Regulatory Flexibility Act Review of Trade Regulation Rule Concerning Credit Practices

FEDERAL TRADE COMMISSION

16 CFR Part 444

Regulatory Flexibility Act Review of Trade Regulation Rule

Concerning Credit Practices

AGENCY: Federal Trade Commission.

ACTION: Termination of review.

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SUMMARY: In accordance with the Regulatory Flexibility Act (5 U.S.C.

601) (``the RFA'') and a published plan for Periodic Review of

Commission Rules (46 FR 35118 (July 7, 1981)), the Federal Trade

Commission solicited comments and data on whether the Trade Regulation

Rule Concerning Credit Practices (16 CFR part 444) (the ``Rule'') has

had a significant impact on a substantial number of small entities, and

if it has, whether the Rule should be amended to minimize any

significant impact on small entities (59 FR 18009 (April 15, 1994)).

The Commission also requested comments about the overall costs and

benefits of the Rule and its overall regulatory and economic impact as

a part of it systematic review of all current Commission regulations

and guides. The notice required comments to be submitted to the

Commission no later than June 14, 1994. Based on the comments received,

which are summarized in this notice, the Commission finds that there is

an insufficient basis to conclude that the Rule has had a significant

economic impact upon a substantial number of number entities of

otherwise merits revision. The Commission is therefore terminating this

review.

DATES: This action is effective as of May 10, 1995.

FOR FURTHER INFORMATION CONTACT:

Sandra M. Wilmore, Attorney, Division of Credit Practices, Bureau of

Consumer Protection, Room S4429, Federal Trade Commission, 6th and

Pennsylvania Avenue NW., Washington, D.C. 20580. Tel: (202) 326-3224.

SUPPLEMENTARY INFORMATION: The RFA requires the Federal Trade

Commission to conduct a periodic review of rules issued by the

Commission that have or will have a significant economic impact on a

substantial number of small entities. For the purpose of the RFA

review, the term ``small entity'' is defined under the Small Business

Size Standards, codified at 13 CFR part 121 and revised by the Small

Business Administration (49 FR 5024-5048 (Feb. 9, 1984)). In addition,

the Commission has determined, as a part of its oversight

responsibilities, to review rules and guides periodically. These

reviews will seek information about the costs and benefits of the

Commission's rules and guides and their regulatory and economic impact.

The information obtained will assist the Commission in identifying

rules and guides that warrant modification or rescission. This periodic

review is conducted in accordance with the Commission's plan for

periodic review of rules (46 FR 35118 (July 7, 1981)).

I. Background and Summary

The Commission promulgated the Rule on March 1, 1984, (49 FR 7740),

and it became effective on March 1, 1985. The Rule applies to lenders

and retail installment sellers (creditors) and prohibits them from

directly or indirectly taking or receiving from a consumer an

obligation that includes certain contract provisions determined to be

unfair, failing to provide a notice to potential cosigners, or using an

unfair method of calculating late fees.

In promulgating the Rule, the Commission found that: (1) consumers

suffers substantial economic and non-economic injury from creditors'

use of the remedies that the Rule restricts; (2) consumers themselves

cannot reasonable avoid these remedies or avoid the harsh consequences

of the remedies by avoiding default; and (3) the overall costs to

consumers are greater than the countervailing benefits that the use of

these remedies provide to consumers or creditors.\1\

\1\See Credit Practices Rule: Statement of Basis and Purpose and

Regulatory Analysis (SBP), 49 FR 7740, 7743-7745 (1984).

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The notice that initiated this review requested comments on whether

any part of the Rule has had a significant impact on a substantial

number of small entities and, if so, whether any such impact can be

reduced consistent with the operation of the Rule.

In addition, the Commission requested comments on a number of other

issues relating to the operation of the Rule.

II. Public Comments

In response to the Federal Register notice, the Commission received

a total of seven comments, four from creditor trade associations\2\ and

three from legal organizations representing consumers.\3\ The

commenters' responses to the questions posed in the notice are

summarized and analyzed below. Unless otherwise noted, the Commission

is not aware of other information bearing on the issues discussed.

\2\Comments were received from the Credit Union National

Association (``CUNA''), which represents 5,000 state and 7,000

federal credit unions in the United States; the CUNA Mutual

Insurance Group (``CMIG''), which provides form contracts and

compliance support, as well as insurance coverage, to CUNA members;

the Illinois Credit Union System, which represents 645 state and

federal credit unions in Illinois; and the Missouri Bankers

Association, a trade association representing 500 commercial banks

in Missouri.

\3\Comments were received from the National Consumer Law Center,

Inc. (``NCLC''); the UAW-GM Legal Service Plan (``UAW-GM''), which

provides legal services to auto workers and retirees; and the law

firm of Williams & Eoannou, which represents consumer debtors in

bankruptcy proceedings and in cases involving possible violations of

federal and state credit laws.

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1. Continuing Need for the Rule

Two commenters directly addressed the question of the continuing

need for the Rule. The UAW-GM and NCLC stated that consumers continue

to need the protection of the Rule. According to Williams & Eoannou,

consumers have benefited from the Rule because it ``eliminated the use

of a limited number of onerous and overreaching boilerplate contract

provisions * * * the limited utility of which in collecting debts was

more than offset by their brutally invasive and disruptive impact on

consumers and their families.'' No commenter discussed any costs

imposed on consumers by the Rule.

2. Proposed Changes to the Rule to Benefit Consumers

All of the commenters made some recommendation regarding changes to

the Rule. Except as noted, the commenters who proposed changes to

benefit consumers did not discuss the cost to creditors of those

changes. [[Page 24806]]

a. Security Interests in Household Goods

i. Definition of Household Goods

One commenter, UAW-GM, stated that the Rule's definition of

household goods is too limited. According to UAW-GM, consumers would be

better protected and the law would be more consistent with other

federal formulations if the definition of household goods under the

Rule were changed to parallel the household goods exemption and lien-

avoidance provisions of the Bankruptcy Code, 11 U.S.C. 552 (d)(3) and

(f)(2).\4\ The exemptions provided under the Bankruptcy Act include

items not covered by the Rule, notably books, animals, crops, and

musical instruments, but do not include the Rule's coverage of wedding

rings and personal effects.

\4\Those provisions of the Bankruptcy Act provide an exemption

for:

The debtor's interest, not to exceed $200 in value in any

particular item or $4,000 in aggregate value, in household

furnishing, household goods, wearing apparel, appliances, books,

animals, crops, or musical instruments, that are held primarily for

* * * personal, family, or household use. * * *

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The Commission did not address this question directly at the time

that it promulgated the Rule, but did indicate that it was aware of the

lien-avoidance provision of the Bankruptcy Act. The SBP refers to the

fact that 1978 amendments to the Bankruptcy Act created an exception to

the old rule that secured loans survived bankruptcy for those loans

secured by blanket security interests in household goods, 11 U.S.C.

552(f)(2), discussed above. The reference occurs in a discussion of the

treatment of the refinancing of purchase money security interests and

does not indicate that the Commission ever considered conforming the

definition of household goods in the Rule to the definition contained

in the Bankruptcy Act provision discussed.\5\

\5\See SBP at page 7767.

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Since bankruptcy is one of the situations in which a creditor's

security interest in the personal possessions of the debtor is most

likely to be at issue, a consistent federal standard as to which items

are protected is sensible. However, we have no evidence that the lack

of such a parallel standard is sufficiently problematic to warrant

amending the rule.

Alternatively, UAW-GM proposed that the list of specific items

included in the definition be described as illustrative and not

exclusive.\6\ In the SBP, the Commission stated its intention to limit

coverage to necessities and to the class of goods for which the injury

to consumers from a security interest exceeds offsetting benefits.\7\

Conceivably, the Rule could be expanded to apply to any other items

meeting that test. However, this could raise certain enforcement

difficulties. It is not clear that, if a creditor took a security

interest in items not enumerated as household goods, the Commission

could establish the requisite knowledge on the part of the creditor to

bring a civil penalty action for a rule violation.\8\ Again, we have no

evidence of problems with the Rule's current definition of household

goods sufficient to justify an amendment to the Rule.

\6\In contrast, the Missouri Bankers Association stated that

there should be no expansion of the definition of household goods

and that any expansion would restrict the collateral that could be

provided by consumers who are not homeowners.

\7\See SBP at pages 7767 and 7768.

\8\Section 5(m)(1)(A) of the FTC Act states that:

The Commission may commence a civil action to recover a civil

penalty * * * against any person * * * which violates any rule under

this Act respecting unfair or deceptive acts or practices * * * with

actual knowledge or knowledge fairly implied on the basis of

objective circumstances that such act is unfair or deceptive and is

prohibited by such rule. (Emphasis added.)

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ii. Property Insurance

The NCLC presumes that creditors take security interests in the

consumer's personal property in order to sell excessively priced

property insurance to the consumer and that the Rule should be amended

to address this problem. The Truth in Lending Act and Regulation Z

impose disclosure requirements relating to the sale of property

insurance by creditors.\9\ Given the legal restrictions on the

Commission's ability to regulate the business of insurance, this agency

may not have the authority to address the pricing of insurance directly

or the expertise to determine what constitutes fair pricing.\10\ We

found no evidence to justify attempting to do so as an amendment to the

Rule.

\9\Section 226.4 of Regulation Z, which implements the Truth in

Lending Act, allows creditors to exclude such insurance premiums

from the finance charge if the insurance coverage may be obtained

from a person of the consumer's choice, if that fact is disclosed to

the consumer, and if the coverage is obtained through the creditor,

the insurance premium and the term of the insurance are disclosed.

\10\See McCarran-Ferguson Act, 15 U.S.C. 1012.

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iii. Cross-Collateralization

Williams & Eoannou observed that the use of cross-collateral

security clauses in revolving charge agreements is increasing. The

commenter notes that the Rule as initially proposed would have

prohibited such clauses, and that that provision was deleted from the

final rule.\11\ The Commission is urged by the commenter to amend the

Rule to prohibit the use of cross-collateral.

\11\According to the SBP:

Cross-collateralization occurs when goods purchased from a

retailer on credit are used to secure credit extended for subsequent

purchases until the account is cleared. A provision of the proposed

rule that we have decided not to promulgate would have restricted

cross-collateral clauses in installment sales contracts.

Essentially, the provision would have required first-in, first-out

accounting for credit contracts covering multiple purchases.

SBP, 49 FR 7740, 7786 (March 1, 1984).

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The Commission did not adopt the provision initially because it

found insufficient evidence in the record that the use of cross-

collateral clauses was prevalent or that cross-collateral, when used,

caused any notable degree of consumer injury. It, therefore, concluded

that the benefits of the provision would not outweigh its costs.\12\ As

the comment did not provide specific information about the prevalence

of cross-collateralization or the degree of injury resulting from its

use, we find no basis for revising that conclusion.

\12\See SBP at page 7786.

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b. Notice to Cosigners

Commenters addressed various aspects of the Rule's cosigner

provision, which will be discussed in turn below.

i. Definition of Cosigner

UAW-GM stated that the cosigner definition should be clarified. The

Rule defines a cosigner as a person who is ``liable for the obligation

of another person without compensation.'' A person is considered not to

have received compensation if that person does not receive goods,

services, or money in return. According to the commenter, in connection

with the financing of automobiles, the cosigner's name is sometimes

placed on the title to the vehicle with the name of the purchaser in

order to avoid the Rule's protections for cosigners.

The commenter states that this is done without the cosigner's

knowledge in situations where the cosigner has no actual access to the

vehicle securing the loan. The cosigner's name on the title suggests

that he has received an ownership interest in the car in exchange for

his commitment to pay and is, therefore, not a cosigner within the

meaning of the Rule. According to UAW-GM, the Commission should amend

the Rule to make clear that, in the absence of an actual possessory

interest in the security, the Rule should apply.

At the time the Rule was promulgated, the Commission

[[Page 24807]] considered comments stating that the cosigner provisions

of the Rule could be avoided by requiring potential cosigners to become

co-applicants for credit. In response, the Commission revised the final

Rule to define as a cosigner ``any person whose signature is obtained

after the initial applicant is told that the signature of another

person is necessary.''\13\ The cosigner definition also states that:

\13\Id. at page 7778.

A person is a consigner within the meaning of this definition

whether or not he or she is designated as such on a credit

obligation.\14\

\14\16 CFR 444.1(k).

Thus, the Commission clearly intended that the definition of

cosigner turn on the circumstances under which the person became

obligated to pay rather than how the person is characterized by the

creditor on the documents evidencing the transaction. Accordingly, the

current Rule would apply to the situation described by the commenter.

In addition, the Rule currently states that it is a deceptive act

or practice for a creditor, ``directly or indirectly, to misrepresent

the nature of extent of cosigner liability to any person.''\15\

Therefore, it should be possible to challenge creditor practices that

seek to avoid the effect of the rule by concealing the cosigner's

status. Such a challenge may be made using the existing provision

without the necessity of amending the Rule.

\15\16 CFR 444.3(a)(1).

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ii. Cosigner Liability

UAW-GM also stated that the Rule should provide that a creditor

cannot collect from a cosigner who was not given the required Notice.

The commenter observed that the Federal Reserve Board (``FRB'') Staff

Guidelines on that agency's version of the Rule\16\ say that an attempt

to collect from a cosigner who did not receive the Notice is a

violation of the Rule.\17\

\16\50 FR 47,036 (1985) and 51 FR 39,646 (1986), Q14(a)-2.

\17\Section 18(f) of the Federal Trade Commission Act requires,

within 60 days after the Commission issues a trade regulation rule

declaring certain acts or practices to be unfair or deceptive, that

the bank regulatory agencies issue a substantially similar rule for

creditors subject to their jurisdiction unless the agencies find

that the practices of their creditors are not unfair or deceptive or

that to promulgate such a rule would ``seriously conflict with

essential monetary and payment systems policies. . . .''

Accordingly, the FRB and other agencies issued their own versions of

the Rule.

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The SBP does not indicate that the Commission considered the

question of the private enforceability of consumer credit contracts

entered into in violation of the Rule. The FRB, which followed the

Commission's lead, did consider this question, as did the Federal Home

Loan Bank Board (``FHLBB'')\18\. Making a contract entered into in

violation of the Rule unenforceable against the cosigner could

potentially provide a private enforcement mechanism for consumers and

give creditors an additional incentive to comply. However, the

commenter provided no information about the actual experience of

cosigners with creditors subject to the other regulatory agencies'

versions of the Rule, including whether their versions effectively

prevented violations or provided relief to consumers. Consequently, the

Commission lacks sufficient information to decide that a proceeding to

amend the Rule in such a manner is justified.

\18\The FHLBB is now the Office of Thrift Supervision (``OTS''),

Department of the Treasury.

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iii. The Notice as a Separate Document

The three credit union-related associations asked that the Rule be

amended to permit creditors to include the Notice in the documents

evidencing the consumer credit obligation rather than requiring that it

be a separate document. The commenters noted that the versions of the

Rule promulgated by the National Credit Union Administration

(``NCUA''), the FRB, and the OTS do not require the notice to be on a

separate document. While the commenters requested this change primarily

for the benefit of creditors, the Illinois Credit Union System also

expressed the view that consumers would be better served if they

received a document that included both the Notice and the terms of the

credit obligation.

In the SBP, the Commission explained its reason for requiring that

the Notice be a separate document:

The purpose of this requirement is to assure that the cosigner

will actually become aware of the notice before becoming obligated.

Thus, the notice document cannot be affixed to other documents

unless the notice document appears before any other document in a

package, and it may not include any other statement * * *.\19\

\19\SBP at page 7778.

Thus, if the result of combining the Notice with the contract were

to make the Notice's message less meaningful to the consumer, as the

Commission believed, this benefit would come with a substantial cost to

the consumer. On balance, and in the absence of information about the

experience of cosigners with creditors subject to the other regulatory

agencies' versions of the Rule, we have determined to retain the

existing cosigner notice provision.

c. Other Rule Provisions

i. Third Party Contacts

The NCLC stated that many creditors continue to contact third

parties in order to coerce consumers into paying debts. When the Rule

was enacted, the Commission considered, but rejected, a provision to

prohibit most creditor contacts with third parties.\20\ The Commission

stated that the record in the rulemaking proceeding did not contain

evidence of widespread abusive third party contacts, that the cost of

the provision would outweigh its benefits, and that the Commission

considered a case-by-case approach more appropriate ``to stem abusive

third party contacts without restricting legitimate contacts.''\21\ We

feel that this approach has been adequate to deter abusive third party

contacts.\22\

\20\Id. at pages 7785-7786.

\21\Id.

\22\Since the Rule was enacted, the Commission has brought one

case against a creditor for abusive third party contacts and other

unfair or deceptive debt collection practices. See Avco Fin. Serv.,

104 F.T.C. 485 (1984) (Consent Agreement).

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ii. Attorney's Fees

The NCLC also stated that consumers who pay creditors' attorney's

fees are routinely overcharged to subsidize the attorney's unsuccessful

collection efforts against other consumers. The Commission considered,

but rejected, a Rule provision prohibiting credit contract clauses

requiring that debtors pay attorney's fees incurred by creditors in

debt collection.\23\

\23\See SBP at pages 7784-7785.

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The Commission expressed the view that, because the proposed Rule

provision would not have restricted the power of courts to impose

attorney's fees on defaulting consumers under state law, the provision

might have had little effect. While the Commission found that most

creditors included attorney's fee provisions in contracts when

permitted to do so by state law, it found that the cost of restricting

this practice outweighed the benefits of doing so. Although the

Commission found that attorney's fees tend to be based on a percentage

of the amount of the outstanding obligation, and sometimes bear little

relation to the amount of work performed by the attorney, it stated

specifically that this does not imply that debtors overcompensate

creditors for their attorney's fees.\24\ Thus the Commission previously

rejected the premise of the NCLC comment. We have received no

information in connection with this [[Page 24808]] review that would

lead us to revise that position.

\24\Id.

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3. Impact of the Rule on Creditors

CUNA, the only creditor representative to discuss the subject,

stated that ``Generally, credit unions have not reported any

significant economic or regulatory impact on their operations due to

this rule.''

4. Proposed Changes to the Rule to Benefit Creditors

The Missouri Bankers Association posited that the Rule provision

prohibiting the pyramiding of late fees is not sufficiently clear as to

what constitutes a late fee.\25\ The Association questioned whether a

returned check fee, for example, would be a late fee under the Rule,

and, if so, whether the creditor would be permitted under the Rule to

collect it.

\25\The three credit union-related associations asked that the

Rule be amended to permit creditors to include the Notice in the

documents evidencing the consumer credit obligation rather than

requiring that it be a separate document, as discussed above.

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This comment calls for an explanation of the Rule, rather than a

modification to it.\26\ The Rule does not prohibit a creditor from

collecting a late fee, nor would it prohibit a creditor from collecting

a returned check fee. The Rule states that, where a charge is assessed

with respect to only one late payment and that charge remains unpaid,

the creditor may not for that reason deem all subsequent payments to be

late or incomplete and assess late charges with respect to those

payments as well.

\26\The Commission has handled inquiries of this nature through

staff interpretation letters, which are placed on the public record.

To date, more than 70 such letters interpreting the Rule have been

issued.

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In the example provided by the commenter, if one check was returned

for insufficient funds, the creditor could assess a returned check fee

if permitted by state law and the terms of the contract to do so. What

the creditor could not do, assuming the consumer did not promptly pay

the returned check fee, is to declare all subsequent payments to be

late or incomplete solely for that reason and assess fees on those

payments.

5. Effect on Other Regulations

Except for the comparisons to the Federal Reserve Board and other

agencies' versions of the Rule discussed above, no commenter discussed

the Rule's effect on other federal, state or local laws or regulations.

6. Effect of Technology or Economic Conditions

No commenter discussed the effects, if any, of changes in relevant

technology or economic conditions on the Rule.

7., 8., and 9. Effect on Small Businesses

According to CUNA, the Rule applies to 5,000 state-chartered credit

unions.\27\ CMIG states that the majority of those credit unions have

assets of $100 million or less. Thus, they are considered to be small

entities for the purposes of the RFA.\28\ The only burden that the

commenters who claim to represent such entities identified as having

been imposed by the Rule on small entities was the requirement

discussed above of providing the cosigner notice as a separate

document.

\27\Federally-chartered credit unions are subject to the NCUA's

version of the Rule.

\28\See Small Business Size Regulations, 13 CFR Part 121.601.

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10. The Notice to Cosigner

No commenter discussed the wording of the notice.

11. Effect on the Cost and Availability of Credit

As mentioned above, CUNA stated that its members generally reported

no significant economic impact on their operations due to the Rule.

Williams & Eoannou stated that the Rule has had no negative impact on

the cost or availability of credit and that the use of credit by

consumers has increased since the Rule became effective. NCLC provided

statistics purporting to show the increase in consumer debt in the

years following the Rule's implementation. In its view, this increase

can be explained in part by increased consumer demand for what became,

as a result of the Rule, a more attractive type of credit. No commenter

suggested any adverse economic impact from the Rule.

12. Disclosure Alternative to the Rule

No commenter addressed the question of an alternative Rule that

would require disclosure of the existence of contract provisions that

might cause injury to consumers, as opposed to restricting the use of

such provisions.

III. Conclusion

The Notice attracted limited public interest. The discussion of

issues relating to small entities, the parties protected by the RFA,

was minimal. A number of varying suggestions were made to expand the

Rule, but none of these had extensive support.

After carefully considering the comments, the Commission believes

that they do not present a sufficient basis to conclude that the Rule

has had a significant impact on a substantial number of small entities.

Similarly, none of the other issues raised in the comments merits

revision of the Rule at this time. The Commission is therefore

terminating this review.

List of Subjects in 16 CFR Part 444

Federal Trade Commission, Consumer credit contracts, Consigner

disclosures, Trade practices, Truth in Lending.

Authority: The Regulatory Flexibility Act, 5 U.S.C. Section 601

(1980).

By direction of the Commission.

Donald S. Clark,

Secretary.

[FR Doc. 95-11360 Filed 5-9-95; 8:45 am]

BILLING CODE 6750-01-M