following notice
to the debtor of its entry on any ground that would have
constituted an adequate defense or set off to the underlying
claim.*! It also requires the court clerk to notify the debtor of

Ann. sections 21-26-1--21-26-6 (1579); Wash. Rev. Code sections 4.60.060-
4.60.070 (1974).

27 The California statute is an exception in requiring detailed proce-
dures designed to ensure intelligent waiver. See supra note 26.

28 See, e.g., Del. Code ‘nn. tit. 10, sections 2306, 3908 (1974); Pa. Ct. R.
Civ. P. 2950-2962 (West 1¥83); Va. Code sections 8.01-431—8.01-441 (1977).

29 Del. Code Ann. tit. 10, section 3908 (1974).
30 Td.
31 Va. Code section 8.01-433 (1977).

130a

the right to contest judgment on these grounds.** Unlike Del-
aware, however, Virginia does not specifically provide for a
hearing on the preliminary question of intelligent or under-
standing waiver.

Pennsylvania also authorizes the entry of judgment by con-
fession against a debtor without advance notice and hearing.
Although some statutory restrictions apply,** it appears that
[7751] confessions of judgment are used relatively frequently
in this state.*4 Pennsylvania’s procedural protections are
more limited than those of Delaware and Virginia. In Penn-
sylvania, judgment is entered by the filing of an instrument
confessing judgment or authorizing a third party to confess
judgment against the debtor. Default is not a necessary con-
dition precedent to the entry of judgment.* The court clerk
must notify the defendant debtor of the entry of judgment
and enclose copies of the documents filed in support of judg-
ment. Such notice is sent by ordinary mail rather than certi-
fied mail, however, and no return receipt is required.** Thus,

32 Td. at section 801-438.

33 Pennsylvania law permits a creditor to take a confessed judgment
from a debtor. It also permits the creditor to enter judgment against the
debtor at any time before default and to use it to create a lien on the
debtor’s real and personal property. The debtor’s residential real estate is
protected from execution on the basis of such a lien, however, in that
execution may not occur until after a trial on the merits of the claim. 41 Pa.
Cons. Stat. Ann. section 407 (Purdon Supp. 1983-84).

Similarly, execution may not be had on such a basis as to any of the
debtor’s property without first proceeding as in any original action when
the claim arises out of a retail installment sale, contract or account. 69 Pa.
Cons. Stat. Ann. section 1605 (Purdon Supp. 1983-84). This chapter pro-
hibits the use of a power of attorney to confess such a judgment, see id. at
section 1401(e), but not the taking of confession from a debtor.

In contrast, home improvement contracts may contain a power of
attorney clause authorizing confession of judgment. Judgment may be
entered before default, thereby creating a lien, but execution before default
is prohibited. Pa. Stat. Ann. tit. 73, section 500-406 (Purdon 1971).

34 See discussion of prevalence infra Section C.
35 Pa. Ct. R. Civ. P. 2951 (West 1983).
36 Pa. Ct. R. Civ. P. 236 (West 1983).

l3la

the court has no assurance that the debtor has, in fact,
received notice. Failure to mail the notice and documents
does not affect the lien against the debtor’s property imposed
by the judgment.*’ As a result, debtors may be wholly una-
ware that their property is subject to a lien.

Pennsylvania law provides for striking off or reopening of a
judgment entered by confession.** To strike a judgment the
defendant’s petition must assert defects appearing on the
record. To reopen a judgment the deferdant’s petition first
must assert prima facie grounds for relief. The existence of
offsetting claims or counterclaims that the debtor has against
the creditor does not constitute grounds for reopening.*® All
defenses that are not included in the petition are waived. The
court determines whether to reopen the judgment on the
basis of the defendant’s petition, the plaintiff's answer, and
on testimony, depositions, and admissions. There is no statu-
tory provision for a hearing on the petition to reopen. Onlv if
the pleadings produce evidence that would require submis-
sion of the issues to a jury will the court reopen the judg-
ment.4° Thus, the reopening of a judgment entered by
confession involves a preliminary pleading contest in which
the debtor has the burden of persuasion.*!

In the event that the court does reopen the judgment, the
lien of the judgment or of any execution issued on it is unim-
paired, although the court may stay execution pending final

37 Td.

38 Pa. Ct. R. Civ. P. 2959 (West 1983).

39 See supra note 5.

40 Pa. Ct. R. Civ. P. 2959 (West 1983). A “defendant must allege a
meritorious defense to liability on the note, and must produce evidence
sufficient to present a jutv question and avoid a directed verdict.” Federal
Deposit Insurance Corp. v. Barness 484 F. Supp. 1134, 1141 (E.D. Pa.
1980).

41 “The placing of this burden upon the debtor is in direct contrast to
the burdens in a normal or pre-judgment creditor-debtor action. In those
cases instituted by a creditor against a debtor, the creditor is considered the
proponent of a claim and the burdens are his.” Swarb v. Lennox, 314 F.
Supp. 1091 (E.D. Pa. 1970), aff'd, 405 U.S. 191 (1972).

132a

disposition of the proceeding.*? This is a discretionary matter,
however; the court is not required to stay execution. No fur-
ther pleadings are permitted after reopening.

Although these statutory provisions afford some means of
contesting a judgment that has been improperly entered, they
fail to ensure that debtors’ rights will be protected ade-
quately. This is true because, as noted above, there is no
assurance that debtors will receive notice of the entry of judg-
ment. Even when debtors do receive notice of the entry of
judgment, the law does not require that they be notified of the
right to contest the judgment or the grounds upon which they
may do so.*3 Evidence in the rulemaking record shows that
debtors may fail to recognize the implication of judgments
entered by confession against them, as weil as the means that
they may use to contest such judgments.** Moreover, igno-
rance of the rights that were waived at the time of confession
is not a statutory defense in Pennsylvania.* Finally, debtors’
due process rights are inadequately protected by Penn-
sylvania statute because the law permits encumbrance of
their property before, rather than after, a hearing on the
merits of the creditors’ claims.

It is also apparent that Pennsylvania’s post-judgment rem-
edies do not provide the procedural equivalent of a trial de
novo to debtors. A creditor in Pennsylvania who has not
obtained judgment by confession must seek judgment

42 7 Stand. Pa. Prac. 172, 174, sections 138, 142.

43 This contrasts with Virginia law, for example, which requires such
notification to the debtor. See supra note 32 and accompanying text.

44 See, e.g., Henry J. Sommer, Community Legal Services of Philadel-
phia, Tr. 10980; Carol Knutson, Neighborhood Lega! Services Association,
Pittsburgh, Tr. 11104; Herschel T. Elkins, Office of the Attorney General of
California, HX-211, Tr. 5290-91.

45 Bernard A. Podcasy, Legal Services of Northeastern Pennsylvania,
Tr. 9629. This contrasts with Delaware law, for example, which provides for
a preliminary hearing on the issue of waiver. See supra note 29 and accom-
panying text.

133a

through a civil suit.46 The action is commenced when the
creditor files a complaint. The district justice sets a date for
hearing, to occur within sixty days of the filing, and notes it
on the complaint. The complaint is then served personally
upon the debtor, along with a notice of the right to contest
and the time period for doing so. The notice includes a promi-
nent warning that failure to appear will result in the entry of a
default judgment. Debtors are informed that they may enter
a defense and may also file a complaint raising a cross-claim
against the creditor. Such a complaint may assert any claim
within the court’s jurisdiction. The district justice who con-
ducts the hearing has authority to subpoena any necessary
witnesses. The court issues a judgment within five days after
the hearing. Costs are awarded to the prevailing party.*”

This procedure is simple, straightforward, and expeditious.
It ensures service of process upon the debtor. It provides full
notice of the debtor’s right to defend, the time and place for
doing so, and the consequences of failure to appear. Because
depositions and interrogatories are not permitted, the burden
and expense of presenting a defense are negligible.

The reopening of a confessed judgment involves a prelimi-
nary pleading contest in which the debtor has the burden of
persuasion. By contrast, to defend against a creditor’s claim
in a trial de novo under the procedures outlined above, the
debtor may simply appear and present any defenses to the
district justice. No lien may be created upon the debtor’s
property until after the debtor has had this opportunity.

46 The civil procedure discussed in this section is the applicable proce-
dure in cases brought before Pennsylvania district courts, which have juris-
diction over claims not exceeding $4,000. See Pennsylvania Rules of Civil
Procedure Governing Actions and Proceedings Before District Justices, Pa.
Ct. R. Civ. P. 301-382, (West 1983). Claims that exceed $4,000 must be
brought in the Court of Common Pleas.

47 If judgment is entered against the debtor, execution may be ordered
by the district justice; alternatively, the creditor may file the judgment with
the Court of Common Pleas. Creditors wishing to execute upon real prop-
erty must choose the latter alternative. See id., Pa. Ct. R. Civ. P. 402, 406.

134a

Notwithstanding a meritorious defense, the procedural
burden of reopening a judgment under Pennsylvania law
requires a greater sophistication and expenditure of [7752]
resources by the debtor than would be required in a trial on
the merits in the first instance. For these reasons, Penn-
sylvania’s post-judgment remedies provide an inadequate
substitute for a trial de novo and fail to guarantee that
debtor’s rights will be protected to the degree that due pro-
cess requires.

C. Prevalence

There is limited record evidence with respect to the preva-
lence of cognovit clauses in consumer credit contracts on a
nationwide basis. Both legal aid attorneys and members of
the finance industry testified to the use of confessions of
judgments in Pennsylvania,*® Illinois,49 and Louisiana.*°
Other evidence points to frequent use in Pennsylvania, Illi-
nois, and Ohio.®! There was also testimony that in Maryland,
although confessions of judgment are prohibited in many

48 Carol Knutson, Neighborhood Legal Services Association, Pitts-
burgh, Tr. 11121 (100 cases in 3 years); Bernard A. Podcasy, Legal Services
of Northeastern Pennsylvania, Tr. 9635 (3 current cases, perhaps 50
others); William T. Gwennap, Pittsburgh National Bank, Tr. 12232-34
(PNB uses cognovits in home improvement loans; other banks in Penn-
sylvania also use them); Leslie R. Butler, Consumer Bankers Association,
HX-488, Tr. 11587 (in Pennsylvania many consumer contracts contain
cognovits).

49 Jerrold Oppenheim, Legal Assistance Foundation of Chicago, HX-79,
Tr. 2147. Confessions of judgment have since been prohibited in consumer
transactions in Illinois.

50 Jane Johnson, New Orleans Legal Assistance Corp., Tr. 407-08; Her-
schel C. Adcock, Louisiana Consumer Finance Association, Tr. 1210 et seq.;
Donald S. Wingerter, Louisiana Savings and Loan League, HX-437, Tr.
10890 et seg.

51 See Hopson, Cognovit Judgments: An Ignored Problem of Due Pro-
cess and Full Faith and Credit, 29 U. Chi. L. Rev. 111, 115 (1961) (these
states produce the “overwhelming bulk” of cognovit judgments). Ohio, like
Illinois, now prohibits the use of a warrant of attorney to confess judgment
in instruments arising out of a consumer loan or transaction.

135a

consumer credit transactions, their use in other kinds of con-
sumer contracts remains common.*”

Survey evidence exists concerning the prevalence of cogno-
vit clauses but does not break down the results by state. A
survey of its members conducted by the Consumer Bankers
Association, for example, shows that approximately 20 per-
cent of banks responding to the survey included cognovit
clauses in the majority of their contracts where permitted by
law. A survey of legal aid attorneys indicates that, where
permitted by law, cognovit clauses were utilized in 20 percent
of loan agreements by credit unions, 21 percent by finance
companies, 16 percent by banks, and 30 percent by creditors
generaily.™

A National Consumer Finance Association (NCFA) survey
of over 13,000 consumer accounts indicates that cognovit
clauses were used in 3.7 percent of consumer credit contracts
used by its responding members and that all but one of the

52 H. Robert Erwin, Consmer Law Center, Legal Aid Bureau, Baltimore,
Tr. 10034 (e.g., home improvement contracts).

53 Richard K. Slater, Consumer Bankers Association, HX-490, Tr.
11630. Mr. Slater indicated that the banks responding to the survey held
over 15 percent of all consumer credit outstanding in the types of credit
extension that the survey addressed and a much larger market share over-
all. Thus, he believed that the survey responses were respresentative of the
overall marketplace, Tr. 11616-17. Although Mr. Slater was unable to pre-
sent the results on a state-by-state basis, he indicated that the number of
respondents was too great to reflect banking practice only in Pennsylvania.
Tr. 11637. He noted that a number of the respondents did business in
Michigan, Illinois, and New York. Tr. 16642.

>4 National Consumer Law Center (NCLC) Survey of Credit Contract
Practices (1977), HX-467 at 44. Although 105 consumer law specialists
responded to this survey, confessions of judgment were not lawful in many
of the respondents’ states. The estimate of prevalence reflects the opinions
of the 22 respondents in whose states the practice was permitted, but
results were not tabulated by state. Thus, the 20 percent estimate of preva-
lence may reflect the practice of creditors in a relatively small number of
states. See Presiding Officer’s Report at 302-04 for an evaluation of this
survey as a whole.

136a

contracts came from Illinois or Louisiana.®** A Commission
staff survey of 1,001 consumer account files subpoenaed from
twelve large consumer finance companies in thirty-five states
found cognovit provisions in seventy-four contracts (7.3 per-
cent). This figure was thought to underestimate the true
incidence of cognovit provisions in the sample, however.’ A
more reliable Bureau of Social Science Research (BSSR) sur-
vey of 1,001 consumer account files drawn from the same
group, but including only nine consumer finance companies
in nineteen states, found cognovit provisions in ninety-six
contracts or 9.5 percent of the sample.®* The results of both
samples show that cognovits appeared in contracts from Col-
orado, Illinois, Indiana, Louisiana, New Jersey, Michigan,
Ohio, Tennessee, and Virginia.®® Although Louisiana, Illinois,
and Ohio account for the majority of the cognovit provisions
in the sample,® consumer account files from these states are
over-represented in the sample. Eleven percent of the con-
sumer account files were from Ohio, for example.*! Because
the consumer files upon which these surveys were based were
not drawn from all states and because some states were dis-
proportionately represented in the file samples, the results do
not necessarily reflect those states in which cognovits were
used most frequently nor the frequency of their use in a given

55 Robert P. Shay, National Conswiser Finance Association, HX-494 at
33, Tr. 12053.

56 For an explanation of the methodology employed and the results of
this and the BSSR survey see R-XI-153 at 3-5, 9-10. For criticism of the
underlying sampling methodology, see Robert P. Shay, National Consumer
Finance Association, HX-494 at 4-10.

57 See R-X1-153 at 4-5. Because many of the files surveyed by the Com-
mission staff were incomplete, it was not possible to determine in all cases
whether a given contract provision was included. In addition, if a provision
was found in all contracts from a given office, staff did not attempt to code
each incidence of the provision. The BSSR survey, in contrast, used com-
plete files and followed formal coding procedures.

58 Jd. at 9.

°° Id., printout A at 14-21, printout B at 1-6.

6 See id

6! Jd. at 3, n.4.

137a

state. They do suggest, however, that the use of cognovits may
be somewhat more widespread geographically than the NCFA
survey would indicate.®

Finally, a 1970 industry survey conducted by the National
Commission on Consumer Finance showed that 17 percent of
large bank respondents and 17 percent of large finance com-
panies stated cognovits to be a highly valuable provision in
contracts for unsecured cash loans. This suggests that, among
these respondents, confessions of judgment are employed on
a regular basis.®

No precise quantification of the extent to which cognovits
are used in consumer credit contracts can be made on the
basis of record evidence. Evidence demonstrates their use in
Pennsylvania, as well as in Louisiana, Ohio, Illinois and, at
least to a limited extent, in several other states. There also is
evidence to show that in states where their use is permissible,
thev are used with some frequency.™ Beyond this, there exists
the issue of full faith and credit that must be paid by the
courts of one state to the judgments of the courts of another
state. To the extent that confessions of judgment are
entered on the basis of the laws of a state in which they are
permissible, they may be [7753] enforceable in other states
where they would not otherwise be permissible.

62 Alternatively, the differences in survey results may reflect changes in
state law or creditor use of cognovits that took place betwen 1973, when the
Commission gathered its survey data, and 1977, when the NCFA conducted
its survey.

63 National Commission on Consumer Finance (NCCF), Technical
Studies, Vol. 5, Tables 25, 27 (1972).

64 See, e.g.. NCLC survey, supra note 54 and accompanying text;
Thomas E. Raleigh, Administrator, Collection Agency Act, Illinois, HX-96,
Tr. 2433; Jerrold Oppenheim, Legal Assistance Foundation of Chicago, Tr.
2147; Herschel C. Adcock, Louisiana Consumer Finance Association, Tr.
1211; William T. Gwennap, Pittsburgh National Bank, Tr. 12232-34.

6° For a discussion of the applicability of the full faith and credit clause

to cognovit judgments, see Hopson, supra note 51 at 143-56; Note, Poverty
Law: Juegments by Confession, 49 Tex. L. Rev. 169, 17] (1970).

138a

On balance it appears that cognovits are prevalent in Penn-
syivania and may be used in other states as well, such as
Virginia, where they are permitted.© Despite the fact that
their use has been prohibited or severely restricted in most
states, the Commission finds that there is sufficient evidence
of continued use of cognovits to warrant a rule addressing
that use.

D. Consumer Injury

Although procedures for reopening confessions of judg-
ment exist, the absence of notice and a hearing prior to the
entry of the judgment causes significant consumer injury.
Cognovit clauses typically are worded in arcane language and
may appear in small print.® Record evidence supports the
conclusion that debtors are unaware that they have agreed to
such clauses and that they waive due process rights by doing
so.*8 When debtors receive notice of a judgment entered
against them, they may not understand its import or that
they must act affirmatively to raise any defenses against it.®
This problem is exacerbated by the fact that many states,
including Pennsylvania, do not require notice informing the
debtor of the right to contest the judgment or the grounds for

56 Record evidence also demonstrates their prevalence in Illinois and
Ohio. Cognovits are no ionger permitted in these states in consumer trans-
actions, however. Although they are also prevalent in Louisiana, the rule
will not prohibit their use in that state. See infra notes 103-105 and accom-
panying text.

§? Carolyn C. McTighe, Legal Aid Society of Cleveland, R-I(c)-38; Henry
J. Sommer, Community Legal Services of Philadelphia, Tr. 10980.

68 Henry J. Sommer, Community Legal Services of Philadelphia, Tr.
10980, 10989; James D. Morris, Legal Services of Northeastern Penn-
syivania, Tr. 9636; Herschel T. Elkins, Office of the Attorney General of
California, Tr. 5290; Bernard A. Podcasy, Legal Services of Northeastern
Pennsylvania, Tr. 9628; Eugene Thirolf, Land of Lincoln Legal Assistance
Foundation, Tr. 3356.

6° Carol Knutson, Neighborhood Legal Services Association, Pitts-
burgh, Tr. 11104; Carolyn C. McTighe, Legal Aid Society of Cleveland, R-
I(c)-38.

139a

doing so.” As a result the debtor may fail to respond despite
having valid defenses to the judgment.”! The rulemaking rec-
ord shows that judgments entered by confession frequently
are invalid on their face.”* It also shows that debtors fre-
quently have some defense to the judgment.”

When debtors are not apprised of their rights and therefore
fail to challenge facially invalid judgments or fail to assert
valid defenses, the consumer injury is clear. The judgment
debtor’s property may be taken in satisfaction of a claim that
would not survive judicial scrutiny at a hearing on its merits.
Loss of this property causes economic hardship, since the
debtor loses both its use and any equity in it. Moreover,
consumers must replace any essential items that are seized,
usually at a greater cost than they were credited with for the
seized property. The economic injury, therefore, is substan-
tial.”

Alternatively, if they have the resources to do so, consum-
ers may simply pay judgment debts when threatened with

© Carol Knutson, Neighborhood Legal Services Association, Pitts-
burgh, Tr. 11104. Compare Pennsylvania notice requirements, supra
note 43 and accompanying text, with those of Delaware and Virginia, supra
notes 30-32 and accompanying text.

7! Henry J. Sommer, Community Legal Services of Philadelphia, Tr.
10980.

72 In an investigative study of Chicago, Illinois, courts, 377 of ‘774
confessed judgments filed during a two-week period in 1960 were invalid.
See Hopson, supra note 51 at 122. Confessions of judgment are no longer
permitted in Illinois, but this study demonstrates the potential for abuse
that exists in states where they are permitted.

73 Carol Knutson, Neighborhood Lega! Services Association, Pitts-
burgh, Tr. 11102-03, 11121-22.

74 See, e.g., Carol Knutson, Neighborhood Legal Services Association,
Pittsburgh, Tr. 11102, Jane Johnson, New Orleans Legal Assistance
Corp., Tr. 413. See generally Karl B. Friedman, Alabama Consumer
Finance Association, Tr. 61; William Bellenger, Michigan Department of
Licensing and Regulation, Tr. 8178; Tom D. McEldowney, Director, Idaho
Department of Finance, Tr. 5056; Andrew Eiler, Consumer Affairs Depart-
ment, United Auto Workers, R-I(d)-92.

112a

Record evidence indicates that differences exist in the
kinds of contracts offered by different creditors. Finance
companies in particular are more likely to use the remedies
subject to this rule than are other creditors.!° Among finance
companies, use of some contract terms is relatively low when
examined nationally. In particular states, however, where cer-
tain remedies are more widely used, the incidence is consider-
ably greater.!! Moreover, within a local area, contracts offered
by creditors of a given class may be substantially identical.!?

10 See generally, National Consumer Law Center Survey of Credit Con-
tract Practices (1977), HX-467; NCCF Technical Studies, Vol. V (1972).
The incidence of particular clauses is discussed in relevant chapters of this
statement.

11 F.g., use of wage assignments is most prevalent in Illinois and New
York, see infra Chapter V; use of cognovits is substantially limited to one
state—Pennsylvania, see infra Chapter IV.

12 E.g., Steven P. McCabe, Consumer League of New Jersey, Tr: 8729,
R-I(d)-87; Paul J. Pfeilsticker, Continental Illinois National Bank & Trust
Co., Tr. 2338; Agnes C. Ryan, Legal Aid Bureau, United Charities of Chi-
cago, Tr. 2244; Drew Johnson, Lane County Legal Aid, Tr. 6305-06; George
H. Jones, Association Management Services, R-I(a)-29 at 4; Jerrold Oppen-
heim, Legal Assistance Foundation of Chicago, Tr. 2155; Michael Burns,
Legal Aid Society of Minneapolis, R-I(c)-99; Carol Knutson, Neighborhood
Legal Services Association, Pittsburgh, Tr. 11103; Robert Erickson, DNA
Legal Services, Tr. 1666; R. A. Stanton, Mid Cities Schools Credit Union,
R-I(a)-525; Raphael L. Podolsky, Connecticut Legal Services, R-I(c)-58;
Richard Wazren, Alabama Lenders Association, R-I(a)-361; Robert Bark,
Republic National Bank of Dallas, R-I(a)-872; Stephen Cochran, Bexar
County Legal Aid, Tr. 1716; Andrew Eiler, Consumer Affairs Department,
United Auto Workers, R-I(d)-92; Hagen McMahen, Independent Bankers
Association of Texas, Tr. 1916; Robert Duke, Texas Consumer Finance
Association, Tr. 1835; Joe Martin, 1st United Bancorporation, Tr. 1136;
Russell Freeman, Security Pacific Bank, R-I(a)-429; but see Donald
Boudreau, Chase Manhattan Bank, R-I(a)-522.

113a

The strong similarity of consumer credit contracts among
creditors of a given kind within a local area limits consumers’
incentives to search elsewhere for a better contract.!° If 80
percent of creditors include a certain clause in their contracts,
for example, even the consumer who examines contracts from
three different sellers has a less than even chance of finding a
contract without the clause.'4 In such circumstances rela-
tively few consumers are likely to find the effort worthwhile,
particularly given the difficulties of searching for contract
terms discussed below.

A second factor also limits the incentives of consumers to
search for better credit contracts. Default is a relatively infre-
quent occurrence, and most often occurs for reasons that are
beyond the control of the borrower.!5 Unlike terms such as
interest rates or payments, which are relevant in every trans-
action, the chances are good that the remedial provisions in
any particular transaction will never be relevant. Thus, con-
sumers would quite reasonably concentrate their search for
credit on terms such as interest rates and payments, rather
than alternative remedial provisions.

Consumers’ limited incentives to seek out better contracts
are compounded by the costs and difficulties of searching for
contract language. Borrowers usually cannot understand the

13 George Stigler, in a pioneering article on the subject of search, shows
that “if the dispersion of price quotations (among) sellers is at all large
(relative to the cost of search), it will pay, on average, to canvass several
sellers.” In contrast, when price dispersion is small and the cost of informa-
tion acquisition is high, it will not pay to search for additional quotations.
“The Economics of Information,” 89 Journal of Political Economy, 171 at
173 (1961). This argument applies, in general, to any information, not just
price quotations. If additional! search is unlikely to discov

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385018_1016%3A2. Public record. Not legal advice.