CFPB Takes Action Against Auto Seller Financing, Construes Failure to Negotiate as Hidden Finance Charge

By: Todd C. Smith

On January 21, 2016, The CFPB (the “Bureau”) issued Consent Order Y King S Corp., d/b/a Herbies Auto Sales, finding various violations of the Truth in Lending Act, 15 U.S.C. §§ 1601 et seq., and Regulation Z, 12 C.F.R. Part 1026; and the Consumer Financial Protection Act of 2010 (CFPA), 12 U.S.C. §§ 5531, 5536. (2016-CFPB-0001 (Jan. 16, 2016).) Among other violations, the Bureau found that Herbies Auto Sales (“Herbies) failed to accurately disclose the finance charge and annual percentage rate for financing agreements, as well as certain costs and discounts that should have been construed as finance charges. Cash purchasers were notably exempt from many of these costs. The Bureau also found that Herbies took unreasonable advantage of consumers, who were unable to protect their interests in selecting and obtaining financing for used car purchases.

Herbies’ sales practices also drew condemnation by the Bureau, which found purchasers’ ability to meaningfully comparison shop frustrated by Herbies’ policy of not disclosing the sale price of a vehicle until after credit purchasers had agreed to buy the car chosen for them, based on Herbies’ calculation of the monthly payment each credit purchaser could bear.

While the majority of the remedial portion of the Consent Order appears narrowly applicable to Herbies—including the requirement that Herbies obtain a signed acknowledgment of receipt of specific disclosures relating to the sale price and finance terms of future sales— the Bureau’s most significant determination may be its decision to construe the gap in average purchase price between cash and credit purchasers as a hidden finance charge in the form of a discount offered to cash purchasers. This decision to hold Herbies responsible for the disparity in bargaining power between cash and credit buyers may prove more significant to other targets of the Bureau’s enforcement activity going forward. It remains to be seen whether the Bureau will extrapolate its findings to other contexts outside of used car sales, in which cash and credit are used for consumer purchases.

U.S. Supreme Court to Decide ECOA Circuit Split: Can Spouses be Required to Sign Personal Guaranties?

By: Joe Patry

The Equal Credit Opportunity Act (“ECOA”), 15 U.S.C. § 1691 et seq. was enacted in 1974 “to eradicate credit discrimination waged against women, especially married women whom creditors traditionally refused to consider for individual credit.” Mays v. Buckeye Rural Elec. Coop., 273 F.3d 837 (6th Cir. 2002), at 5 (all references to pagination is to the pagination in the .PDF copies of the cases to which this post links). Under ECOA, a creditor cannot discriminate deny an application for credit solely because of that person’s marital status. See 15 U.S.C. § 1691(a).

Based on recent decisions, the Courts of Appeal for the Eighth Circuit and Sixth Circuit are split on the question of whether a creditor may require a spouse to execute a personal guaranty for a loan. If a guarantor is considered an “applicant” under ECOA, then requiring a spouse to guarantee a loan violates ECOA and may allow the spouse to use the affirmative defense of recoupment to avoid enforcement of the personal guaranty.  Last month, the Supreme Court of the United States granted the writ of certiorari to resolve this circuit split.  The case has not yet been set for argument.

In Hawkins v. Community Bank of Raymore 761 F.3d 937 (8th Cir. 2014), the husbands of Plaintiffs Valerie J. Hawkins and Janice A. Patterson were the two members of PHC Development, LLC (“PHC”).  Id. at 2. Patterson and Hawkins themselves had no interest in PHC.  Id.  From 2005 to 2008, Community Bank of Raymore (“Community”) made four loans to PHC, totaling $2,000,000. Id.  Hawkins, Patterson and their husbands signed personal guaranties on the loans.  Id.  The loans went into default and Community demanded payment not only from PHC but also from Hawkins and Patterson as guarantors.  Id.

Hawkins and Patterson sued Community, asserting that Community violated ECOA when it forced them to execute the guaranties solely because they were married to their husbands – the members of PHC.  Id.  Further, Hawkins and Paterson claimed that because of the alleged ECOA violation, the personal guaranties were unenforceable against them.  Id.  The trial court found that Hawkins and Patterson were not “applicants” within the meaning of ECOA and thus there was no ECOA violation, and granted summary judgment for Community.  Id.

On appeal, the Eighth Circuit noted that ECOA makes it “unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction . . . on the basis of . . . marital status.”  Id. at 3 (citing 15 U.S.C. § 1691(a)).  An applicant is any person who applies “directly” to a creditor for “an extension, renewal, or continuation of credit . . . .”  Id. (citing 15 U.S.C. § 1691a(b)).  Interpreting this definition, the Federal Reserve Bank promulgated 12 C.F.R. § 202.2(e), which provides that the definition of “applicant” under ECOA includes guarantors.  Id. 

Under the Chevron doctrine, federal courts typically defer to a federal agency’s interpretation of a statute if (1) the statute is ambiguous or unclear and (2) if the agency’s reading is reasonable in light of Congress’s intent.  Id.  at 4; Chevron U.S.A. v. Natural Resources Defense Counsel, 467 U.S. 837 (1984). If the statute is clear, then the analysis stops and the second step is irrelevant. Hawkins at 4. Applying the first step of the Chevron doctrine, the Eighth Circuit found that ECOA was clear that a guarantor is not an applicant because ECOA requires that, to be an applicant, a person must request credit directly from a creditor.  Id.   However, when making a guaranty, a person does not request credit.  Id.  Rather, a guaranty is collateral and security for an underlying loan; although a guarantor makes the guaranty so that credit will be extended to a borrower, providing a guarantee does not constitute a request for credit.  Id.

The Hawkins court noted that the Sixth Circuit recently reached a contrary conclusion in RL BB Acquisition, LLC v. Bridgemill Commons Dev. Grp., 754 F.3d 380 (6th Cir. 2014), where BB&T required the borrower’s wife to execute a guaranty on a commercial loan.  Id. at 3.  In RL BB, the borrower’s wife claimed that this requirement violated ECOA, and she argued that the personal guaranty was thus unenforceable.  Id. at 4.  The trial court in RL BB ruled against the borrower’s wife and found that the guaranty was enforceable.  Id.

On appeal, the Sixth Circuit noted that the Federal Reserve has interpreted ECOA as prohibiting a creditor from requiring an applicant’s spouse from guaranteeing a security instrument.  Id. at 5.  While the Sixth Circuit noted that ECOA does not explicitly define an applicant to include a guarantor, the Sixth Circuit highlighted that the Federal Reserve’s regulations define an applicant as a guarantor (meaning that a guarantor would be able to sue for an ECOA violation).  Id. 

Applying the first prong of the Chevron doctrine, the Sixth Circuit found that an ambiguity existed in ECOA’s definition of “applicant” because a guarantor approaches a creditor in the sense that she offers her own personal liability if the borrower defaults.  Id.  Further, the Sixth Circuit explained that a guaranty is made in consideration of the borrower’s receiving credit.  Id.  The Sixth Circuit explained that an “applicant” requests credit, but credit is the right granted by a creditor to a debtor to defer payment of debt.  Id.  Thus, the Sixth Circuit found that an applicant requests credit but the debtor enjoys the benefit of the credit, and as a result, an applicant and the debtor could be different persons.  Id.  Looking at the larger purpose of ECOA to prevent discrimination “in any respect” of a credit transaction, the RL BB court reasoned that the broad remedial goal of the statute meant that the term applicant could be ambiguous.  Id. 

Because the Sixth Circuit found that the term “applicant” could be ambiguous, the court continued from where the Eighth Circuit stopped and moved on to the second prong of the Chevron analysis.  Id. With respect to the second prong, the Sixth Circuit found that because an “applicant” could include a guarantor (and that a creditor could not require a spouse to be a guarantor), the Federal Reserve’s interpretation in Regulation B was reasonable and thus entitled to deference.  Id.  Because the borrower’s wife impermissibly had been required to execute a personal guaranty, the personal guaranty was not enforceable and the Sixth Circuit reversed the lower court’s finding and allowed the borrower to use the affirmative defense of recoupment to prevent the enforcement of the guaranty.  Id. at 12.

Lenders that require a personal guaranty from a spouse should monitor the Supreme Court’s resolution of this circuit split. If the Supreme Court agrees with the Sixth Circuit, creditors should ensure that spouses are not required to execute personal guaranties on loans, as such guaranties may well be unenforceable.

Supreme Court Rules that Written Notice Is Sufficient to Rescind Under TILA

By: Daniel A. Cozzi and Diana M. Eng

The Supreme Court of the United States recently held that a borrower can exercise its right to rescind a loan pursuant to the federal Truth in Lending Act (TILA) by providing written notice to the lender within three (3) years of the loan closing date. In doing so, the Supreme Court reversed the Court of Appeals for the Eighth Circuit’s affirmation of the District Court of Minnesota’s decision, which had held that a borrower must file a lawsuit within three (3) years of the consummation of the loan to exercise his/her rescission rights.

In Jesinoski v. Countrywide Home Loans, Inc., the United States Supreme Court considered “whether a borrower exercises this right by providing written notice to his lender, or whether he must also file a lawsuit before the 3-year period elapses.” Jesinoski v. Countrywide Home Loans, Inc., No. 13-684, 574 U.S. _____ (2015).

Under TILA, borrowers have the right to rescind certain consumer mortgage transactions up to three days after the loan closes. Specifically, TILA grants borrowers the right to rescind a loan transaction, “until midnight of the third business day following the consummation of the transaction or the delivery of the [disclosures required by the Act], whichever is later, by notifying the creditor, in accordance with regulations of the [Federal Reserve] Board, of his intention to do so.” 15 U.S.C. 1635(a). However, if the creditor fails to provide requisite TILA disclosures, a borrower may rescind the transaction up to three years from the date the loan closes. 15 U.S.C. 1635(f).

On February 23, 2007, Larry and Cheryle Jesinoski (“Petitioners” or “Jesinoskis”) refinanced their home loan and obtained a mortgage from Countrywide Home Loans, Inc. (“Respondent” or “Lender”) in the amount of $611,000. Exactly three years later, the Jesinoskis mailed a purported rescission notice to Lender. The Lender responded on March 12, 2010 and refused to acknowledge the validity of the rescission. On February 24, 2011 – one year after the Jesinoskis sent their notice of rescission, the Jesinoskis filed suit in the District Court of Minnesota, seeking rescission of the mortgage and damages.

The District Court agreed with the Lender and held that the Petitioners were barred from exercising rescission pursuant to TILA, as they had failed to file a lawsuit within three years of the consummation of the loan. Jesinoski v. Countrywide Home Loans, Inc., 2012 WL 1365751 (D. Minn. Apr. 19, 2012). The District Court found that the Petitioners’ written notice within three years was insufficient to exercise their rescission rights. The Eighth Circuit affirmed. Jesinoski v. Countrywide Home Loans, Inc., 729 F. 3d 1092 (8th Cir. 2013) (per curiam). The Eighth Circuit relied on its prior decision in Keiran v. Home Capital, Inc., 720 F. 3d 721 (8th Cir. 2013), which held that a borrower must file a lawsuit for rescission within three years of the loan’s consummation to exercise rescission rights under TILA.

The Supreme Court disagreed with the District Court and the Eighth Circuit, holding that “Section 1635(a) explains in unequivocal terms how the right to rescind is to be exercised: It provides that a borrower ‘shall have the right to rescind . . . by notifying the creditor’ . . . of his intention to do so’ (emphasis added). The language leaves no doubt that rescission is effected when the borrower notifies the creditor of his intention to rescind.” The Supreme Court further declared that the “statute does not also require him to sue within three years.”

Lender raised several additional arguments that the Supreme Court ultimately dismissed. First, Lender argued that TILA rescission only requires written notice (and not legal action) when the parties dispute the adequacy of the TILA disclosures (e.g., whether the borrower is actually entitled to the three-year rescission period rather than the three-day rescission period). The Supreme Court found that Section 1635(a) makes no distinction between disputed and undisputed rescissions. Second, Lender argued that pursuant to the common law, rescission requires that a borrower tender the proceeds received under the transaction prior to rescission. The Supreme Court also dismissed this argument, finding that TILA rescission need not follow the rules and procedures of “its closest common-law analogue.” The Supreme Court further stated, “[t]o the extent §1635(b) alters the traditional process for unwinding such a unilaterally rescinded transaction, this is simply a case in which statutory law modifies common-law practice.”

In light of this decision, lenders should be aware that a written notice provided by the borrower, within three years of the loan consummation is sufficient to exercise his/her right to rescission under TILA. However, the Supreme Court provided no guidance on when a lawsuit must be commenced after written notice of rescission is sent.

U.S. Regulators Approve Risk Retention Rules For Mortgage Backed Securities

By: Daniel A. Cozzi

On October 22, 2014 The Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; U.S. Securities and Exchange Commission; Federal Housing Finance Agency (FHFA); and Department of Housing and Urban Development adopted rules to implement the credit risk retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act, enacted in 2010, requires the implementation of stricter rules governing mortgage-backed securities. The adopted rules seek to balance the importance of the securities market in providing credit to homeowners with appropriate underwriting standards, in light of the 2008 financial crisis. (“During the financial crisis, securitization transactions displayed significant vulnerabilities arising from inadequate information and incentive misalignment among various parties involved in the process.”) See Joint Final Rule to implement the requirements of section 941 of the Dodd–Frank Act.

Under Dodd-Frank, firms which issue mortgage-backed securities must retain a portion of the risk or demonstrate that the mortgages are held by borrowers with an ability to repay the debt. These risk retention requirements are meant to ensure that lenders retain some “skin in the game.” The rules require that lenders retain 5% of the risk associated with mortgages packaged as securities or comply with Consumer Financial Protection Bureau rules governing borrower debt-to-income ratios. The latter exception would require that lenders verify that a borrower can repay the debt and comply with other requirements, such as verification that the borrower’s debt payments do not exceed 43% of his or her income.

The new rules go into effect in the Fall of 2015 and will only impact the market for private securities. Securities sold to Fannie Mae and Freddie Mac are exempt from the new rules.

Proposed Amendment to 2013 Mortgage Rules May Provide Some Limited Relief to Lenders and Servicers

By Louis Greenfield

On April 30, 2014, the Consumer Finance Protection Bureau (“CFPB”) issued three minor proposed changes to the mortgage rules, aimed at ensuring access to credit.  One of these proposed changes allows mortgage lenders to refund excess points and fees to borrowers, so that mortgages may remain classified as Qualified Mortgages and allow the lender to retain the protections from liability associated with these mortgages. This proposed change affects what is commonly known as the “Ability-to-Repay” rule under TILA (Regulation Z), and offers certain protections to Qualified Mortgages.

  • To be classified as a Qualified Mortgage, among other things, “the up-front points and fees charged in connection with the mortgage must not exceed 3 percent of the total loan amount, with higher thresholds for various categories of loans below $100,000.”
  • However, because determining the fees and points is often a complex process and involves judgment calls, there can be inadvertent errors.
  • This new proposed change will allow a lender to cure these inadvertent errors up to 120 days after the loan is made by refunding the excess points and fees to the consumer to the extent it exceeds the 3 percent threshold.  In particular, this ability to cure has three pre-requisites
    1. The creditor (or assignee) originated the loan with a good faith intention that the loan constitute a qualified mortgage and otherwise complied with other qualified mortgage pre-requisites, as defined under the regulation.
    2. The creditor (or assignee) must refund the dollar amount by which the points and fees exceed the applicable limit at consummation within 120 days after consummation of the loan; and
    3. The creditor (or assignee) must maintain and follow enumerated policies and procedures within the proposed changes for post-consummation review of loans and for refunding to consumers amounts that exceed the limit.

In short, this appears to be a welcome attempt by the CFPB at a limited safe haven provision for lenders or servicers who inadvertently exceed the 3 percent threshold on up-front points and fees. The CFPB is currently seeking public comment on this proposal.