consumer credit regulation: a creditor-oriented viewpoint

Consumer Credit Regulation: A Creditor-Oriented ViewpointAuthor(s): Homer KripkeSource: Columbia Law Review, Vol. 68, No. 3 (Mar., 1968), pp. 445-487Published by: Columbia Law Review Association, Inc.Stable URL: http://www.jstor.org/stable/1120896 .

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CONSUMER CREDIT REGULATION: A CREDITOR-ORIENTED VIEWPOINT

HOMER KRIPKE*

Consumer credit has been subject to a large variety of legal controls, some of them of general application like the usury laws and general principles of bankruptcy, fraud and duress, and some of them of special application like the small loan laws and the Retail Installment Sales Acts. In recent years, two movements for further legislation in this field have been dominant. One of these is a federal effort. It was for many years spearheaded by Senator Paul H. Douglas of Illinois and its leadership was taken over, after Senator

Douglas' 1966 election defeat, by Senator Proxmire of Wisconsin. Their bill, as finally passed in 1967 by the Senate,' offers a single panacea for all troubles in consumer credit, namely disclosure of the cost of credit on a simple interest

per annum rate. The other effort is that of the National Conference of Com- missioners on Uniform State Laws [NCCUSL] to produce a balanced code with regulatory as well as disclosure provisions that would replace the helter- skelter legislation in this field. Mention should also be made of a third movement for the passage in the states of "little Douglas bills," which in most cases go beyond the single Douglas-Proxmire panacea to include regulatory provisions, some of them of considerable stringency.2

The clamor from Better Business Bureaus, city and county attorneys, legal aid bureaus, social and welfare workers and others having contact with

wage earners and the unemployed poor shows that there is something seriously wrong in the social performance of consumer credit at the poverty level. To use Berle's phrases, the charge is that the consumer finance industry has not

yet achieved a satisfactory "corporate conscience" and has not yet become

subject to a "public consensus,"3-that is, it is not yet performing its function in a manner deemed acceptable to the public. Of course, it could hardly be

expected that the public would love its creditors; but the clamor goes beyond

* Professor of Law, New York University School of Law. Professor Kripke states: I was for 20 years associated with the consumer finance industry, in companies with important consumer finance departments, as staff counsel and an officer. This experience has irretrievably affected my thinking and it was, therefore, appropriate for the editors to suggest that my article on the topic of consumer credit be from the creditor point of view. I should point out, however, that during the period of my service as a Special Adviser to the NCCUSL Special Com- mittee, I had no commitment to any company in this field, and have none at present. 1. S.5, 90th Cong., 1st Sess. (1967). The House of Representatives considered and

reported a somewhat different bill, H.R. 11601, 90th Cong., 1st Sess. (1967). This bill was amended on the floor of the House and then passed February 1, 1968, under the Senate bill number, S. 5. There has been no conference report as this article goes to press.

2. E.g., MASS. ANN. LAWS chs. 140A, 255D (Supp. 1966). 3. A. BERLE, POWER WITHOUT PROPERTY 90-91 (1959). See also A. BERLE, THE

20TH CENTURY CAPITALIST REVOLUTION chs. II, III, V (1954); A. BERLE, ECONOMIC POWER AND THE FREE SOCIETY (1957).



COLUMBIA LAW REVIEW

this, and the rise in personal bankruptcies and wage adjustment gives evidence of deep dislocation.

Whether the present bills would bring the industry into conformity with the public interest is the theme of this article.

The present writer is not one who seeks to defeat reform legislation or refuses to lend it a helping hand on the plea that reform must come from the heart rather than from statutory enactment. While statutes may not alone do the job, they may at least satisfy the necessary conditions for an environ- ment in which the job can be done. Therefore, both legislative proposals must be approached from a sympathetic point of view, whether or not one shares the high hopes of their proponents.

Nevertheless, the general conclusion of this paper is that this drive for consumer protection must be viewed as a part of the current general movement encompassed by such slogans as "the war on poverty." These slogans are all to the good, and the writer does not intend to be supercilious about them. But setting the problem in this context should reveal how difficult the

problems are, and how little curable by dramatic legislation. As Professor Daniel P. Moynihan has said: "Somehow liberals have been unable to acquire from life what conservatives seem to be endowed with at birth, namely a

healthy skepticism of the powers of government agencies to do good."4

I. CLEARING AWAY THE MISCONCEPTIONS

Any movement in which emotions and intense convictions run high, particularly where liberals participate to help the underdog, gives rise to mis-

conceptions and distortions. On no subject is rational discussion made more difficult by these factors than on the subject of consumer credit. Before the current legislation is examined, some of these pre-conditioning emotional factors must be dealt with.

A. Religious Emotionalism in Usury Questions

The subject of interest and usury has been distorted and indelibly colored

by a religious background based on quotations from Exodus and Deuteronomy, which the medieval church construed to forbid taking interest altogether and the later church construed to forbid taking more than a reasonable interest. This part of the story has been told many times.6 It is perhaps more difficult to trace the manner in which the magic figure of 6% per annum became the reasonable rate of interest, and anything higher a subject of pejoratives like

4. Moynihan, Riots: Where the Liberals Went Wrong, Boston Globe, August 5, 1967, ? A at 5.

5. See, e.g., R. TAWNEY, RELIGION AND THE RISE OF CAPITALISM passim (1922); Hershman, Usury and the Tight Mortgage Market, 22 Bus. LAWYER 333, 334-35 (1967); Bernstein, Background of a Gray Area in Law: The Checkered Career of Usury, 51 A.B.A.J. 846-48 (1965).

[Vol. 68:445 446



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usurious, bloodsucking, oppressive, and so forth.6 A "6% myth" is found

by many investigators to be the basis of consumers' expectations about the normal charge for credit.7

At any rate, the type of state legislator who is always ready to defend motherhood and the American flag has a field day with any effort to breach

visibly the 6% ceiling. Thus, in a number of states, including such important ones as New York, New Jersey and Pennsylvania, that ceiling has never been generally breached. The survival and the depth of these attitudes is an

important fact of life. A striking example occurred as late as the spring of 1967, when even top-rated utilities and other corporations were paying better than 6% per annum on their bonds (made possible by the inapplicability of the New York usury law to corporations) ; the New York legislature denied a request of the highly respected New York savings banks for per- mission to charge more than 6% per annum on home mortgages, even though the refusal meant that New York savings would be transferred out of the state.

B. The High Expense Factor in Consumer Credit

Yet long before the present credit stringency, which has breached the

6% figure for even prime borrowers in wholesale quantities, the 6% per annum "myth" was an anachronism in the field of consumer credit. There were two reasons for this.

First and more important, the handling cost of small credit amounts, particularly with installment repayment terms, is of a totally different order of magnitude from the handling cost of the typical bank loan or term credit. When consumer credit revived toward the end of World War II, it was

commonly said that it cost 60 times as much to handle a dollar of consumer credit as it did to handle a dollar of ordinary bank loans. It costs no less to record a $13 monthly installment payment than it does to record the single payment of a $100,000 note, and the cost of handling the remittance in the bank collection system is no smaller. Indeed, the handling cost of a smaller item may be higher, because the $13 item may be brought in cash to a counter or paid with a money order, an endorsed payroll check or the like, instead of

being paid directly by check.

Second, no matter how careful the credit approval, some percentage of consumers are going to lose their jobs, experience family illness, or otherwise become unable to pay, and the losses experienced even in the most conserva-

6. The writer remembers, from his days as a student, a law professor thundering from the platform: "The law knows no other interest rate than 6% per annum!"

7. W. MORS, CONSUMER CREDIT FINANCE CHARGES: RATE INFORMATION ANI) QUOTA- TION 88 (1965) [hereinafter cited as MORS]; F. JUSTER & R. SHAY, CONSUMER SENSI- TIVITY TO FINANCE RATES: AN EMPIRICAL AND ANALYTICAL INVESTIGATION 60 n.15 (1964) [hereinafter cited as JUSTER & SHAY].

1968] 447



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tively administered companies cause a higher loss ratio and collection expense than in traditional bank lending or institutional term lending.

The greatly increased salary scale in the white-collar fields since World War II has aggravated these problems. Expenses are held in line in the consumer field only by increasing standardization of handling, especially mech- anization through one-time-carbon multiple forms and use of the whole new technology of computers, tapes, and so forth, both for handling and for accounting. One significant consequence of this is that every nuance of regulation that forces individual handling or variation from routine adds greatly to

expense. The cost of labor is frequently the largest single item of expense, greater even than the interest cost of the money borrowed by the credit grantor.

While the writer recommends (as will appear below) acquiescence in the current drive to force all rate disclosure into the pattern of simple interest per annum, it must be recognized that the expense of handling, including normal losses, produces normal rates of 12% to 36% per annum, and even

higher minimum charges for very small amounts and short terms. It is not realistic to work up moral indignation based on the comparison of these numbers with the 6% myth.

C. The Folklore of the Rapacious Repossessing Creditor-and the Real Evil

For this reason the writer earnestly believes that the archetype of the creditor as rapaciously eager to repossess, to profit hugely by resale and otherwise to oppress the debtor, is in large part an archmyth, at least as applied to creditors catering to middle-class buyers. In the first place, resale markets for consumer goods with the exception of automobiles are so poor that the alleged resale profits are a fantasy. More important, a company of institutional size simply cannot afford the amount of individual handling by persons capable of making decisions that would be necessary to operate oppres- sively.8 Even if every dollar of principal and finance charge is ultimately realized by collection, an account that requires individual collection handling yields a loss. When expectations are defeated, the creditor no doubt tries to collect, with greater or lesser zeal; but that a creditor of institutional size deliberately walks into a collection struggle at the inception of the credit is to this writer unbelievable.

This is not to say that there is no room for criticism of business of substantial size. Recent incidents in automobile and drug safety and other exam- ples have shown the contrary, and the credit business is no exception. But

8. To every statement there are exceptions. The writer once participated in a company decision not to participate in financing the type of oppressive second mortgage consolidating loan where the "fees" and other charges tended to run as much as 50% of the amount of the loan. The writer was shocked to find local companies of significant size participating in that kind of financing.

448 [Vol. 68:445




neither is big business necessarily evil, even in credit situations where there are numerous enforcement proceedings. One must recognize that business morals are in a state of evolution.9 Yet one can still say that the social quality of responsible business is generally below the social quality of the individuals who compose it, for business operates on the quantitative basis of profit, not the qualitative basis of social performance.10 The self-interest of business alone makes the writer disbelieve that credit grantors of substantial size, with reputations to protect in the financial world, walk into specific credit-

granting situations knowing that there will be a collection problem to sweat out.11 On the other hand, since in consumer credit the consumer's principal

9. Lippmann, 1968-The GOP's Big Chance, New York Post, Dec. 16, 1967, at 27: In the upper class, among the managers and owners of corporate industry,

there has been a revolutionary change of attitude since the first appearance of big business. There has been developing a remarkable sense of obligations of power by the men who have become used to the exercise of power. The age of the robber barons and of the sweatshop capitalists has passed away and in the great modern corporate aggregations there is a new generation of managers who realize that they are part of a new form of social organization.

The old concepts of the economists and of the reformers do not fit the :Facts any longer. They do not describe these men who conduct enterprises which are a mixture of public and private participation and who have learned that while they must work for private profit they must serve the public welfare. This new form of economic organization has been identified by Prof. Kenneth Galbraith. We are living in a post-capitalist and post-Marxian era. Like so many epoch- making changes in man's affairs, the new epoch has begun before the men who live with it are fully aware of it. 10. Cf. Briloff, The Responsibilities of the CPA for Fair Corporate Accountability,

FINANCIAL ANALYSTS J., May-June, 1966, 51 at 52-53: Second, closely related to this acceptance of the corporate entity is our

acceptance of the postulate of "Quantification" as the basis for making rational economic decisions, as an effective means of description, and as basic to the communication of qualitative information about the enterprise. This abject acceptance of quantification ignores such expressions of concern as Kenneth Boulding's: "Things which are not so easily measured in dollars, however, such as morale, good or ill feeling . . . and so on, do not find such ready entrance either to the information system or to the consciousness of the businessman. These things may be just as important in the long run for the survival of his business, however, as the accounting magnitudes on which he is so fully informed." 11. The major sales finance companies have always contended that the consumer is

his own best creditman. Thus, Dr. Sidney Rolfe (then economist for C.I.T. Financial Corporation) said in NATIONAL INDUSTRIAL CONFERENCE BOARD, TIE ECONOMICS OF CONSUMER DEBT (STUDIES IN BUSINESS ECONOMICS No. 50) 20-21 (1955):

.. .And so there had to be a fundamental collateral value, at least at the outset, to make a mass market possible.

What happened is that instalment credit markets were a little too successful in the sense that there never occurred any really significant losses from default. In 1931-1932, everybody thought that sales finance debt would never be repaid and that severe losses would occur. But this didn't happen. The record in that period was that about 85% of the outstanding debt was liquidated within one year, and the balance very shortly thereafter, with very little loss of equity.

It was a very good voluntary record and one of the things that changed people's minds about instalment credit. The consumer had proved himself an excellent credit manager, fundamentally honest, and anxious to keep his car or other durables, even while foregoing other items. As this success became apparent, the industry felt free to leave the collateralized base and move more and more towards personal credit. The banking system, in its entry into the consumer credit field, moved into the area of personal credit much further than other institutions . ...

. .. There is good reason for favoring a collateralized concept. Briefly,

1968] 449



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"asset" is his job, the law of averages makes certain that some percentage of credit extensions will go into default, even those of a conservative and careful creditor. The economic growth made possible by sales financing in middle-class contexts has been well worth the social cost of these defaults. But recent evidence makes it clear that the growth of the urban slums, welfare loads and our "revolution of rising expectations" has extended the instalment

buying system beyond the middle class to levels that the companies which

pioneered the sales finance system would never have touched. In the process merchants use shocking sales tactics to overload the consumers with debt for

shoddy merchandise, and find financing to meet their needs. And it may be

argued that even without overt oppression, the percentage of defaults and forceful collection at these levels raises serious question as to the social utility of the credit-extension process. Credit has become increasingly available to, and even forced on, persons of lower and lower economic strata, thus increas-

ing the percentage of cases of default. Vigorous collection efforts and garnishment become necessary, and bankruptcy comes to seem a desirable way out.12

Even in reputable financing, once the credit is extended and a default occurs, an irresistible dynamic takes hold, the result of the profit mainspring of the private sector of the economy, and more particularly of the bloodless- ness of the "Organization Man" and the impersonality of the public company. Men who are compassionate in personal affairs feel that they cannot be com-

passionate in their business affairs with other people's money, "I can't do it, because we're a public company." Here more than in the idea of "overreach-

ing creditors"13 at the time of credit extension lies "the immorality of large organizations" which Moynihan, following Niebuhr, finds to be "the central danger of the age."14

But these are strong words. Moynihan has elsewhere recognized that in our present "time of troubles"15 liberals must unite with responsible conservatives, and that government is unlikely to provide the money needed in the poverty areas.16 Certainly government is not going to take over the credit

the sales finance industry has found that excesses in credit are self-correcting, without outside control.

But the major companies were always oriented toward the purchaser of new cars or high grade used cars and other quality purchasers, not to lower economic groups. The issue is whether at the lower levels the consumer is capable of acting in his own interest, and whether the financer is functioning antisocially in not vetoing the consumer's effort to make a mistake. The difficulty is that one can know only that a percentage of transactions, not any particular transaction, will be mistakes. Still a different problem is presented at the lower levels when the creditor overcomes the consumer's doubts and persuades him to take on a dangerous burden.

12. See, e.g., Adler, California Creditors Lend Hand to Debtors Facing Bankruptcy, N.Y. Times, Nov. 6, 1967, at 75, col. 6. 13. Jordan & Warren, A Proposed Uniform Code for Consumer Credit, 8 B.C.

IND. & COMM. L. REV. 441, 457 (1967). 14. Moynihan, The President and the Negro: The Moment Lost, COMMENTARY,

Feb., 1967, at 31, 42. 15. 1 A. TOYNBEE, A STUDY OF HISTORY 12 (Abridged Ed., 1947). 16. Moynihan, supra note 4, at A-5, A-73; Idea Broker in the Race Crisis, LIFE,

Nov, 3, 1967, at 77.

450 [Vol. 68:445




function in these areas, and when an economic activity is left in the private sector, it is futile to bemoan the normal consequences of the profit motive.17 It is precisely the lack of clear fault at the inception of the contract, and the

dynamic of the profit motive thereafter, that make the problem of remedies so difficult.18

To say all this is not to say that instances of overreaching oppression or even of hardship without overreaching are to be ignored. A human being is not a statistic. The stories coming from the poverty areas indicate that unsound and overreaching credit practices create hardship in more than the unavoidable percentage of cases where expectations are defeated. Yet, sales credit in the poverty areas must in most instances perform a desired social function or it would long since have collapsed under its own weight. The

problem is to control credit granting and enforcement in these areas without

destroying the system itself. Still more, the problem is to do so without

hampering the valuable and successful system of installment credit for middle- class buyers. The problem is to avoid being stampeded by a specific problem into burdensome legislation applicable to all.

D. The Structure of Finance Charges; Time Prices and Rebates

Consumer finance rates are frequently quoted as, for example, $6.50 per $100 per year, that is, the customer is to pay a finance charge of $6.50 for each $100 of the original amount of the credit for each year any part of the debt is outstanding, notwithstanding installment repayment. Out of this form of quotation and computation come many of the most emotional issues in this field, including the famous time price doctrine. Because they came from the same form of quotation, several quite distinct issues are confused. A

simple example will enable us to sort out and discuss the issues.

Assume that a buyer in New York buys a used car for $1800, paying $600 by cash or trade-in, leaving a balance of $1200. If he paid this additional amount in cash, he would have to deliver, let us say, 12 $100 bills. Instead he

signs an agreement to pay $1200 plus an "add-on charge" of $6.50 for each

$100 thereof for one year, or $78 over 12 months, making a total obligation of $1278 and a monthly installment of $106.50. Let us suppose further that at the end of the sixth month he pays the sixth $106.50 payment and also is prepared to pay up the balance of the contract, less an appropriate rebate.

It is apparent that the computation of the contract on the basis of an "add-on" of $6.50 per $100 per year presents three interrelated problems. First, the charge of $6.50 per hundred or $78 for a year will be found to be

exactly equivalent to interest at 12% per annum, or 1% per month, on the

reducing balances if the contract had been constructed to require 12 monthly

17. Cf. A. BERLE, POWER WITHOUT PROPERTY 90 (1959). 18. Discussed in Part IV infra.

1968] 451



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payments, each of $100 plus interest on the unpaid balance.19 Is a charge equivalent to 12% per annum usurious under New York's 6% per annum

usury law ? Second, the facts present the question whether disclosure of the rate of

charge in terms of an "add-on" of $6.50 per $100 per year is misleading, or is as useful to the customer as disclosure of a rate of 12% per annum.

Third, the facts present the question whether quotation of a finance

charge of $78 instead of a rate of 12% per annum on unpaid balances implies that the appropriate rebate after one half the period is $39 (one half of $78) instead of the lesser rebate usually offered by the creditor.

These problems are further discussed below. 1. The Time Price Doctrine. When consumer installment sales credit

appeared on the scene to finance the movement of automobiles, refrigerators, radios and the like, the standard 6% per annum rate would not cover the

handling cost; yet the strong religious background prevented direct breach of the 6% ceilings in most states. The growth of credit selling was made

possible by "the time price doctrine." This doctrine avoided the obstacle of

usury by the judicial holding that the time price differential, the difference between the cash price ($1800 in our example) and the time price ($1800 plus a $78 time price differential, in our example, or $1878) was not to be measured against usury restrictions, but was a matter for free bargaining, like any other price. The doctrine was not deviously invented for use in installment sales of the new forms of personal property, but had originated respectably in 19th-century cases related to land sale.20 Moreover, it was

adapted to chattel sales transactions because of the ease of precomputing equal monthly installment payments for all rates of charge and for all amounts and all maturities in sales transactions, as against the difficulties of setting up payment schedules based on per annum interest quotations.

Far too much paper has been wasted arguing the merits of this doctrine as a legal matter, for the question is inherently not susceptible of a rational answer. A legal concept like interest or usury is not a natural phenomenon the contours of which can be measured with a calipers, but a human con- struction as broad or as narrow as man says it is. If man says that the concept of usury includes time price differentials, then it does. If man says the contrary, then it does not. So much for the law.21

19. It is frequently said that a rate of so many dollars per $100 per year should be doubled to find the true interest rate per annum. Then why is not the true interest rate here 13% (2 X 6%%) instead of 12%? The answer is that the installment payments do not quite reduce the average term of the obligation- to one-half the nominal term. The average term of an obligation payable in installments over 12 months is 62 months, not 6 months. Thus, the rate does not quite double, because tle average term is always one-half month more than one-half the nominal term. This one-half month factor dimin- ishes in importance as the overall term lengthens to several years.

20. See, e.g., Hogg v. Ruffner, 66 U.S. (1 Black) 115 (1861); Brooks v. Avery, 4 N.Y. 225 (1850).

21. Among the early articles which took the legal issue seriously, see Berger, Usury

452




The question rather is whether the concept has served and continues to serve a useful purpose, or whether it is being used for an evasive purpose contrary to public policy. The fact is that it originally served an extremely useful purpose in making possible the installment selling of automobiles and other consumer goods. It is generally accepted today that the growth of installment selling is in large part responsible for the astonishing rise in our standard of living and the growth of our middle-class economy. It is not mere

flag-waving to say that if the time price doctrine had not been available to side-

step the usury laws, the economy would not have developed as it has. Once the doctrine was generally accepted, it became possible to go to the

legislatures in most states and obtain the enactment of Retail Installment Sales Acts in which the maximum permissible rate for sales credit was ex-

pressly set by statute without regard to the general usury laws.22 These statutes found ready acceptance because they served the purposes of all

parties. For those interested in consumer protection, they put a ceiling on

permissible time price charges, which had under the judge-made doctrine been totally unregulated. For the financing companies, they gave financing charges a statutory foundation that would not be periodically disturbed by judicial refusal to follow the time price doctrine.23

Once the legislatures undertook to deal directly with permissible rates on installment credit sales apart from the permissible rates for other forms of credit, the emotional issues involved in the time price concept should have

disappeared. The time price principle was only a legal rationalization for avoidance of the general usury laws. When the legislatures provided special laws, the legal argument whether time price differentials were interest passed beyond being a silly exercise in logic, and became completely obsolete.24

The well-intentioned advocates of consumer protection who are the moving forces behind the current legislation have not learned this obvious truth. The amount of energy still being expended to beat an obsolete horse is tremendous, totally wasted; it obscures the real issues. Since sale credit and loan credit are both regulated in the proposed NCCUSL Bill, and for the most part in identical terms, what difference does it make to these zealots what one calls the regulated amount?

On the side of the credit companies and merchants, the emotional defense

in Instalment Sales, 2 LAW & CONTEMP. PROB. 148 (1935); Ecker, Commentary on "Usury in Instalment Sales," 2 LAW & CONTEMP. PROB. 173 (1935).

22. See, e.g., N.Y. PERS. PROP. LAW ?? 303, 404 (McKinney's 1962, Supp. 1967). 23. See Kripke, Captive Finance Companies: Legal Aspects, 89 AMER. MANAGEMENT

ASS'N MANAGEMENT BULL. 13 (1966). 24. For recent writing on this subject, see McEwen, Economic Issues in State

Regulation of Consumer Credit, 8 B.C. IND. & COMM. L. REV. 387, 390 (1967). A splen- didly dispassionate analysis of the problem is in Littlefield, Parties and Transactions Covered by Consumer-Credit Legislation, 8 B.C. IND. & COMM. L. REV. 463, 464-67 (1967). This otherwise sound analysis is marred by the author's inexplicable association of the problem of time price with that of third-party freedom from defenses in consumer sales transactions. Id. at 467-69. See infra Part III.

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of the time price doctrine has been almost equally vehement, and for the most part equally supererogatory, but there is some spotty justification for it beyond nostalgic affection. In the few states in which a general usury provision is embodied in the constitution, preserving the time price doctrine is a must if credit sales are to continue, and the consumer credit companies and their counsel are justifiably sensitive to any possible legislative declara- tion by Congress or the NCCUSL which would change the atmosphere and interrupt the course of decision in those states. Would the consumer representatives desire such a change, at the price of putting consumer time credit in the straitjacket of the old usury laws?

2. The Add-On Rate and Fair Disclosure. One explanation for the

astonishing continued excitement displayed by consumer spokesmen in refer- ence to the time price doctrine is their confusion of this matter with other aspects of consumer financing. One of these aspects is the question whether the consumer understands that the $6.50 per $100 per year add-on rate is about equivalent to 12% per annum, or thinks that 6272% is the true per annum interest rate. The spokesmen tend to confuse the issue whether "add- on" quotation is fair disclosure with the time price doctrine itself. The highly charged emotional issue of fair disclosure is discussed in Part II of this paper.

3. Appropriate Rebates of Add-On Rates. Another source of the excitement is a confusion of the time price doctrine with the problem of rebates on consumer prepayments. Some people assuming the responsibility of speaking for consumers seem never to have gone beyond the simple assumption that if a 12-month installment contract is paid in full at the end of 6 months, only one half of the "finance charge" has been earned and the other half should be rebated. Since credit agencies apply a different standard known as "the Rule of 78" which produces a lesser rebate, consumer groups are quick in their denunciation of the Rule.

But if one makes the slight effort required to understand the Rule, the denunciation must stop. Let us go back to our case of the $1200 balance on a used car, payable in 12 monthly installments.

As a first simplification, it is apparent that during the first month of the credit the buyer has the use of his 12 $100 bills. After he makes the first payment, he still has the use of 11 $100 bills for another month; after the second payment he has the use of 10 $100 bills; and so on. Over 12 months of the contract he has the use of 78 $100-months, and the finance charge must pay for this use. In the first month of a 12-month contract, the creditor, therefore, earns 12%78 of the finance charge; the second month he earns 1 48; and so on. At the end of the six months, the creditor has earned 57/78 of the finance charge or $57, and the buyer on prepayment is entitled to a rebate of $21, not $39. This is the Rule of 78. The denominator is 171 for 18 months;

454 [Vol. 68:445




300 for 24 months; 666 for 36 months. The same figure of $57 as the charge earned would be found if you computed 12% per annum or 1% per month interest on the $100 bills in use during each month. Obviously, more interest or finance charge is earned in the early months when more money is in use than in later months. The foregoing is only an approximation of a true actu- arial calculation, but it is a remarkably close approximation.25

The arithmetic and the authority are irrefutable, yet it is characteristic of the atmosphere in this field that the persons purporting to speak for consumers continue to abuse the Rule of 78. If they are not so naive as to think that the consumer is entitled to a 50% refund after one half of the period of the installment obligation, they still think that the Rule of 78 cuts corners

substantially in favor of the creditor. In commenting on the fourth draft of the NCCUSL Bill a government representative and a representative of a

public foundation which has published in the field of consumer credit both criticized the Rule of 78 in interestingly identical language:

Refinancing, using the Rule of 78 is, of course, lucrative for the creditor not necessarily because of the refinancing itself but because of the yield to the creditor that the Rule of 78 permits.

No doubt, it is the function of public representatives to exercise an alert

skepticism toward the explanations of industry representatives; for if the conventional wisdom were always believed, there would always be a good reason for continuing things exactly as they are and nothing could ever change. But is it not also the function of public representatives to exercise some discrimination in their criticisms, and to aid the legislatures by understanding enough to distinguish that which is merely the conventional wisdom from that which is sound ?26

II. THE SIGNIFICANCE OF DISCLOSURE-PAST AS WELL AS FUTURE

For the many years that Senator Douglas was a member, the Senate

Banking and Currency Committee hammered away at the disclosure bill which has come to be known as the Truth-in-Lending Bill. When he was defeated for re-election, the torch was passed to Senator Proxmire of Wisconsin. The gist of the bill was to require disclosure of the cost of all financing as a

simple interest per annum rate.27 Retailers and the financing industry long

25. See R. JOHNSON, METHODS OF STATING CONSUMER FINANCE CHARGES ch. 4 (1961) [hereinafter cited as JOHNSON]; MORS, supra note 7, ch. 4.

26. I was at first puzzled by the belief of the authors of the above quotation that the Rule of 78 was unfair on rebates, or that it permitted any particular yields. I asked for an explanation, but remained unenlightened. Later Professor Johnson pointed out to me that the authors were probably referring to the fact that the Rule of 78 gives a smaller refund for prepayment on a small loan with stepped rates, after precomputation, than would the same step-rate loan without precomputation. See MORS at 28-32. But this very special case is far from justifying the authors' blanket condemnation of the Rule of 78.

27. I.e., a rate per annum on descending principal balances. This is to be distin-

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opposed the bill on three principal grounds: First, it was too broad in scope, requiring simple interest disclosure where it was simply not applicable. Second, in cases of uneven or skipped installments or other technical difficulties, it was impossible to compute an accurate simple annual interest rate. Third, a simple interest disclosure was less meaningful to the buyer or borrower than either the dollar amount of finance charge or a dollars per $100 per year add-on rate disclosure. At each year's hearings, state and federal governmental witnesses paraded before the Committee testifying that they supported the bill in principle. Their testimony did not descend to such details as proper scope and feasibility. Their letters and testimony call to mind Will Rogers' suggestion to eliminate the submarine menace by boiling the oceans. Having formulated the principle, they left it to others to work out the details.

Senator Douglas, one of the present author's political heroes, was in this one instance surprisingly inflexible-the more so in that he alone of the many senators and witnesses who made the legislative record understood the relationship of the religious background and the corresponding rigidity of the usury laws to the growth of other forms of disclosure.28 Instead of using the forum of his Committee hearings to explain that consumer credit could not be conducted at the traditional ceiling rate of 6% per annum, that consumers must be expected to pay a higher rate and legislatures must allow it, he used it to insist adamantly on the exact scope and form of per annum interest rate disclosure in his bill.

The retailers and finance industry were right that the bill was too broad. It required one to quote an interest rate for leases, even short-term leases with service and risk elements, although there is no conceivable way to separate the money cost from these other factors.29 It seemingly required insurance costs, recording fees, title fees and certain other costs that have nothing to do with the use of money to be treated as part of the interest cost of a deal. It was also true that there were a number of financing situations vary- ing from equal monthly installments, in which an accurate simple annual interest rate could not be calculated in advance by retailers' clerks on the selling floor, but the bill provided no tolerance for error.

Even when Senator Proxmire took over in the present Congress, the first draft of his Bill S. 5 was almost as rigid and unworkable as the earlier drafts.30 Then came two decisive breakthroughs. First, as it appeared likely

guished from the add-on rate per year described in Part I. D, supra, which is based on the original amount financed notwithstanding installment reductions, and must, therefore, be approximately doubled to obtain the simple interest per annum rate.

28. See Senator Douglas' testimony, Hearings on S.5 Before the Subcomm. on Financial Institutions of the Senate Comm. on Banking and Currency, 90th Cong., 1st Sess., at 37-63 (1967) [hereinafter cited as 1967 Senate Hearings]. 29. The text of the definition of "credit" in the early bills was identical with that quoted note 30 infra.

30. Senate Print of S.5, 90th Cong., 1st Sess. ? 3(2) (Jan. 11, 1967). The definition of "Credit" reads:

456 [Vol. 68:445




that the bill might make some legislative progress, the Board of Governors of the Federal Reserve System, which had been content with general en- dorsement of the principle of the earlier bills while pleading that it was not the appropriate administering agency,31 now faced the possibility of having to administer an unworkable bill. For the first time, it came down to earth and

supported the efforts of the industry to make the bill workable in scope and

provide workable definitions, for many of which it pointed to the NCCUSL Bill then being drafted.32 Secondly, the Treasury made available to the Senate Committee a revised version of a chart it had worked out for the De-

partment of Defense, providing for determination of the simple interest per annum rate within certain ranges. This made clear the necessity for tolerance of some deviation from an accurate mathematical computation; this elimi- nated most of the difficulties in computing a simple interest per annum rate for irregular installment situations. The Proxmire Bill, amended to take account of these matters, was passed at the first session of the 90th Congress, June, 1967. A somewhat different version has been passed by the House of Representatives,33 but the differences have not been resolved in conference as this article goes to press.

During the latter portion of the period of pendency of the Douglas and Proxmire Bills, a Special Committee of the NCCUSL had set out to draft a Uniform Consumer Credit Code. This effort was to some extent a continuation of an earlier effort by the American Bar Foundation, which had led to an extensive survey of the consumer credit field.34 The NCCUSL used as a model the remarkably successful Uniform Commercial Code, which it had formulated in cooperation with the American Law Institute. The Special Committee was organized with two law professors as Reporters-Draftsmen, and other law professors, economists, and sociologists as technical advisers,

"Credit" means any loan, mortgage, deed of trust, advance, or discount; any conditional sales contract; any contract to sell or sale, or contract of sale of property or services, either for present or future delivery, under which part or all of the price is payable subsequent to the making of such sale or contract; any rental-purchase contract; any contract or arrangement for the hire, bail- ment, or leasing of property; any option, demand, lien, pledge, or other claim against, or for the delivery of, property or money; any purchase, or other ac- quisition of, or any credit upon the security of, any obligation or claim arising out of any of the foregoing; and any transaction or series of transactions having a similar purpose or effect. 31. Statement of Chairman William McChesney Martin, Jr., Hearings on S. 1740

Before a Subcomm. of the Senate Comm. on Banking and Currency, 87th Cong., 1st Sess. 276 (1961). Letter of Chairman Martin, Hearings on S. 750 Before a Subcomm. of the Senate Comm. on Banking and Currency, 88th Cong., 1st and 2d Sess., pt. 2, at 1308 (1964).

32. Testimony of Vice Chairman Robertson of the Board of Governors of the Federal Reserve System in 1967 Senate Hearings, supra note 28, at 659-85.

33. The House Committee on Banking and Currency reported H.R. 11601, 90th Cong., 1st Sess. (1967). The version thereof printed in H.R. REP. No. 1040, 90th Cong., 1st Sess. (1967) is not trustworthy. For purposes of the topics treated in this article, the House Bill is identical with the Senate Bill (S.5), although there is a material difference in the definition of finance charge (see note 57 infra) and the House Bill contains some additional material. Still more material was added on the House floor and the House text was then substituted for the Senate text and passed as S.5.

34. B. CURRAN, TRENDS IN CONSUMER CREDIT LEGISLATION (1965).

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together with various industry panels to advise on special items like insurance, house-to-house sales, and so forth. An over-all Advisory Committee met with the Special Committee in numerous two-and-three-day sessions; it was drawn from outside NCCUSL ranks and represented the segments of the

industry, such as retailers' associations, the American Bankers Association, the finance-company groups, house-to-house canvassers, credit card companies and various consumer representatives from Better Business Bureaus and state regulators. In contrast with the inflexible Senate approach are this

group's patient efforts to achieve solutions which sometimes accommodate the views of all, and are at worst compromises drawn in a good faith effort to

preserve the essential results desired by all. The Special Committee took for

granted the principle of disclosure of credit costs to consumers and has

struggled mightily to produce reasonable solutions to the problem of the

significance of title and closing costs in real estate, and of insurance costs and other charges for special benefits. It has not been slow to avoid frustration of its purpose by finance charges otherwise labeled, and has insisted that broker-

age costs, investigation fees, and the like, be treated as part of the money costs to the buyer or borrower.

The collaboration of the diverse groups of industry representatives and consumer spokesmen with the NCCUSL Committee, while courteous and in

good humor at all times, has not (in the writer's opinion) been completely successful. The representatives of large and successful credit grantors who are the industry representatives on the Advisory Committee find it difficult to

comprehend the really shocking tales of abuse and woe coming out of the

poverty areas, and the need to deal with that situation. The consumer representatives, on the other hand, take a simplistic view and expostulate at the NCCUSL Committee's reluctance to whip the money changers from the

temple, for they refuse to understand that the problem is broader than what to do to the "overreaching creditor" to vindicate his "unsuspecting victim." That would be easy if we could isolate that case. The problem is what rule of law can be devised for that case that will also work fairly for legitimate financing, in the slums and in middle class situations. Again, concentrating on the default case that shows up in their legal aid offices, the consumer spokesmen fail to realize that any loss they succeed in throwing on the creditor in such cases will get passed on in higher costs and rates to equally meritorious and necessitous credit users who struggle through their contracts without default. Further, the consumer representatives demand a prescribed contract because the consumer cannot understand enough to take care of himself; yet with schizophrenic inconsistency, they would require overly elaborate disclosure procedures (e.g., disclosure before, not at, the signing of the coltract) in pursuit of the will-of-the-wisp hope that consumers would shop mlore effec-

tively for credit if only they could get enough disclosure. The fact that con

458 [Vol. 68:445




sumers will eventually pay for all operating red tape, and that this fact ought to require responsible consideration of the claimed need for elaboration, seems not to interest them.

A. Simple Interest Per Annum Rate Against Dollars-Per-$100-Per-Year

The NCCUSL's Special Committee spent a substantial portion of its time over the years debating the basic question whether disclosure of consumer finance charges should be on a simple interest per annum basis or on the basis of dollars-per-$100-per-year. In favor of the latter was the long tradi- tion of quotations in this form in the sales finance industry and in the industrial banks, and the views of the Special Committee's distinguished Reporter- Economist.35 Opposed were the practices of several institutions: rates of

ordinary commercial banks and real estate lenders, and bond yields, are

quoted on a simple interest per annum basis; the small loan companies and credit unions quote on a simple interest per month basis, which can readily be converted to an annual basis by multiplying by 12; and savings rates paid by savings banks and other savings institutions are quoted on a simple interest per annum basis. As a matter of precedent, the case for simple interest is the stronger. And simple interest makes possible not only comparison shopping between credit suppliers, but also comparison of the cost of credit with the detriment of using existing savings or of building savings before

committing an expenditure. But the argument probed deeper. The inflexible Douglas approach was

based on the assertion that the dollars-per-$100-per-year basis was completely misunderstood by consumers and that it therefore understated and concealed the effective cost of credit, which is roughly twice as high as the nominal

dollars-per-$100-per-year rate. The industry representatives, disclaiming any intent to deceive the consumer, argued that he was not in fact deceived. More

particularly, they argued that consumer financing rates were something different from interest and should not be cast in a form in which they would

unfairly and misleadingly be compared with interest. They argued that every charge for the use of money is composed of three elements-a "pure" interest

rate, an expense factor and a risk factor. In ordinary bank and institutional

lending and in the bond market and real estate first mortgage market, the

expense and risk factors are minor and the cost of money is basically an interest charge for which a simple interest per annum rate is appropriate. The

industry argued that in the consumer finance business the other two elements are an overwhelmingly larger portion of the total cost. The expense of installment collection and record-keeping even without delinquency is high; default expenses and losses are high; and it would be totally misleading to

submerge all of these in a simple interest computation.36 35. See JOHNSON, supra note 25, ch. 3. 36. Summarized in JOHNSON, supra note 25, ch. 3.

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On balance, in this writer's opinion, the proponents of the simple interest

per annum rate have the better of the debate. The arguments about handling costs and risk factor do not meet the essential point. No doubt it is true that the expense and risk factors become greater than the pure interest costs. For this reason, the failure of the Senate Committee to use its forum for the education of consumers and state legislatures as to the necessary range of costs is to be deeply regretted. Nevertheless, the breakdown of his creditor's costs is not the consumer's concern. A substantial part of the expenses of the sales finance company has been the cost of sales solicitation, that is, acquiring the privilege of doing business with the dealer who originally acquired the consumer's obligation. Surely, from the consumer's point of view this cost is no more meritorious than interest. Similarly, it makes no difference to him that his expenditure for finance charge goes partially to overhead and collection costs and partially to losses on the transactions of others, as well as to the pure interest cost. They are all the same dollars of

expense to him. If he can shop better elsewhere, or if he chooses to avoid this kind of cost and accumulate his money in a savings bank to pay cash

ultimately for his purchase, the simple interest per annum rate is the yard- stick of his detriment. The details of the detriment are unimportant.37

Therefore, in the writer's opinion the Douglas-Proxmire Truth-in-

Lending requirement of simple interest per annum disclosure is sound. Present indications are that the NCCUSL will also adopt it, especially under the

compulsion of the prospective enactment of the federal bill.38 The NCCUSL decision was long in coming, but this was in part the fault of those who spent their time scolding the finance companies for the time price doctrine, and failing to get at the major job of education that will be necessary to permit direct modification of the usury laws and to dispel the "6% myth" in the minds of the public.

B. The Significance of Disclosure in Time Sales Finance

But how big an advance is this disclosure requirement? Here the writer differs sharply with prevailing estimates by the proponents of the legislation. So much zeal and pressure have been devoted to achieving disclosure that the impression is abroad that it represents a tremendous advance; that the consumer will be able to shop more competitively; and that this will bring down the cost of credit. Learned statistical treatises have been written showing that many consumers do not understand how much they are paying

37. See JOHNSON, supra note 25, at 83-84; MoRs, supra note 7, at 78. 38. In the last public draft of the NCCUSL Bill, W.D. 6, ? 2.304(1) provides for

simple interest per annum disclosure, in contrast with W.D. 4, which provided for disclosure of an "add-on" rate of dollars-per-$100-per-year.

The NCCUSL Bill is the Uniform Consumer Credit Code being drafted by a Special Committee of the NCCUSL. As this article goes to press, a Sixth Working Draft or Third Tentative Draft has been made public and is cited without further identification. Where earlier drafts are cited, the working draft will be named-e.g., W.D. 4.

460 [Vol. 68:445




for credit. To the writer, these efforts to apply the methods of mathematics and the physical sciences to social questions, by applying statistical tech-

niques to the answers to very "iffy" questions in surveys, are far from

convincing in themselves.39 The writer does not doubt the general accuracy of the conclusions that many consumers do not understand the cost of their credit measured as a rate per annum when quoted in another form; and that the Douglas type of bill will have some effect in making consumers understand their costs better. But he submits that a simple interest per annum bill is not going to be the major social reform that the proponents contend, because the process of competitive sorting out of credit sources for consumers entitled to lower rates is already well under way.40 The statis- ticians have only to lift their eyes from their coefficients of correlation and look about them. If they did so, what would they see ?

The answer can be found in the present plight of the great independent sales finance companies which pioneered the extension of credit for consumer installment buying when automobiles, refrigerators and radios came into

being. Since banks refused to take on this kind of credit, these companies prospered greatly in the interval between the wars and in the early period after World War II, built some enormous personal fortunes, and became

important institutions in our financial structure. Through them billions of

dollars were drawn from many sources-from the public securities markets

for stock and bonds, from insurance companies, pension funds and other in-

stitutional lenders, from the temporary free cash of industrial corporations

(through commercial paper) and from bank credit-and were funneled into

consumer credit to expand our economy. Nothing succeeds like success, and the banks saw the success of these

companies. Banks entered the field gingerly after World War II and later

at an accelerated rate. Their share of consumer credit has gone up and that

of the finance companies has gone down. Not only has the finance companies'

position in this field failed to grow with the growth of the field; but, in

view of inflation, there seems to have been an absolute decline in number of

units they handle. The sales and credit approach of the finance companies was always focused on the dealer or merchant. Their purpose was to handle

all of the dealer's consumer credit up to the point where the "mix" became

unprofitable. Where the finance rate was high enough and the over-all quality of the mix good enough to keep loss ratios at a conservative level, they were

able to handle a large proportion of the total business of the dealer.

In recent years, however, the better class of buyer has not obtained his

credit through the dealer but either from banks advertising "low bank rates"

39. See JUSTER & SHAY, supra note 7; MORS, supra note 7, ch. 5. 40. Of course, if the consumer is getting the best rate he is entitled to, he cannot

move to a lower-rate financer no matter how much disclosure he receives. See JUSTER & SHAY, supra note 7, at 14, for the concepts of the "rationed" and "unrationed" consumers, See id. at 75.

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462 COLUMBIA LAW REVIEW [Vol. 68:445

or from the credit union maintaining a tax-sheltered and cost-sheltered

operation. This shift constantly eroded the quality of the mix available to the dealer and to the sales finance companies and impelled the finance com-

panies to lower rates in an unsuccessful effort to meet the competition.41

Perhaps this is all to the good-in the absence of this process, the better consumer credit risk might be subsidizing a uniform finance rate for the benefit of the poor risk. Good or bad, however, the process has nearly run its course, and the simple interest per annum disclosure required by the current legislation will at best accelerate its completion.42 The consumer

may not know exactly how much he pays for credit, but he knows where it is cheapest. Thus, consumers who qualify for the lower rates have already moved to the banks and the credit unions, which administer credit far more

selectively than the finance company trying to serve the dealer.43 This result does not mean merely that the better class of consumer credit

user is protected against subsidizing the less worthy user. The "ecological" consequences of this shift have not fully been appreciated, and they have

perhaps not yet fully run their course.

One consequence is the banks' adaptation to their new role. When the banks' loan ratios are taxed from consumer and other demands, they borrow some of the financing techniques of sales finance companies, namely, acquiring additional capital in the form of subordinated debentures (called by the banks "capital notes") and tapping the temporary excess cash of industry in the form of commercial paper (called by the banks "time certificates of deposit"). It may be questioned, however, whether a bank has the same adaptability as

41. See Industry Antalysis of Finance Industry, VALUE LINE, July 14, 1967, at 1371, 1391.

42. As Professor Johnson points out, rates quoted on a uniform basis can be compared, regardless of what that basis is. JOHNSON, supra note 25, at 80-83. Until now, most banks competing for consumer business have quoted on a dollars-per-$100-per-year basis, which is the same basis as that used by the dealers and finance companies. Still worse, some banks have quoted on a discount basis, which makes the rate look even smaller. See MORS, supra note 7, ch. 4. The credit unions quote the same way, or on a 1% per month basis, and the disclosure enthusiasts fear that the consumer will not know that this low number is equal to 12% per annum. Thus, the low-rate financers have not failed to attract customers because of any disadvantages in their current forms of rate quotation.

A leading investigator has concluded that consumers do know the comparative advantages of different credit sources. Statement of Professor George Katonah, Hearings on S. 2755 Before a Subcomm. of the Senate Comm. on Banking and Currency, 86th Cong., 2d Sess. 805-08 (1960), approved in JOHNSON 80-81.

See also JUSTER & SHAY, supra note 7, at 56-62; Professor Mors, in J. ZIEGEL & R. OLLEY, CONSUMER CREDIT IN CANADA 164 (1966). Professor Mors cites an article by Professor Johnson as indicating an opposing view, but I do not so read it, and Professor Johnson has assured me that he concurs in the view stated herein. See note 51 infra.

43. The banks have recently engaged in a competition in recklessness in passing out credit cards to consumers from lists of names, without application or credit check, to the point where no less an authority than Miss Betty Furness, the President's Assistant for Consumer Affairs, has had to warn them. N.Y. Times, Sept. 20, 1967, at 49, col. 8. But this recklessness is characteristic only of the banks' current efforts to establish early beachheads in the credit card field. Exactly the opposite approach, one of substantial caution, has been characteristic of the banks' approach in dealer financing or in lending for purchase of automobiles and other consumer goods.




a finance company as a mechanism for channeling into consumer credit the

long-term investments heretofore made by institutional investors. Another consequence follows from the effect of the loss of the upper part

of the mix on the profitability of the consumer operations of the independent sales finance companies. These companies are now among the least favored

industry groups for investment.44 Their securities are selling far below the

peaks of several years ago. Their loss ratios are being held in line only by sharply increased selectivity in purchases. They have been striving frantically to diversify away from concentration in consumer credit, first into other areas of credit and more recently into nonfinancial enterprises. They have become some of our major conglomerate enterprises.45 They are cutting back in their service to the dealer, both by refusing to take the lower part of the mix if they cannot get the upper part, and by refusing to handle the dealer's inventory or "wholesale" financing on a break-even basis if they do not get an adequate mix of the "retail" consumer installment paper where the

hoped-for profit may be. Then the dealer and his factory supplier complain that they are not being served adequately, because not enough retail credit is being extended to facilitate retail sales and not enough wholesale credit to keep dealers' stocks full. The factories announce that if the independent sales finance companies will not do the job for them, they will take on the

job through their own subsidiary finance companies. In the automobile business Ford and Chrysler have recently activated their own finance companies. A similar process took place shortly after World War II in the home appliance field, when the independent sales finance companies essentially withdrew because they could not overcome the adverse profit factors of a large number of installments and small balances. The appliance factories had to pick up the burden by creating their own finance companies, which, because of low

profits, many of them would gladly give up if someone would do the consumer credit job for them.

In the home improvement field, particularly aluminum siding, the inde-

pendent finance companies have withdrawn or sharply curtailed their purchases, because they could not control their costs and they feared the bad public relations arising from customer dissatisfaction with unreliable dealers

44. See STANDARD & POOR'S FINANCE AND SMALL LOAN INDUSTRY SURVEY, Sept. 7, 1967. Among their troubles is that the confidence of lenders in the finance industry has recently been affected by several debacles, some in consumer finance and some in the closely related industrial time sales. See McDiarmid, Crisis of Confidence: To Attract Fresh Capital, Finance Companies Should Change Their Ways, BARRONS, April 10, 1967, at 5. Another problem is the money crisis, which squeezes both their margin of profit and their leverage.

45. For this reason the table in the next footnote does not include any of the major independent sales finance companies. Even after the recent request of the American Institute of Certified Public Accountants for disclosure of divisional results of conglomerate companies, they have not segregated their consumer financing income from their other financing income, and it is impossible to derive any meaningful consumer operating results from their conglomerate figures. But see C.I.T.'s Treadmill, FORBES MAGAZINE, Oct. 15, 1967, at 27.

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and poor installations. Some of the basic aluminum companies and the large fabricators have picked up the load unwillingly with their own sales finance

arrangements. What is the significance of all of this for disclosure? Only this! The

operations of factory-controlled consumer credit finance companies do not

produce a rate of return on capital that would be considered satisfactory in other industries, and even the present low profits would be impossible to achieve were it not for the leverage made possible by the implicit guarantees of the parent companies (see table in footnote).46 The manufacturer can get an adequate return on the sterilized capital only by increasing the price of the product itself. Thus, the cost of subsidizing credit to the lower level of the consumer mix gets fastened on all cash and credit buyers through the medium of the profitless factory-owned finance company, not only on the

upper portion of the credit mix as was done through the independent sales finance companies.47

To avoid misunderstanding, let it be emphasized that the writer does not contend that the disclosure is a step backward. It is long overdue, in simple comparable form. But significant effects on consumer shopping for credit will be minimal because the sources of the best deals have long been known by those entitled to them. On the other hand, the overall economic effects of sorting out credit buyers have only just begun to be felt.

C. The Significance of Disclosure in Consumer Loans

In the loan field, the story is different, but the conclusion is the same. Originally and until recently, the loan business comprised lending by banks at their usual rates of about 6% per annum, and loans by the small loan companies at about 24-36% per annum. In recent years, the middle ground has been partially filled in by statutory authorization for lending in the area of 12% per annum by the personal loan departments of banks under special rules for consumer credit; by credit unions; by Morris Plan and industrial banks; and by other special legislation, like the Pennsylvania statute on consumer discount companies.48 A gap has remained between this middle ground and the 24-36% rates of the small loan companies. Therefore, con-

46. The table on the following page must be understood to represent very rough and ready calculations based on the 1966 annual reports of the companies mentioned, without separating the nonconsumer finance income of some of the companies, but with such adjustments as could be made therefrom to eliminate the effects of nonfinance operations where the latter were substantial. The figures are cited not as being meticulously calculated but as illustrating the general position.

47. Senator Douglas was correct in asserting that dealers frequently retain a share of the gross finance charge when selling installment paper to financers, and that this frequently accounts for a significant part of dealer income; but these circumstances do not justify his generalization that the poor subsidize the rich in time sales finance. 1967 Senate Hearings, supra note 28, at 50. There might be more force to this if the total profit level in time sales finance were at a rate competitive with other industries. See the preceding footnote.

48. PA. STAT. ANN. tit. 7, ?? 6201-19 (1967),

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Income Before

Interest and Leverage Income Taxes Net Income Net Income (Borrowings as % of Funds % of Funds as % of in relation to

Employed Employed Net Worth Net Worth)

Merchant-ozetned Sales Finance Co's.

Singer Credit Corp. 9%* 2%* 10%* 5Y to 1' Westinghouse Credit Corp. 6Y2% 1%- 10% 10 to 1 Montgomery Ward Credit Corp. 7% 1%+ 8% 5 to 1 Ford Motor Credit Corp. 5% Nominal Nominal 9 to 1'* GMAC 6% 1% 8% 112 to 1

Small Loan Co's. Beneficial Finance Corp. 10%+ 4% 16%+ 3+ to 1 Household Finance Corp. 10%+ 3.5% 17%+ 3.5 to 1

* Without deducting losses, absorbed by parent company. ** Including subordinated debt held by parent company.

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COLUMBIA LAW REVIEW

sumers who do not qualify for credit in the 12% area have in general had no recourse to legal lending except from the small loan companies. The small loan

companies thus have had a quality of borrower in their mix superior to that which the rates would justify, and this advantage shows in their ratios of net income to monies employed compared to the dismal results of the consumer sales finance companies.49

It is hard to believe, however, that the consumer borrower does not know the comparative scales of the rates available. He may not understand fully the effect of a Morris Plan program in doubling his nominal rate,50 but he

surely knows that the bank is cheaper than the Morris Plan or the credit union, and that all of these are cheaper than the small loan company.51 With the exception of those using a credit union because of its handiness to the

job and the convenience of payroll deductions, consumers already are choosing the class of lender with the lowest rate available for their quality of credit. Disclosure may tell them what the percentage rate is, but it will be all but meaningless information, since few of them will have access to cheaper credit.52

D. Disclosure in Revolving Credits

The writer finds it hard to understand the furor53 as to whether the rate on department store charge accounts should be stated as a monthly percentage on balances or as a per annum percentage on balances. It seems

impossible to believe that consumers cannot compute 12 times 1'2% per month to arrive at an annual percentage rate; or that if there are such consumers, that the additional annual rate information would enable them to shop effectively for credit. As a matter of fact, there is seldom rate competition among stores in a given locality in revolving credits, and purchases are frequently too small to warrant paying cash and financing elsewhere. Even

49. See table on page 465 supra. 50. See notes 55-56 infra and accompanying text. 51. Professor Johnson reported some figures showing substantial overlap in the

classes of borrowers using banks and those using small loan companies. Johnson, Con- sumer Credit: Trends in Cash Borrowing, BANKING, Jan. 1965, at 48. But he recognizes that the evidence is fragmentary. In a personal talk, Professor Johnson confirmed to the writer his support of Professor Katonah's conclusion that consumers in general know where the credit is cheapest. See note 42 supra. The crucial question is whether the particular consumer qualifies for the low rates.

52. The meaning of disclosure in permitting a choice between purchasing on credit and saving while deferring purchases is considered at Part II, F, infra.

53. The original Proxmire Bill, S. 5, of January 11, 1967, made its simple interest per annum disclosure requirement applicable in all cases, including department store revolving credits. The Chairman of the Penney Company appeared before the Senate Committee to argue that no per annum rate could be computed in advance, because the rate depended on the manner in which the particular company computed the charge, and the dates within charge periods when purchases or payments were made. 1967 Senate Hearings, supra note 28, at 199-201. The Senate Bill as adopted permits revolving credit disclosure to be made on a per month basis, with elaborate exceptions. S. 5, 90th Cong., 1st Sess. ?? 3(g) & (h), 4(d) (1967). The House Committee reluctantly followed this lead with some dissents and with promises of floor fights. H.R. REP. No. 1040, 90th Cong., 1st Sess. 13-15, 107-112, 124-128, 135-139 (1967). The House amended the Bill on the floor to require annualization of the rate.

466 [Vol. 68:445




if rate competition existed, the particular merchandise sold by the particular store is more likely to determine the place of shopping than slight variations in revolving credit rates. The zealotry embodied in this argument about the

importance of the per annum rather than the per month disclosure is well illustrated by the contrasts in the testimony of a Federal Reserve Board witness before Senator Proxmire's Committee. He testified that it was essential for consumers' protection that the charge account rates be disclosed on an annual, not a monthly basis. Yet the same witness swept aside the genuine and important variations among these plans in free carrying time and in the application of credits, which are of great significance in a cost comparison and also of considerable technical difficulty. He suggested a disclosure legend set forth once at the inception of a revolving credit arrangement, taking it for granted that the consumer could understand and remember this complicated disclosure.54

E. Disclosure and Price Competition

The problem of achieving effective price comparison for credit is far more complicated than the advocates of the disclosure panacea would admit. Not only are there the problems of legitimate charges, like title insurance costs, appraisals of collateral, and so forth, not included in the finance rate, but there is the question of the cost of added obligations of the debtor accompanying the obligation to pay principal and finance charges. Suppose that the rate is only 6% per annum on an obligation payable without installments at the end of one year, but the borrower is required to purchase from the lender a "certificate of investment" by monthly installment payments, which matures without interest at the end of a year in an amount just sufficient to offset his own debt.55 Obviously, any right-thinking representative of consumers will see through this and say that this is the equivalent of an installment payment loan and the 6% per annum rate is substantially doubled. Suppose that instead of a certificate of investment the consumer is required to make equal monthly deposits with the bank lender in an aggregate amount sufficient to offset the debt at the end of the year.56 Again our consumer representatives will see through this and recognize the true rate as being double the nominal rate. While neither the Douglas-Proxmire Bill nor the NCCUSL Bill deals expressly with these devices, it may be expected that courts would interpret these statutes as requiring disclosure of the doubled rate.

54. Testimony of Vice Chairman Robertson, 1967 Senate Hearings, supra note 28, at 661-63. See the treatment of these problems in the NCCUSL Bill ? 2.310. 55. This is "the Morris Plan" as used by Morris Plan Banks and industrial banks.

See JOHNSON, supra note 25, at 25. 56. This is a variation of the Morris Plan. This device was used by a Philadelphia bank before Pennsylvania passed special legislation for consumer loan departments of

banks,

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Suppose, however, as we move into the era of full consumer disclosure, the banks continue to maintain a selective loan policy at, say, 9% per annum, but it turns out that the only consumers who qualify are those who maintain a 20-30% compensating balance in a checking account in the bank. This is a device that the banks regularly use with commercial borrowers to increase the actual yield of their nominal rate by reducing the effective amount of money lent. We may be sure that in the new era this device will apply to consumer borrowers, if it does not apply already. We read that the banks are making consumer loans only to their regular customers. Certainly, the proposed statutes do not deal expressly with this subtler means of increasing the effective rate, while disclosing a lower one. Can we expect that the courts will stop it? The writer would be surprised if they did. It will be an advantage that banks of deposit will have over competing financers in the disclosure era.

On the other hand, the finance companies frequently have a source of profit that would not be included in rate disclosure. They encourage the consumer to protect his life by insurance in the amount of the debt, and they or affiliates sometimes make a direct or indirect profit on the insurance. In automobile finance, they may also make a profit on the physical damage insurance. Some consumer representatives think that there is something immoral in this, but the insurance does have advantages for both parties, and it is not ordinarily thought immoral in American business to seek to achieve a large rather than a small sales "ticket." Potential abuses are kept in check by recent state legislation on the subject, including a Model Credit Life Insurance Statute, as well as by the proposed provisions of Article 4 of the NCCUSL Bill. Some consumer representatives want to forbid these insurance profits by the financer, or to require them to be disclosed as part of the finance rate, but the NCCUSL Bill does not follow these views.57

F. Disclosure and Its Effect on Saving Versus Borrowing

No doubt disclosure that the purchase of a used automobile on credit with an 8% "add-on" rate involves a credit cost of around 15% per annum will come as a surprise to some car buyers. But, assuming that the buyer is financing through the dealer and a sales finance company because 15% is the best rate available to him,58 it is evident that he does not have the choice of withdrawing the money from a checking account, or a savings account, or other similar source where it is earning only 5% per annum. If the buyer had that kind of resource, he would be entitled to a better credit rate at a bank.

But would the buyer be impelled by disclosure to withhold his purchase and save at 5% per annum until he could pay cash, rather than pay 15%

57. See ?? 2.202(1)(b), 4.104, 4.108(1)(c). Nor does the Senate Bill, S. 5, 90th Cong., 1st Sess. ? 3(d)(2)(C) (1967). But the House Bill, H.R. 11601, 90th Cong., 1st Sess. ? 2 (1967), omits the Senate's exclusion of insurance premiums from the finance charge (with a surprising exception for nonfiling insurance premiums). 58. As argued above, text beginning at note 40, supra.

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per annum? It was long thought that interest rate fluctuations would severely affect the demand for credit, but the experience of 1966-67 has certainly shown the contrary in the industrial field and has led to more direct management of the supply of money. What difference does it make to a man planning a profitable factory that his interest cost will be 6.25% rather than 5.75% ?

Very little. The difference comes to an insignificant part of the cost of the

product. The same is true in the consumer field. If the consumer needs a used

car to get to work, he will not wait until he can save the money just because the rate is higher than he thought. The important question is whether he can

manage the monthly payments.59 Of particular interest is Juster and Shay's estimate that the consumer's net yield on an automobile or washing machine is 30% a year,60 which makes it a bargain for him to pay any conscionable finance rate rather than wait and save. This is a dollars-and-cents computation, and there are in addition the psychic satisfactions of not waiting.

III. THIRD PARTY FREEDOM FROM DEFENSES

A perennial source of argument in consumer regulation, and indeed in all sales finance regulation, has been the question whether the bank or sales finance company that buys the installment obligation from the seller may be free from merchandise defenses that the buyer would have against the seller. The financers have sought to free themselves by arranging for sellers to obtain

negotiable notes for the unpaid balance of the purchase price, which the financers then take as holders in due course. Or they have induced sellers to insert in their forms provisions to the effect that the buyer will not set

up against third-party holders of the obligation any defenses he may have

against the seller. Judicial efforts to deal with this problem have produced no unanimity.

Some cases sustain the devices. Others assert either that the note was not

negotiable because it had been physically affixed to a conditional sales contract or that the third party was so close to the inception of the contract that he was not a holder in due course, and still others hold that waiver of defense clauses are invalid efforts to confer negotiability by contract. Professor Gil- more finds a modern trend against the validity of the holder in due course

position and against the waiver of defense clause.61 To the writer the trend is not that clear.62

59. See JUSTER & SHAY, supra note 7, at 6-46, particularly at 24. 60. JUSTER & SHAY, supra note 7, at 16-17. See Testimony of Professor Ray

McAlister, 1967 Senate Hearings, supra note 28, at 463, that the consumer will pay any rate to get the product.

61. Gilmore, The Commercial Doctrine of Good Faith Purchase, 63 YALE L.J. 1057, 1097-1100 (1954).

62. See, e.g., Burchett v. Allied Concord Financial Corp., 74 N.M. 575, 396 P.2d 186 (1964).

469 1968]




The finance companies have always argued that they were entitled to the benefit of freedom from defenses, although the present writer, as a finance

company lawyer, remarked nearly 20 years ago that the argument was much ado about nothing from a statistical point of view.63 The banks, even more sensitive to the question than finance companies, have insisted upon holder in due course positions, arguing that they cannot hold assigned receivables

legally unless there is a binding and enforceable obligation. Here, as in so

many other instances, the banks seem to be obsessed with a need to have a clean opinion of counsel on the enforceability of every piece of paper instead of being content to establish loss reserves for the portion of their receivables which statistics show is likely to be uncollectible because of defenses good against the banks.

The Uniform Commercial Code originally sought to deal with the problem by denying the third party freedom from defenses in the case of consumer goods.64 This version was originally adopted in Pennsylvania. The bitter opposition of the banks led it to be dropped from the 1957 and subse-

quent Official Texts of the Code, although the Code does still undertake to

preserve any local law to this effect.65 The NCCUSL Bill, the proposed Uniform Consumer Credit Code, goes

back in substance to the 1952 version of the Uniform Commercial Code in

making the third party holder subject to defenses in favor of the consumer

buyer against the seller.66 The complete weight of academic thinking is in favor of the proposal.

63. Kripke, Chattel Paper as a Negotiable Specialty Under the Uniform Commer- cial Code, 59 YALE L.J. 1209, 1215-16 (1950). The writer was referring to the position of major companies financing major products. The present controversy relates principally to sales financing in the fringe areas of products and debtors.

64. UNIFORM COMMERCIAL CODE ? 9-206(1) (1952 version). 65. UNIFORM COMMERCIAL CODE ? 9-206(1). In cases other than consumer goods, the

Code makes clear that a waiver of defenses clause is valid, and execution of a negotiable note is equivalent thereto.

66. ? 2.404 (alternative B). An alternative proposal A is also presented. This provides that the financer may cut off buyers' defenses 6 months after giving the buyer notice of the transfer of the obligation unless the buyer gives written notification of any defenses he has within such 6 months. The provision is essentially similar to those providing for a 10-day notice in the New York Retail Installment Sales Acts, N.Y. PERs. PROP. LAW ?? 302.9 and 403.3 (McKinney Supp. 1967). See note 75 infra.

There are spokesmen for consumer interests who contend that even these provisions do not go far enough, for they do not apply to consumer loans. They contend that where a seller does not formally enter into a credit arrangement with the buyer, but a lender grants the buyer credit, the lender who knows that the buyer will use the proceeds of the loan to purchase the goods from the seller should be subject to defenses of the buyer against the seller. McEwen, Economic Issues in State Regulation of Consumer Credit, 8 B.C. IND. & COMM. L. REV. 387, 401-02 (1967).

In its broadest form, as just stated, this proposal is untenable. No lender would undertake a loan to a casual borrower if he were going to become subject to defenses between that borrower and a seller of goods unknown to the lender, and the lender would not undertake an investigation of such a seller's trustworthiness. In a more limited form, the proposal could have some plausibility. If one assumes a continuing course of loans between one lender and buyers from a given seller, it can at least be seriously argued that the situation is essentially like sales financing, with a regular arrangement between the credit seller and the financer. To the writer this comparison falls down, because in many of these cases the lender is really dealing at arm's length with the borrowers; has no real connection with or control of the sellers; and is simply




Part of this is based on the folklore that financers dominate the dealers, who become mere agents of the financers. As a generalization, this view is com-

pletely erroneous,67 as anyone who has seen the reality of financer competition for dealer business in the field of automobile credit and other favored types of credit knows. Anyone, also, who has seen financing institutions deceived

by dealers knows how unrealistic it is to argue that the financing institution was so close to the credit aspects of the original deal that he should have known of the breach of warranty. The financial institution's routine knowledge of the credit aspects of the bargain does not imply knowledge of breach of warranty or representation as to the merchandise.

Professor Gilmore reached his support of the position taken in the draft

by an entirely different route.68 After a survey of rules cutting off defenses in various third-party situations, he concluded that commercial business re-

quires this result. Accordingly, he concluded that the third party holder of an installment obligation arising from the sale of commercial equipment should be able to take free from defenses. In so doing, he had to disapprove a leading case applying the same rule for equipment that he advocates for consumer goods.69 He concluded that in the case of consumer goods his doctrine of third party freedom from defenses should not be applicable, because the consumer transaction is not commercial.70 This is true from the point of view of the consumer, but it is not clear that his is the proper vantage point. From the viewpoint of the merchant the transaction is as commercial as any other transaction. The merchant selling consumer goods is just as much in business as the one selling equipment, and he has the same need to cash his receivables through a financer with confidence in their collectibility. From the point of view of the financer the transaction is just as commercial and the need for collectibility is just as great as in any other situation. Which viewpoint should prevail? In negotiable instruments law, where the holder-in-due-course doctrine originated, the needs of the financer were treated as decisive.

Since from that vantage point the standard arguments in favor of the position taken by the original Uniform Commercial Code and now by the Uniform Consumer Credit Code are unconvincing, the writer argued against that rule in an article written some time ago.71 He now repudiates his former position, but for reasons quite dissimilar to those stemming from "negotiable"

a name (perhaps one of several) that a seller suggests to his buyers as a possible source of funds. It might conceivably be possible to define such a relationship as would make the proposed rule reasonable, but in the writer's opinion few cases should be included other than credit card situations, where the credit card company certainly has an arrangement with the store.

67. This assertion does not apply to such cases as Unico v. Owen, 50 N.J. 101, 232 A.2d 405 (1967), where the financer dominated the seller by contract and was probably a sister company of the same financial group.

68. See Gilmore, supra note 61, at 1099-1102. 69. Commercial Credit Corp. v. Orange County Machine Works, 34 Cal. 2d 766,

214 P.2d 819 (1950). See Gilmore, supra note 61, at 1101 n.129. 70. See Gilmore, supra note 61, at 1101-02. 71. See Kripke. supra note 63.

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and "holder-in-due-course" theories or Professor Gilmore's commercial- versus-consumer antithesis.

The one thing certain about the typical consumer's execution of a

purchase contract with a waiver of defense clause is that he is unaware of the consequences of signing. The instrument is a contract of adhesion-a form contract proposed by a seller on a take-it-or-leave-it basis-and these contracts have appropriately been called private legislation.72 It is reasonable in a Uniform Consumer Credit Code to take the position that private legislation has no place in this field and that the law of remedies will be prescribed.

Looking at the matter legislatively, we may ask who, as between the consumer and the financer, ought to bear the risk of the merchant's breach of

warranty or delivery of shoddy goods? The consumer sues the merchant only once or episodically. The financer, even though it does not control the merchant or participate in the breach of warranty, ordinarily has a continuing relationship with him and some experience of his performance of warranties. The financer is certainly better equipped with staff to check the merchant's

reputation for reliability and fair dealing. It is submitted that the risk of cases of legitimate customer dissatisfaction should be thrown on the financer. The financer is best able to force redress by maintaining an action over against the merchant or by charging withheld amounts in the financer's hands, even where his basic purchase of the obligation from the merchant was without recourse. The financial institution always protects itself by warranties from the merchant as to freedom of the obligation from customer defenses. Moreover, such a rule would cut off the sources of credit of a merchant with repeated bad warranty relations with his creditors.

The clinching argument is the contrast between the legal relationships in consumer financing and the legal relationships in the financing of commercial accounts receivable. In that field the financing institutions, many of which are also engaged in the consumer field, have never sought to extend to the commercial field their assertion that they are entitled to freedom from customer defenses. There is one simple reason for this: the commercial buyers would not stand for it, for the purchase contracts in the commercial field are not contracts of adhesion. What then happens to the question of freedom from defenses in the commercial field? The financer as part of its credit determination studies the experience of the seller in respect to customer complaints and returned goods, and if the percentage is too high, refuses to do business with that merchant. The same type of credit thinking would provide the answer in the consumer field.73

72. Shuchman, Consumer Credit by Adhesion Contracts, 35 TEMPLE L.Q. 125, 130 (1962). In a second part of the article, id. at 281, Shuchman deals with the present problem as a case of adhesion contracts in consumer financing. At id. 284-87 he expresses views coinciding with those of the present writer as to the unsoundness of the courts' usual attacks on the problem through the concepts of negotiability and holder in due course.

73. There is an intermediate type of contract involving purchases of equipment (i.e.,

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A remark of the late Professor Edmond Cahn is strangely relevant:

The democratic revolution that began in the seventeenth century and is still under way in the twentieth is gradually providing the law with a new and different perspective. The old point of view-the imperial or official-was that of the processors: the new point of view, which we may call the consumer perspective, is that of the consumers of law and government. A free and open society calls on its official processors to perform their functions according to the perspective of consumers.74

Why "strangely relevant"? Because Cahn was not talking of consumers in our limited sense, or about the corresponding concept of processors, but of consumers in the much wider sense of consumers of law, and "processing" judges and policemen. Yet if the terms are read in our narrow sense the

language is still applicable and persuasive. Moreover, Cahn's "imperial" viewpoint is essentially that of the financers and merchants in its impact on the little people. In the poverty areas we hear increasingly of financers denying adjustments under a holder-in-due-course claim, and even of merchants still on the scene deceiving buyers with stories that the merchant need not make

adjustments because "the finance company has the paper." In a reputable milieu-reputable merchants, reputable products, reputable

financers-the freedom from defenses rule is statistically unnecessary. In

poverty areas it works badly. Its time has run out.75

IV. REGULATION

The Senate version of the Truth-in-Lending Bill never went beyond its

panacea of disclosure of finance costs computed as simple interest per annum. A House version of the Truth-in-Lending Bill had some regulatory provi-

nonconsumer goods) by substantial industrial concerns, subject to title retention by the seller. It seems reasonable to accept Professor Gilmore's view and to conclude that a business concern ought to be able to read its contract and if it signs a waiver of defense clause, should be bound by its waiver. But what if a negotiable note is used, such as was involved in the leading case of Commercial Credit Corp. v. Orange County Machine Works, 34 Cal. 2d 766, 214 P.2d 819 (1950) ? It is the writer's hunch that many businessmen simply are not alert to the consequences of signing a negotiable note and to the fact that such notes have the power to cut off defenses when negotiated. A negotiable note used in this context comes close to a contract of adhesion. Yet neither the Uniform Commercial Code, the Uniform Consumer Credit Code, nor Professor Gilmore proposes to protect the businessman.

74. Cahn, Law in the Consumer Perspective, 112 U. PA. L. REV. 1, 9 (1963). 75. I have some question about the alternative version of ? 2.404 of the NCCUSL

Bill (alternative A), which is similar to existing statutes in New York and other states. See supra note 66. Persons experienced in legal aid work in New York say that the notice comes buried in a lot of junk mail, and is not understood by the buyer. The NCCUSL Bill is superior to New York's law in requiring that the notice be conspicuous, and in denying effectiveness to the notice where the financer knows that the seller has a history of customer dissatisfaction and unsatisfactory adjustments. But the NCCUSL Bill is less satisfactory than New York's law as to preserving the buyer's right to claim breach of obligations of the seller not yet due, and even the New York act is unsatisfactory as to long-lasting warranties. Compare NCCUSL Bill ? 2.404 (alternative A) with N.Y. PERS. PROP. LAW ? 403.3(a) (McKinney Supp. 1967).

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sions76 which were poorly conceived, and have been dropped from the Bill as reported. The NCCUSL Bill covers the ground in more balanced fashion.

An important feature of the NCCUSL Bill is its integrated approach to consumer credit, including its consolidation of uneven and fragmentary state legislation on installment sales, small loans, usury, and the like. It contains a series of regulatory provisions which should be discussed at two levels: first, the technical questions of the efficacy and soundness of each

provision; second, the policy question of the desirability of stringent enforcement restrictions on the creditor.

A. The Merits of Specific Regulatory Provisions

1. Application of Payments Following Consolidation. Reversing the

position of earlier drafts, the present draft of the NCCUSL Bill provides that where two purchases are made at different times and the contracts are con- solidated into a single debt payable on a single schedule of payments and secured by all goods purchased, all payments subsequent to the consolidation shall apply to pay off the debt on the first goods purchased and these goods shall be released from the security interest when the payment is completed.77 This seems to the writer to be wrong. The effect of applying all of the payments after the consolidation to the first goods purchased is that payments made pursuant to obligations incurred for the later purchases are being used to pay off the first purchase. This allocation means that the later purchases preserve the original amount of debt despite the declining value of the collateral. The statute thus compels an unsound credit practice, exactly the kind which the draftsmen excoriate when they are not compelling it.78 A creditor should not be forced to write such an unsound contract. He can and he should easily evade the statute by denying to the debtor the convenience of consolidation. If he does this, the debtor will then be making appropriate payments on each account, and will keep the debts in line with the declining value of the collateral in use. The problem of scheduling to accommodate the debtor's ability to pay can be handled by separate extensions in the two accounts, instead of by consolidation. The point is a relatively minor one, but provides a very clear example of over-reaction to an abuse leading to an error in the opposite direction.

There are two other approaches determining the proper application of payments after a consolidation. One of them is so wrong that it produced the diametrically opposed but equally wrong provision of the draft. It con-

76. H.R. 11601, 90th Cong., 1st Sess. (1967). 77. ? 2.409 (alternative A). This reversal is pursuant to the direction of the Com-

mittee of the Whole at Honolulu in August, 1967. W.D. 4, ? 2.409 had provided for pro rata application in the manner recommended in the text, and the draftsmen have continued to carry this as an alternative version despite the direction of the Committee of the Whole. See NCCUSL Bill ? 2.409 (alternative B).

78. See text accompanying notes 87-88 infra.

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templates that after the consolidation all payments are applied pro rata on both accounts in proportion to their existing balances at the time of application. Thus, the first purchase is not paid off until the second is paid off, and all collateral is tied up until both debts are paid off. This approach was deservedly questioned as unconscionable in a case that has attracted wide attention.79

The proper solution is between the two one-sided ones. After the consolidation, payments are applied between the two accounts proportionately to the original amounts of the respective purchase prices, not proportionately to the amounts outstanding at the time of payment. This makes the payments operate with a rough equivalence to the way they would if there had been no consolidation. It keeps the amount of the debts harmonious in relation to the original amounts of debt and values of the collateral, and it releases the first collateral after the associated debt should reasonably be deemed to be retired. This is the solution of the New York and Illinois acts regulating consumer installment sales,80 and of the original versions of the NCCUSL Bill.

2. No Wage Assignments; No Garnishments Before Judgment. The NCCUSL Bill forbids wage assignments, and garnishment before judgment.81 This has caused some resistance. There are those who contend that since the typical consumer has no significant assets, refusal to permit wage assignments would destroy his only available means of assuring repayment and would deny him loans from a legitimate lender.82 But the denial of wage assignments would not destroy the basis of a legitimate loan to a wage earner, for the Code proposes only to alter the timing of a creditor's access to the employer. Access to wages can usually be gained under local process through garnishment after judgment. The potential impact on the employer of notification of wage assignment or of garnishment is such that it seems reasonable to require the creditor to prove his rights by taking judgment before resorting to this drastic remedy. Many cases have been settled before judgment, either because the employee raised a defense that the creditor chose not to test in court, or as a result of amicable agreement. These settlements avoid unnecessary dis- turbance of the employer. On balance, these provisions seem reasonable.

3. Garnishment After Judgment. The NCCUSL Bill limits the amounts that can be required to be paid under a garnishment after judgment to the excess of earnings over $100 a week, $65 a week in the case of men without dependents.83 Here the problem seems to the writer to deserve further study.

79. Williams v. Walker-Thomas Furniture Co., 350 F.2d 445 (D.C. Cir. 1965). 80. N.Y. PERS. PROP. LAW ? 410.3 (McKinney 1962); ILL. ANN. STAT. ch. 121 1/2,

? 522 (Smith-Hurd Supp. 1967). 81. ?? 2.410, 3.403; ? 5.104. 82. See Hearings on the Uniform Consumer Credit Code Before the NCCUSL

(August, 1967) at 329-32; R. DOLPHIN, AN ANALYSIS OF ECONOMIC AND PERSONAL FACTORS LEADING TO CONSUMER BANKRUPTCY 96 (1965),

83. ? 5.105.

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The restriction catches only consumer credit as defined and, therefore, does not catch charge account credit or service credit, including medical bills. Yet

among the most frequent plaintiffs in the collection courts, and not uncom-

monly the most ruthless, are the doctors with a large credit practice. A study in Flint, Michigan listed the doctors as among the creditors against whom the debtors were the most resentful.84 But they would be completely exempt from the present restriction. Garnishments by doctors or other creditors not

subject to the proposed statute might be subject to another comparable restriction in the procedure laws of the state.85 But, if so, the inconsistency and lack of coordination of the statutes is apparent.86

Not only that, but the oft-stated purpose of this and other restrictions-

namely to discourage creditors from improper overextension of credit by denying them their remedies-would not at all be served by the restriction in its present form. A creditor, for instance, might make the most careful credit check as to his debtor's assets and existing obligations before extending credit conservatively. Nothing he could do either by advice or even by exact-

ing covenants against future borrowing could preclude the debtor from sub-

sequently incurring obligations recklessly; the more reckless the subsequent creditor, the more likely that that creditor will be ruthless in denying extensions and in proceeding to judgment and garnishment. Such a later reckless creditor would, therefore, be the first to garnish the excess over the $100 per week exemption,87 and the conservative creditor would come later and too late. The restriction becomes a matter of first-come, first-served in enforcement, without regard to the conditions under which the debt was incurred.

The writer has no easy answer to this problem; but it seems as a minimum that restrictions on garnishment belong in the procedural statutes of the state applicable to all forms of creditors and not just in a statute of this scope.88 They should be designed to protect the minimum needs of the debtor and his family, not based on the notion-mistaken, as the writer will argue below-that sound credit granting should be compelled by denial of remedies.

4. Denial of Deficiency Judgments. Again as part of their thinking that over-extensions of credit should be controlled by denying remedies to the

84. DOLPHIN, supra note 82, at 85, 107. 85. E.g., N.Y. CPLR ? 5231 (McKinney 1963). The hodgepodge situation is shown

by the fact that in New York Medicaid clients, along with other recipients of public assistance, are exempt from wage garnishment. N.Y. Soc. WELFARE LAW ? 137-a (McKinney 1966); N.Y. Times, Oct. 25, 1967, at 29, col. 3.

86. A Comment to ? 5.105 in W.D. 6 attempts to explain that there is no inconsistency between the garnishment provision of the NCCUSL Bill and other garnishment laws of the state, but that the more exemptive prevails in each case. It is not clear to me that this solves all problems. Moreover, it is not clear that the two overlapping statutes would be read in the fashion suggested in the Comment, instead of by the rule that a later enactment repeals an inconsistent earlier one.

87. Professor Johnson has said that the first garnishment writs are frequently served by the creditor last to extend credit. NCCUSL August 1967 Hearings, supra note 82 at 438.

88. See Karlen, Exemptions from Execution, 22 Bus. LAWYER 1167 (1967).

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creditor, the draftsmen of the NCCUSL Bill propose that deficiency judgments in credit sales should be denied where the creditor has repossessed the

goods, under certain specified conditions. The difficulty with the idea is indicated by the draftsmen's uncertainty as to the reason for the denial. One

suggestion was that if defaults occurred early in the schedule of payments, the creditor had overextended credit and should accordingly not be allowed a

deficiency judgment. An earlier public form of the bill made the amount of a

permissible judgment dependent on the unpaid balance at the time of re-

possession, allowing no deficiency judgment if the balance at that time was

$500 or less.89 The latest working draft makes the amount depend on the

original size of the obligation, allowing no deficiency judgment where the

obligation originally was $1000 or less.90

All of these approaches seem to the writer to be faulty. Early default is less likely to prove that the creditor was reckless than that the debtor was

dishonest; or that he capriciously changed his mind or unhappily lost his job. And a rule dependent on the unpaid balance is merely capricious if the balance is not related to the amount of the original debt. The latest version seems to be based on the theory that the collateral value of goods which sell for $1000 is slight, but it is not apparent why this justifies the proposed rule.

The basic significance of a restriction on deficiency judgments has to be questioned so long as the creditor has the option of foregoing the property and enforcing the personal obligation of the debtor. It is very clear that the draftsmen intend to give the creditor this right in this statute.91 This means that even though the goods are of slight resale value like clothing, jewelry, appliances, or even a new car which loses a large percentage of its value when it is driven out of the showroom and again after a model change, the debtor can be forced to pay if he has a job or other resources. A creditor can simply ignore the collateral. Since suit on the personal obligation is

permitted, what additional equity does the debtor have for claiming that he should be free of personal liability because the creditor resorted to the collateral and tested out its salvage value first? What is the practical value to the debtor of a rule against deficiency judgments in this situation ?

The only type of restriction on deficiency judgments that could be defended is one under which the debtor would be excused from deficiency if he had performed a certain percentage of his obligation-for example, if he had paid 60% of the amount of his original contract before submitting to

repossession.92 This would be an approach similar to that which underlies

89. W.D. 4, ? 5.103. 90. ? 5.103. 91. Jordan & Warren, A Proposed Uniform Code for Consumer Credit, 8 B.C. IND.

& COM. L. REV. 441, 457-8 (1967). "In any event, he can always sue for the unpaid debt; however, he must allow the debtor to keep the goods if he does."

92. See ILL. ANN. STAT. ch. 121Y2, ? 526 (Smith-Hurd Supp. 1967).

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the provisions of the Uniform Commercial Code93 and the Uniform Condi- tional Sales Act,94 which required resale of the repossessed goods by the creditor on the theory that payment of a specified percentage of the contract indicated the likelihood that the collateral was at least equal in value to the remaining debt and might indicate a surplus. So here payment of a specified percentage might indicate that the remaining value of the collateral is equal to the remaining value of the debt and that no deficiency should be permitted.

But this is still only a superficial approach. The deeper question remains whether the creditor should have any more responsibility than the debtor for the fact that the resale value for cars financed as new or for appliances, clothing and the like is only a small portion of the cost.95 The still deeper question remains whether the Code's overall approach of restricting creditor remedies is sound. This question is the subject of the next inquiry.

B. Policy Issues on Restriction on Remedies

In the writer's opinion an effort to strike down the abuse of overextension of credit by restricting the remedies of the creditor is wrong. The NCCUSL Bill is mild and restrained compared to the proposals of some consumer advocates, but it still goes too far. This is not to say that there may not be individual remedies like wage assignments which should be curbed, but curbing remedies as a general approach is wrong.96 It confuses the areas of oppression of the consumer with universal practice. Legislation that is aimed at one situation but has its impact on all cases cannot fail to cause problems.

That overreaching by credit sellers creates serious problems in poverty areas cannot be denied in view of all the evidence of abuse. But the remedy for abuse must be direct, by procedures aimed at the abuse, not by devices aimed at penalizing the creditor when dislocation manifests itself in default. For the dislocation manifested by the default may have nothing to do with the abuse.

It must be recognized that even in the poverty situations, putting aside the cases of fraud and high pressure in home sales, the buyers do want the

93. ? 9-505(1). 94. ? 19. 95. Without a legislative restriction, there would be room for reducing the number

and size of deficiency judgments by realistic application of the requirement of commercial reasonableness in resales. See Family Fin. Corp. v. Scott, 24 Pa. D. & C.2d 587 (Allegheny C.P. 1961).

See also the suggestion of the National Bankruptcy Conference that allowance of deficiency claims in bankruptcy may be limited by consideration of the fair value of the collateral. Countryman, Proposed Nezw Amendments for Chapter XIII, 22 Bus. LAWYER 1151, 1155 (1967).

96. See ZIEGEL & OLLEY, supra note 42, at 105. A single justifiable exception may be the provisions of Article 2, Part 5, of the NCCUSL Bill (?? 2.501-2.505) on home solicitation sales. Here practices of unscrupulous operators are so large a part of the total picture that it may be necessary to put a burden on the operations of respectable operators to have an adequate rule. Compare the writer's present views on third party freedom from defenses, Part III, supra.

478 [Vol. 68:445




goods. Even in the famous Frostifresh case,97 the question of remedies was

complicated by the fact that the Spanish-speaking people deceived into buying a home freezer at a high price chose to keep the freezer. Thus we cannot

adopt restrictions on remedies so punitive as to put the credit sellers in the

poverty areas, and their financers, out of business. Despite the present high social cost, they serve a social purpose. The demand for modern appliances and other amenities, and for such necessities as color television and stereo

sets, is irresistible at all levels of poverty, including that of welfare clients.98 The avowed purpose of the NCCUSL draftsmen to induce denial of credit

by restricting remedies stands in the way of an irresistible movement, and is like opposing a fly swatter to a bomb barrage.

An attack from a restriction-on-remedies point of view comes nowhere near reaching the basic social problem. Moynihan has taught us99 that below the upper middle class we no longer have a continuous spectrum shading from white-collar workers to blue-collar skilled, semi-skilled and unskilled workers to unemployed. We are rapidly dividing ourselves into white collar or union- ized middle-class workers with strong ethnic and neighborhood loyalties and a status to protect on one hand, and, on the other, a dispossessed urban poor, both white and black, an underclass, a Lumpenproletariat. A minority of the latter, in response to modern thinking about the affluent society and the war on poverty, guaranteed wages, negative income tax and the like, has come to feel that it is entitled to such bare essentials of living in our modern

society as color television and stereo sets; and that if society does not provide them, it is entitled to burn up our cities to distract attention while its members help themselves. This is, of course, an exaggeration and a partial view, and in our reactions to these events we should not forget that before this class formed, society-all of us-failed. But our sympathies must in any event run to the majority of this class, the law-abiding members of the dis-

possessed, who get the possessions they want from credit purchases. For these, an effort to shut off credit would be fruitless and would merely take them to the loan sharks.

Moreover, it will be found impossible to draft remedies which distinguish the illegitimate merchant and credit grantor from the legitimate and fair credit grantor in the poverty areas, or from the legitimate and respectable bank or finance company grantor in middle-class situations.

97. Frostifresh Corp. v. Reynoso, 52 Misc. 2d 26, 274 N.Y.S.2d 757 (Dist. Ct. 1966), rev'd per curiam, 54 Misc. 2d 119, 281 N.Y.S.2d 964 (Sup. Ct. 1967). See note 108 infra.

98. See Williams v. Walker-Thomas Furniture Co., 350 F.2d 445 (D.C. Cir. 1965). 99. Moynihan, supra note 4. See also M. HARRINGTON, THE OTHER AMERICA (1962).

Lippmann, 1968-The GOP's Big Chance, New York Post, Dec. 16, 1967, at 27: The affluence which the expanding American economy is producing has lifted a large part of the working class to a standard of living which has made it a part of the middle class.

And this has meant that the working class which has been left behind, in the main the Negroes, has little solidarity with-and, in fact, has a dangerous antagonism toward-those who have forged ahead.

1968] 479




The bulk of the default problem arises not from overextension of credit or other over-reaching, but from the debtor's change of circumstances. The

simple fact is that the typical consumer, even in middle-class situations, is not a balance sheet risk. He has no significant assets. His only significant "asset" which makes him creditworthy is a job,100 that is, his future earning power.101 Collection troubles occur because the job is lost, or because the take-home pay has to be devoted to paying for a sick wife, or because the debtor has made later credit purchases. They may not at all be the fault of the creditor, who

may have been adequately or even excessively conservative in his extension of credit. There are also the real deadbeats, the debtors who can pay but will not, or who have used fraudulent devices to build up the debt.102 Even the

100. Jordan & Warren are therefore wrong in thinking that modern informational services can enable a creditor to pass sound credits. Jordan & Warren, A Proposed Code for Consumer Credit, 8 B.C. IND. & COM. L. REV. 441, 457 (1967). Information can verify the existence of a job, but not its future continuance. It can verify existing monthly payment demands, but not those the debtor will acquire voluntarily in the future by other purchases, or involuntarily by illness or other misfortune.

101. This is the basis for the efforts of creditor interests to restrict the automatic right of wage earners to a discharge in "straight" bankruptcy, instead of trying a rescheduling of debts under Chapter XIII of the Bankruptcy Act-an effort which consumer representatives and bankruptcy academicians have greeted with shocked indignation. See The Committee on Bankruptcy and Corporate Reorganization, Denial of Bankruptcy Relief to Wage Earners Able to Resort to Plans under Chapter XIII of the Bankruptcy Act, 22 RECORD OF N.Y.C.B.A. 490 (1967); Countryman, Proposed New Amendments for Chapter XIII, 22 Bus. LAWYER 1151 (1967); Driver, Proposal-To Amend the Bankruptcy Act to Require That Consideration Be Given to the Use of Chapter XIII, 18 PERSONAL FIN. L.Q. REP. 41 (1964) ; Meth, Filling the Gaps in the Law of Consumer Bankruptcy, 23 Bus. LAWYER 173 (1967) ; Twinem, Reduce Unneces- sary Personal Bankruptcies: Amend the Bankruptcy Act, 23 LEGAL AID BRIEF CASE 252 (1965). The indignation misses the point: When a consumer buys on credit, the credit is simply not justified on an asset or balance sheet basis. Moreover, few goods have a resale value equal to their cost new to the consumer, so the credit is seldom justified on a collateral value basis. The credit is really extended against the debtor's future earning power; the transaction is in economic expectation an assignment of future wages, whether or not the state has a statute authorizing such assignments. The creditor group feels that if a consumer's earning power and the demands on it have not significantly changed since the credit was extended, he does not have the moral right to obtain a bankruptcy discharge and free up the earning power on the basis of which the credit was extended. The proponents of the Bill to restrict the availability of discharge for wage earners argue that even if the wage earner has later involved himself too deeply for the original schedule of payments, he ought on some reasonable basis to have to devote his earning power to his debts through a Chapter XIII Plan. One study indicated that 49% could have done so. Dolphin, The Economic Feasibility of Chapter XIII, 20 Bus. LAWYER 477 (1965). Philosophically those taking this view have a legitimate argument. The difficulty comes in drawing a proper line between so restricting discharge, on one hand, as to nullify its proper purpose, giving a man a fresh start (especially if his own weakness in overbuying was encouraged by creditors); and on the other hand, permitting the repudiation of just debts deliberately incurred, through purposive and unnecessary bankruptcy. In the present writer's view, since the collateral under purchase money debt is always subject to repossession and is not exempt in bankruptcy, cases of deliberately planned overbuying in expectation of bankruptcy will be rare, and the remedy of discharge should be available against a permanent burden from human weakness.

102. This is a phase of the story not widely publicized by legal aid bureaus, social workers, and better business bureaus, for deceived creditors do not come to them with their complaints. See DOLPI-IIN, supra note 82, at 90-91; ZIEGEL & OLLEY, supra note 42, at 104-05. As Commissioner Baggett stated in NCCUSL Afugust 1967 Hearings, supra note 82, at 440: "We in Oklahoma had an extensive number of hearings before our Legislative Council in which a large number of debtors appeared and complained of the collection practices of their creditors. It became apparent, as one legislator observed, that what they really object to is collection."




draftsmen concede that coercion by the state should be available to make them

pay, but the draftsmen provide no formula for restoring against the deadbeats the creditor remedies they propose to emasculate in favor of "the naive victim of the overreaching creditor."'03

A realistic test of the merits of restriction of deficiency judgments would

go beyond pin-pricking proposals which merely put the creditor to an election of remedies between the personal obligation and the collateral. Why not abolish the personal obligation in installment sales altogether, leaving the creditor only the remedy of repossession? At a stroke this would eliminate the evils of the "overreaching creditor," the evil of sharp practices in estab-

lishing deficiencies by sales for inadequate prices, the devastation of the debtor by large deficiencies, and collection abuses by garnishment and similar means. Installment sales would then become leases binding on the creditor but terminable at the will of the debtor. The fact that the resale market in

many goods is very poor would then become exclusively the creditor's, not the debtor's concern. Are we really prepared to pay the price of this simple and effective solution to the problem of overselling and of deficiency judgments and garnishments? Would our economy survive if the creditor no longer extended credit against the debtor's future earning power, but increased the down payment requirement and shortened the term until his debt was safe solely on a collateral-secured basis? Would our economy survive the drastic reduction of credit extension on furniture, appliances, jewelry and the like? If we are not prepared to eliminate reliance on future earning power and resort thereto, more hard-headed thinking is required about re-

stricting remedies.104

103. Jordan & Warren, supra note 100, at 457. 104. Law students and graduate lawyers working with me on problems in this field

have recently told me that in their opinion the above terminable lease idea is substantially the conception of an installment purchase obligation actually held by many of their contemporaries, even college graduates working for professional degrees in other fields. Such persons, I am told, simply have no conception of the fact that if they buy a color TV on time, they have a legal obligation beyond giving it back when they are tired of paying. If so, the situation is indeed alarming. One's first reaction is that the situation among the urban uneducated poor must be that much worse, but on reflection this is probably not so. The sheltered middle-class college student may never have had to think about the problem, while there probably is no member of the urban poor who has not heard a sad story about garnishments. See, however, Comment, Consumer Legislation and the Poor, 76 YALE L.J. 745, 753 & n.45 (1967). In any event, the question sharply arises whether the law and the economy can afford to see this point in the consumer perspective (in Edmond Cahn's phrase, see text at note 74 supra), and make the law conform to this kind of expectation. The fact is that a buyer is committing his future earning power by installment buying just as realistically as he does under present New York law by notification of an assignment of wages (N.Y. PERS. PROP. LAW ?? 46-49-b (McKinney Supp. 1967). This is the present foundation of consumer credit, and the question is whether the foundation can be removed.

I have spent some anxious moments considering whether in this thinking I am merely spouting the conventional wisdom. Compare text after note 25 supra. That California functions with no apparent ill effects on the extension of credit under a rule which bars deficiency judgments except for motor vehicles (CAL. CIV. CODE ? 1812.5 (West Supp. 1967))-a rule basically similar to ? 5.103 of W.D. 6-proves nothing except that creditors can live with an election of remedies doctrine. The harder question is whether creditors can live with a system of law which precludes resort to future earnings by omission of any provisions for wage assignments or garnishments. I have sought earnestly

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The effort to affect buying practices and satisfaction of wants among the urban poor by credit remedy restrictions throws out a useful social device in order to get at abuses. Far better, it would seem, would be an effort to en-

courage more respectable companies to make credit responsibly available in the ghettoes.l05 Even if regulatory limitations on remedies were drafted with an effort to debar only the reckless overextender of credit, the separation formula could not be perfect. The result must inevitably be to cause legitimate lenders who are not staffed for sweating out difficult collections to withdraw from borderline lending cases. Is this desirable? It seems to the writer obvious that it is not. Rather, the writer agrees with those who, motivated by the same consumer-protective attitudes which motivate the NCCUSL draftsmen, who desire to encourage legitimate credit extenders to enter the field. The Chairman of the Greater Washington Chapter of Americans for Democratic Action pointed out that "since low-income families cannot meet the established unrealistic credit-rating standards imposed by reputable merchants, they are channeled indirectly into the hands of unscrupulous merchants who sell in- ferior products at inflated prices .... We fully expect the reputable merchants

to go out and aggressively solicit this new market."'06 Would not passage of the sharp NCCUSL restrictions on remedies defeat this worthwhile effort?

Since the draftsmen have erred by focusing exclusively on the overextender of credit in poverty areas, let us break the problem down:

for an answer to this question in Pennsylvania, where there is no wage garnishment. Finance lawyers with national background but experienced in Pennsylvania point out that Pennsylvania has a practice of confession of judgment before default. My next question is what difference this makes in a poverty area where the debtor has no real assets to be reached under a judgment. From there the story breaks into fragments. There are stories of complaisant constables who will go out to the plant on payday and stage an act designed to make the debtor believe that he can be forced to pay part of his salary periodically to the creditor. There are also stories and assertions that even in poverty areas the debtor will make arrangements to pay rather than suffer the ignominy of having his furniture seized under the judgment. It would seem that this remedy would be less effective the deeper one goes into the poverty areas. Thus, the final question is whether unsound credit-selling practices are any less a problem in Phila- delphia than in New York. I know of no authoritative answer, but the feeling is that the abuse is more acute in New York. If so, severely limiting garnishment by increasing the minimum garnishment exemption from $30 to $100 a week in New York, as Sec- tion 5.105 of the NCCUSL Bill proposes, might have a similar beneficial effect.

105. For this reason, the writer fully supports the NCCUSL Bill in so far as its high rate ceilings amount in substance to the repeal of usury restrictions. The well-known history of small-loan legislation shows that the poor will get the credit they need one way or another, and that if the rate is not sufficient to permit the legitimate creditor to operate, the poor will resort to the loan sharks. Recent studies also confirm the view that credit is more available to poorer credit risks where the rate ceiling is high enough to compensate for the risk. J. CHAPMAN & R. SHAY, THE CONSUMER FINANCE INDUSTRY: ITS COSTS AND REGULATION 55-56, 75 (1967); Kawaja, The Economics of Statutory Ceilings on Consumer Credit Charges, 5 WESTERN ECONOIIC J. 157 (1967); Goudzwaard, Price Ceilings and Credit Rationing (to be published in the J. of Finance); Johnson, Regulation of Finance Charges in Consumer Instalment Credit, 66 MICH. L. REV. 81 (1967). It is strange that the draftsmen of the Code, who have learned this lesson well, do not realize that it applies equally to creditors' remedies.

106. ADA WORLD, Sept., 1967, at 9. Cf. Curran, Legislative Controls as a Response to Consumer Credit Problems, 8 B.C. IND. & COMM. L. REV. 409, 432 (1967), suggesting that the responsible, not the irresponsible, credit grantors become cautious when remedies are restricted.

[Vol. 68:445 482




(1) Traditional enforcement remedies should be retained for the deadbeats.

(2) For the naive victim of an overreaching creditor, relief should turn on the doctrine of unconscionability of the contract under all of the circumstances of the particular case. The NCCUSL Bill has a section on this pointl07 with which the writer has no quarrel. But the writer thinks it should be the

primary remedy for this type of oppression, without the purposive specific limitations on creditors' remedies.108

The proposed unconscionability section is in form essentially a repetition of Section 2-302 of the Uniform Commercial Code, but its position in the Uniform Consumer Credit Code clearly makes it applicable also to the credit

aspects of a sale. For this reason, department stores and other sellers, even

though they are now subject to the Uniform Commercial Code in their

capacity as sellers, are bitterly complaining. They are joined by the institutions which finance sales, with the standard arguments about uncertainty of

interpretation, the risks of a jury trial, and so on. These arguments have some validity, but not enough to carry the day. Experience under Section 2-302 of the Commercial Code proves that the unconscionability provision has been

interpreted with restraint and has not been abused even by defendants in-

voking it. In fact, there have been surprisingly few cases under Section 2-302.109

The paucity of cases suggests a rebuttal question: What good is a remedy that requires the beneficiaries to carry a heavier burden of litigation than urban poor are capable of carrying? This is a legitimate question. Part of the answer lies in the recent growth of legal aid services for the poor. A

107. ? 2.412. 108. Eloquent criticism of the history and draftsmanship of the unconscionability

provision of section 2-302 of the Uniform Commercial Code has been made. Leff, Un- conscionability and The Code-The Emperor's New Clause, 115 U. PA. L. REV. 485 (1967). This does not change the value of an unconscionability provision as an invitation to the courts to exercise their equitable powers. One can agree with Leff (page 558): "The courts will most likely adjust, encrusting the irritating aspects of the section with a smoothing nacre of more or less responsible applications ...."

109. Williams v. Walker-Thomas Furniture Co., 350 F.2d 445 (D.C. Cir. 1965); In re Elkins-Dell Mfg. Co., 253 F. Supp. 864, 873 (E.D. Pa. 1966), rev'g In re Elkins- Dell Mfg. Co., 2 UCC REP. 1021 (Opinion of Referee, E.D. Pa. 1965) and In re Dorset Steel Equipment Co., 2 UCC REP. 1016 (Opinion of Referee, E.D. Pa. 1965); State v. ITM Inc., 52 Misc. 2d 39, 275 N.Y.S.2d 303 (Sup. Ct., N.Y. Cty. 1966); Frostifresh Corp. v. Reynoso, 52 Misc. 2d 26, 274 N.Y.S.2d 757 (Dist. Ct., Nassau Cty. 1966), rev'd, 54 Misc. 2d 49, 281 N.Y.S.2d 964 (App. Term, 2d Dept., 1967). Under the theory of the reversal in the last case, the creditor would lose only the amount of his unconscionable extortion, not his principal or reasonable profit or reasonable trucking and service charges. This would leave the threat of a holding of unconscionability a paper tiger indeed, and the present writer thinks that the reversal was erroneous.

For the special problem of unconscionability predicated on high finance charges, see note 114, infra, and related text.

Experience under British and Canadian legislation applicable to unconscionable lending transactions has also indicated no reasonable cause for alarm on the part of legitimate credit grantors. See Unconscionable Transactions Relief Act, c. 410 ONT. REV. STAT. (1960); Contracts Relief Act of 1964, c. 11 (B.C.); Money-lenders Act of 1900, 63 & 64 Vict., c. 51. See note 114 infra.

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more important part must lie in the active and self-starting role for the administrator contemplated by the NCCUSL Bill, who will have authority to sue to enjoin unconscionable courses of conduct in credit-selling fields.1l0

In the writer's opinion, the inconveniences of an unconscionability test are a part of the price that department stores and other reputable sellers must pay for entering the credit field with installment plans, revolving credits and credit cards. The abuses in the field of consumer credit have been sufficient to present a genuine problem which cannot be blinked away, and the state must deal with the problem. Even though they do not participate in the evils, the legitimate sellers and credit institutions cannot be exempted by name or description, and they have the choice of being confined by rigid remedial restrictions in the state's attempt to reach these evils, or of submitting to the uncertainties of an unconscionability standard. In the writer's opinion the risks are less onerous than the rigidities.

The question would stand on a different footing if administrative orders or regulations based on an unconscionability theory had the force of law under the NCCUSL Bill. The writer admits that he would be taken aback if the ideas of some of the consumer spokesmen in the NCCUSL discussions acquired the force of law when one of the spokesmen became a state administrator, with rule-making or adjudicative powers. But the NCCUSL Bill is not drafted that way. State administrators asserting unconscionability can bring actions in the courts only to enjoin allegedly unconscionable courses of conduct, not individual acts.1l In addition to the fact that the administrators would be unlikely to attack reputable stores and credit institutions (and certainly not without prior discussions, for the action can be brought only after the defendant has refused the administrator's request for discontinuance), the courts' previous action on questions of this kind should be a source of satisfaction and confidence.l12 Moreover, the power to make a finding of unconscionability is hemmed in by carefully drafted requirements of sub- findings.13 On the one point as to financing costs where an existing decision suggests some legitimate cause for concern,1l4 the NCCUSL Bill very soundly

110. Cf. State v. ITM Inc., 52 Misc. 2d 39, 275 N.Y.S.2d 303 (Sup. Ct., N.Y. Cty. 1966), where such a suit was brought by the Attorney General of New York.

The writer would be less than candid if he did not state that there will have to be thorough study of and careful discrimination in applying an unconscionability standard. It is easy to find unconscionability where a salesman falsely represents that a television set is specially made and cannot be bought elsewhere, as in the ITM case, when in fact it can be bought in any store for a fraction of the present price. But is not a house-to- house canvasser entitled, under our competitive system, to something more for the added expense of house-to-house canvassing? Similarly, while no doubt the poor pay more (see D. CAPLOWITZ, THE POOR PAY MORE (1963)), are there not extra expenses in poverty areas for such things as broken windows and pilferage that add to the merchants' costs? The just solution simply is not as easy as the consumer spokesmen think.

111. ?? 6.108(1), 6.111. 112. Supra note 108. 113. ? 6.111(3) and (4). 114. See American Home Improvement, Inc. v. Maclver, 105 N.H. 435, 201 A.2d

484 [Vol. 68:445




provides that a finding of unconscionability may not be based on the creditor's

making an authorized charge.115

(3) It remains to consider what we should do for the delinquent debtor whose delinquency is due to family illness, or some such cause. Here in the writer's opinion is a larger problem than "overreaching." This is so even

though any reputable creditor will be willing to work out an extension if the debtor has any hope of overcoming his difficulties. The debtor's misfortune could be "insured" by our legal institutions by throwing the loss on the creditor through denial of enforcement remedies. But the loss so allocated would not come to rest on the bloated stockholders of the creditor. The cost would be and would have to be passed on by the creditor to the debtors who do pay, as bad debt expense which must be recouped in the finance rate, leaving the creditor with a profit margin sufficient to keep capital employed in the competitive credit market as against other opportunities to invest funds

profitably.1"" This spreading of cost might be legitimate social engineering. There is an analogy in the recent growth of strict liability in tort in the field of products liability. In that field, the courts are consciously creating an un- conventional form of insurance by passing loss back to the manufacturer from the injured consumer,117 but the courts are there aware that the liability is without fault and that the cost will be redistributed by the manufacturer

among consumers, and their vision is not obscured by adjectives like "over-

reaching." Such an approach must be taken consciously. The formulation of such an insurance scheme ought to produce standards for entitlement to the denial of remedies very different from the automatic denials proposed by consumer representatives; the latter restrictions are motivated by a desire to punish the creditor for an assumed sin of overextending credit.. The NCCUSL Bill is very mild compared to some proposals, but philosophically the approach of denial of remedies is wrong, because the assumptions of fault of the creditor is appropriate only in the special, not the typical, case. If we are unwilling or unable to think in terms of the suggested social insurance

program, then it seems to the writer that after providing for minimum take-

886 (1964), the reasoning of which is questionable although the facts are extreme. A finding of unconscionability was based on the circumstance that the seller paid nearly half the cash price as a commission, and added another half for 60 months' installment financing. See also Attorney General for Ontario v. Barfried Enterprises Ltd., 42 D.L.R.2d 137 (Can. 1963), deciding that the Unconscionable Transactions Relief Act could be applied to a flat charge, which if it were interest could be regulated only by the Federal Interest Act of Canada; Miller v. Lavoie, 60 D.L.R.2d 495 (B.C. 1966) and English cases cited therein, which treat the rate of charge as subject to statutes of this sort but take a very realistic view with respect thereto.

115. ? 6.111(4). 116. This passing of losses back to the debtors who do pay is impliedly recognized

in a Comment to the NCCUSL Bill, which justifies the authorized high rates by refer- ence to the remedial provisions of the Bill. Comment to ? 3.508.

117. See, e.g., Greenman v. Yuba Power Products, Inc., 59 Cal. 2d 57, 377 P.2d 897, 27 Cal. Rptr. 697 (1963); Goldberg v. Kollsman Instrument Corp., 12 N.Y.2d 432, 191 N.E.2d 81, 240 N.Y.S.2d 592 (1963).

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home pay through a proper restriction on garnishment, we should let normal enforcement remedies take their course. There is an ultimate safety valve for the unfortunate debtor in the form of state wage-earner receiverships,118 bankruptcy discharge or wage adjustment under Chapter XIII of the Bank-

ruptcy Act.119

V. LICENSING

As currently drafted the NCCUSL Bill requires licensing of lenders mak-

ing regulated loans, that is, charging a rate of return over a specified rate ;120

but the licensing is based on character and fitness (which means essentially unlimited entry), not on convenience and advantage (which means restricted

entry). Much argument centers on the question of the desirability of restricted

entry as against free entry into the small loan field. Dire predictions are made that under free entry improper persons will enter the field attracted by the small loan scale of rates and will either abuse the public or create financial disaster for themselves through their own inexperience and their ignorance about how to extend credit and about the expenses of a small loan operation.

We are told earnestly that licensing on a convenience and advantage basis is necessary to keep out loan sharks, and the California experience in creating a small loan apparatus to dry up the loan shark racket is cited. The defenders of the convenience and advantage form of licensing can now also point to the most recent important work in the field of finance economics-the Chapman and Shay book, which concludes that loan costs are lower if a loan office has a

large number of loans.121 From this it may be argued that restriction on entry reduces the costs of the lender and, therefore, may reduce costs to the borrower.

The writer remains unconvinced by these arguments. Small loan rates tend to be at statutory maximums, and there is no evidence that any savings are passed on to consumers. On the contrary, the evidence is that small loan

companies have maintained their profits even while the sales finance com-

panies have suffered.122 The really important public policy argument is that controlled entry is

necessary to protect against loan sharks. The writer does not follow this argument. Loan sharks operate illegally anyway, and do not want to submit to the controls of licensing, reports, inspection and the like. It is hard to see

118. See DOLPHIN, supra note 82 at 22-24, for discussion of the Michigan statute. The NCCUSL Bill, in drafts before W.D. 4, has had an Article on wage-earner

receiverships, but it was omitted beginning with W.D. 4 because it had not reached as advanced a state of drafting in the work of the NCCUSL's Special Committee as other sections of the NCCUSL Bill. Provision for such an Article has been restored in the latest non-public draft, W.D. 7.

119. A controversy is now raging over whether a Referee in Bankruptcy should be able to force a bankruptcy into an extended pay program under Chapter XIII instead of a discharge in "straight" bankruptcy. See note 101 supra.

120. ?? 3.501, 3.502, 3.503. 121. CHAPMAN & SHAY, supra note 105, ch. III. 122. Table, supra note 46; STANDARD & POOR'S FINANCE AND SMALL LOAN INDUSTRY

SURVEY, Sept. 7, 1967.

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how an increase in the number of legal lenders through free entry can help the loan sharks who continue to operate illegally; and it is hard to see how one who was willing to be an oppressive and illegal lender outside the law is

likely to be any more dangerous in the unusual case where he chooses to take a license and becomes subject to the law's disciplines.

The argument of policy here reminds one of a stately stage pantomime. Behind the show is the effort of several small loan lenders to retain the

monopolistic position they built up by obtaining licenses many years ago (when they were easier to get) or by grandfather rights or by purchase; and on the other side is the effort of the large sales finance companies, being squeezed out of their field by bank competition and rising costs,123 to enter the more lucrative small loan field. The small loan companies are supported by the existing small loan regulators, both because persons regulated and the

regulators tend to develop symbiotic relationships, and because regulators can

scarcely be expected to realize or admit that their shuffling of papers is not of

overwhelming public importance. Is there any serious evidence that licensing controls the illegal lender effectively? And would not licensing with free entry to those who can pass a character test control the legal lender as effectively as the present restricted entry under a convenience and advantage test?

The reader is warned that the writer's background in this general area was with the sales finance companies and that he is prejudiced. Nevertheless, for what it is worth, he states his opinion that there is in the present licensing process no protection from loan sharks or other benefit that would justify continuation of the present legalized scarcity and protection from competition. Free entry into the field would no doubt create some temporary dislocation, some oversupply of offices, some disasters arising from the entry of the

inexperienced and incompetent; but after a few years the result of open competition would almost surely be seen in the narrowing of the gap between the present 12% rates of the credit unions and industrial banks, and the 24-36% rates of the small loan companies.

123. Supra, text at notes 40-47.

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consumer credit regulation: a creditor-oriented viewpoint

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