by Ian Forsythe
There is a great deal of misconception about whether lenders (including banks, credit unions, and finance companies) are subject to the claims and defenses that a consumer has against a merchant when the lender provides the funds to finance a consumer transaction. This issue arises in a variety of situations involving the use of credit in consumer transactions, and this article will present the more common scenarios and discuss the various reasons why, in most cases, lenders are subject to the claims and defenses that a consumer has against the merchant.
In the first scenario, a buyer purchases a vehicle from a motor vehicle dealer, and finances the purchase by entering into a retail installment contract with the dealer. The retail installment sales contract contains terms upon which the dealer is willing to finance the purchase, including the interest rate, amount of payments, number of payments, and total finance charge. However, before the dealer consummates the retail installment contract with the consumer, the dealer investigates the consumer’s creditworthiness and compares it against pre-determined credit standards that are provided to the dealer by banks and lenders. In this way, the dealer attempts to gain some assurance that the retail installment sales contract will be approved for assignment to a bank or lender in exchange for the lender tendering a lump sum payment to the dealer.1 Assuming the lender accepts assignment of the retail installment sales contract and pays the dealer for assignment of the retail installment contract, the bank or lender (as assignee of the retail installment contract) then advises the consumer to send all payments to the bank or lender.
In the second scenario, the merchant arranges a loan for the consumer by referring the consumer to a lender with whom it has a referral or contractual relationship, and the consumer then obtains a “purchase money loan” directly from the lender to finance the purchase. In this situation, the merchant obtains a financial benefit from the issuance of the loan, either because it has an ownership interest in the lender, or by way of a referral fee, or a commission, or other financial incentive arrangement.
In the third scenario, a consumer finances purchases from a merchant with the merchant’s “store brand” credit card. There are two types of store brand credit cards — “private label” and “in house.” Most store brand credit cards are private label cards that have the merchant’s label directly on the card (e.g., Home Depot), and they can only be used at that particular merchant, but they are actually issued by a bank (e.g., Citibank). “In house” credit cards also have the merchant’s logo directly on the card, and they can only be used at the merchant identified on the card, but they are different than private label cards because they are issued by the merchant, and not by a bank. Only a few very large merchants, like Walmart and Target, have the resources to issue their own “in house” credit cards.2 If a consumer uses a private label, store brand credit card to finance a purchase, then his or her purchase is being financed by a bank, and not by the merchant, and to the extent that the bank asserts that it is not subject to the claims and defenses that the consumer has against the merchant, the principles discussed in this article apply. However, if a consumer uses an “in house” store brand credit card, then the lender and the merchant are one and the same, and the consumer can assert any claims and defenses directly against the merchant.
In the fourth scenario, and perhaps the most common, a consumer purchases goods from a merchant using a general purpose credit card or other open-ended credit plan where the merchant has no referral relationship with the credit card issuer. The general purpose credit card may include a “co-branded” credit card issued by a merchant that can be used anywhere.
In all of these scenarios, the consumer may later find out that the product was unsatisfactory, or he or she was the victim of fraud, or the merchant failed to honor certain promises related to the sale, or some other wrongful conduct on the part of the merchant. Nevertheless, the lender will insist upon payment, and the lender will usually assert that it is not responsible for the merchant’s misconduct. Most consumers feel helpless in this situation because the lender tells them that they have to repay the loan regardless of what the merchant did, and that their obligation to repay the loan is independent of whatever claims or defenses he or she may have against the merchant. In essence, the consumer feels robbed of the only realistic leverage he or she has to force the seller to provide satisfaction — the power to withhold payment.3
If payment is not forthcoming, the lender will continue to collect the debt and will report the consumer as delinquent to the credit reporting agencies. If the consumer still does not pay after 180 days, the lender will report the account to the credit reporting agencies as “charged off,” and may hire a collection agency, or it may assign the debt to a collection agency. The collection agency will then initiate its own collection efforts, including reporting the same debt again to the credit reporting agencies as a “collection” account (resulting in two separate negative reports on the consumer’s credit report). If the consumer still does not pay, the lender or the debt collector may file a lawsuit against the consumer, seeking to recover the amount of the original transaction, plus accrued interest, late fees, court costs, and attorneys’ fees.
In all of these cases, the lender’s attempt to divorce himself or herself from responsibility for the merchant’s wrongdoing is not only fundamentally unfair,4 but it is contrary to law. That is, despite the insistence of many banks, lenders, and credit card companies to the contrary, in most cases, lenders are subject to the claims and defenses that the buyer has against the seller in a consumer transaction. Before I provide the various reasons why this is true, I need to identify a fourth scenario in which the lender is usually not responsible for the merchant’s misconduct. In the fourth scenario, the consumer obtains a loan directly from a lender without any involvement of the merchant, and without being referred to the lender by the merchant. For example, a consumer may get a loan directly from a bank to finance the purchase of a vehicle and use the proceeds of the loan to purchase a vehicle from a dealer. Assuming the consumer was not referred to the bank by the dealer, and assuming the dealer does not get a commission or referral fee from the bank for issuing the loan, then this type of loan is considered a direct loan, and the lender is usually not subject to the claims and defenses that the consumer has against the merchant.
With respect to the first four scenarios, there are a number of reasons why the lender is subject to the claims and defenses of the consumer. First, F.S. §516.31(2) provides that the holder or assignee of any negotiable instrument or installment contract, other than a currently dated check, which originated from the purchase of certain consumer goods or services is subject to all claims and defenses of the consumer debtor against the seller when the consumer purchased or obtained goods or services primarily for personal, family, or household purposes.5
Second, the common law provides that the assignee steps into the shoes of the assignor, and is subject to the claims and defenses that could have been asserted against the assignor as if the assignment had not been made.6 This has always been the common law rule in Florida,7 and is reflected in Florida’s Uniform Commercial Code (as amended January 1, 2002). The code provides that unless an account debtor has made an enforceable agreement not to assert defenses or claims, the rights of an assignee are subject to all the terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract, and any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notification of the assignment authenticated by the assignor or the assignee.8 Despite popular misconception to the contrary, this is the general rule of assignee liability in Florida: An assignee is subject to defenses or set-offs existing before an account debtor is notified of the assignment, and when the account debtor’s defenses on an assigned claim arise from the contract between him or her and the assignor, it makes no difference whether the breach giving rise to the defense occurs before or after the account debtor is notified of the assignment.9
The general rule of assignee liability applies unless an account debtor has made an enforceable agreement not to assert defenses or claims.10 Some consumer credit contracts do not contain an agreement that the debtor will not assert defenses or claims in order to comply with the FTC Holder Rule, discussed below, and further analysis is, therefore, unnecessary to conclude that the assignee is subject to the claims and defenses that the consumer has against the merchant. However, even when a consumer credit contract contains a debtor agreement not to assert defenses or claims, the agreement is not enforceable in a consumer contract to which the FTC Holder Rule applies, even if the required language is not included. If the FTC Holder Rule applies, the contract will be interpreted as if the FTC Holder Rule language was included, even if it was not.11
Even if the consumer/debtor has made an enforceable agreement not to assert defenses or claims, it may only be enforced by an assignee who takes the assignment for value, in good faith, and without notice of a claim of a property or possessory right to the property assigned, and without notice of certain claims and defenses of the debtor.12 The assignee is intended to be in a position that is no better and no worse than that of a holder in due course of a negotiable instrument under U.C.C. art. 3.13 Therefore, for example, if a lender has notice of the consumer’s claims or defenses prior to assignment, the lender cannot claim protection equivalent to that of a holder in due course, and is, therefore, subject to the claims and defenses of the consumer against the merchant.
Even if an enforceable agreement not to assert defenses or claims exists, and even if the assignee took the assignment for value, in good faith, and without notice of defenses or claims, the assignee is nevertheless subject to “real defenses.” Real defenses include defenses based on 1) infancy of the obligor to the extent it is a defense to a simple contract; 2) duress, lack of legal capacity, or illegality of the transaction which, under the law, nullifies the obligation of the obligor; 3) fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms; and 4) discharge of the obligor in insolvency proceedings.14 For example, if a contract is illegal, and the illegality is apparent on the face of the document, the assignee cannot take “without notice.” Thus, a lender/assignee is subject to a consumer’s claim that the credit contract is usurious regardless of whether the lender took the assignment for value and in “good faith.”
Even if an enforceable agreement not to assert defenses or claims exists, and even if the assignee took the assignment for value, in good faith, and without notice of defenses or claims, and even if the debtor does not have any real defenses, the assignee is nevertheless subject to the debtor’s claims and defenses if the assignee has a “close connection” with the assignor. Florida courts have adopted the close connection theory, which supplies an exception to the holder in due course rule when a financial institution has a close working relationship with the merchant in a consumer transaction.15 If a financing company is closely connected with a transaction, it cannot be heard to say that it, in good faith, was an innocent purchaser of the instrument for value before maturity against whom the defense of failure of consideration may not be properly maintained. Thus, a provision precluding a purchaser from asserting certain claims or defenses against the financing company will not be enforced when it appears that the lender has a business relationship with the dealer, or where the lender routinely accepts assignment of credit contracts from the lender, or where the lender provides forms for use by the dealer, or where the lender provides the dealer with minimum credit scores and other criteria that the dealer uses to screen credit applicants in anticipation of obtaining approval from the lender to assign the credit contract to the lender.
In the unlikely event that the lender’s claim to be free of the consumer’s claims and defenses survives the application of Florida law, like the sailors in the Odyssey, the lender would have successfully navigated past the Charybdis of state law only to be defeated by the Scylla of federal law.16 This is because in 1975, the Federal Trade Commission determined that it constitutes an unfair and deceptive practice for a seller, in the course of financing a consumer purchase of goods or services, to employ procedures that make the consumer’s duty to pay independent of the seller’s duty to fulfill his or her obligations. As a result, the commission promulgated the “Trade Regulation Rule Concerning the Preservation of Consumers’ Claims and Defenses,” which became effective on May 14, 1976.17 This rule is commonly referred to as the “Holder in Due Course Rule” or the “FTC Holder Rule,” and is designed to ensure that consumer credit contracts used to finance the purchase of consumer goods or services specifically preserve the consumer’s rights against the seller. The rule requires that consumer credit contracts contain the following notice provision: “Notice: Any holder of this consumer credit contract is subject to all claims and defenses which the debtor could assert against the seller of goods or services obtained pursuant hereto or with the proceeds hereof. Recovery hereunder by the debtor shall not exceed amounts paid by the debtor hereunder.”18
Thus, the holder of a consumer credit contract is subject to the consumer’s claims and defenses against the merchant as a matter of contract law arising out of the terms of the contract itself. And even if the lender fails to include the required notice, it is nevertheless considered to be a part of the credit contract as a matter of law, and the lender is nevertheless subject to the consumer’s claims and defenses just as if the FTC notice had been included, and any waiver of defense clauses are rendered ineffective.19
The purpose of the FTC Holder Rule was well explained by a Florida appellate court:
Prior to the passage of the FTC Holder Rule, many consumers were caught in a “no win” situation when the seller failed to remedy the defect either because of its unwillingness or its disappearance from the market. The institutional lenders then took advantage of protections under the holder in due course doctrine when the consumer sought to assert seller misconduct as a defense to the predator’s suit for payment on the note. The rule is expressly designed to compel creditors to either absorb seller misconduct or seek reimbursement of those costs from sellers.20
The Truth in Lending Act (TILA) provides additional protections to consumers who finance a purchase with a credit card or other open-ended credit plan. TILA provides that if a cardholder makes a good-faith attempt to resolve the dispute with the merchant, and the disputed transaction occurs within the same state as the cardholder’s designated address, or within 100 miles, and the merchant fails to satisfactorily resolve a dispute regarding property or services purchased with the credit card or open-ended credit plan in a consumer credit transaction, the cardholder may assert against the card issuer all claims (other than tort claims) and all defenses arising out of the transaction and relating to the failure to resolve the dispute.21 The cardholder may withhold payment up to the amount of credit outstanding for the property or services that gave rise to the dispute, and any finance or other charges imposed on that amount.22
Assuming that the lender is subject to the claims and defenses that the consumer has against the merchant, what are the consumer’s remedies? In most cases, the consumer has the right not to pay the outstanding balance to the extent of the consumer’s damages. The consumer may assert those claims and defenses against the lender to reduce the amount the account debtor owes, or to a return of monies paid to the assignee, but the consumer usually does not have the right to an affirmative recovery from the assignee.23 Also, the FTC Holder Rule provides that the consumer may assert, by way of claim or defense, a right not to pay all or part of the outstanding balance owed the creditor under the contract, but the debtor may bring an affirmative action against the assignee only in situations in which the debtor is seeking a return of monies paid on the account, including any down payments, or where rescission is appropriate.24 However, the limitation on affirmative recovery under the FTC Holder Rule does not eliminate any other rights the consumer may have as a matter of local, state, or federal statute. Because the words “recovery hereunder,” which appear in the text of the notice, refer specifically to a recovery under the notice, and if a larger affirmative recovery is available against a creditor as a matter of state law, the consumer would retain this right.25
In addition, Florida law explicitly provides that a buyer who has suffered damages as the result of a seller’s wrongful conduct may, upon notifying the seller, deduct his or her damages from the sales price still due under the contract,26 and a lessee may deduct damages for default from amounts owed to lessor.27 Further, the rights and remedies for material misrepresentation or fraud include all rights and remedies available for default, and remedies for material misrepresentation or fraud include all remedies for nonfraudulent breach.28
The discussion thus far has been limited to the lender’s derivative liability for the claims and defenses of the consumer as against the seller. The assignee can also be liable if there is an independent basis to hold the lender liable under Florida’s Unfair and Deceptive Trade Practice statute.29 Institutional banks and lenders often cite GMAC v. Laesser, 718 So. 2d 276 (Fla. 4th DCA 1998), for the proposition that lenders are not responsible for the misconduct of dealers. However, that case was based upon a finding by a jury that “GMAC deceptively helped the automobile dealer in question steal Laesser’s trade-in vehicle and ‘flip’ him from a car purchase into a lease.” That finding was reversed on appeal, and GMAC was awarded appellate attorneys’ fees. However, the verdict in that case was based upon a finding of independent fault on the part of GMAC, and was not based upon GMAC’s derivative liability as assignee for the acts of the dealer.
In most cases, despite common misconceptions, when a lender who provides financing for a consumer transaction seeks payment from the consumer, the lender is subject to the claims and defenses that the consumer has against the merchant.
1 If the lender refuses to accept assignment of the retail installment contract on terms that are acceptable to the dealer and refuses to pay the dealer the lump sum that the dealer expected to be paid, then the dealer will attempt to “unwind the deal” with the consumer. Automobile dealers take the position that they are not in the business of lending money, despite the fact that they routinely enter into retail installment contracts with consumers, and in most cases they will have the customer sign a document that contains language purporting to make the retail installment contract contingent upon assignment to a lender in exchange for a lump sum payment.
2 “Co-branded” credit cards are yet another type of credit card that also have the merchant’s logo directly on the card, but they can be used anywhere, just like any general purpose credit card.
3 Federal Trade Commission Staff Guidelines on Trade Regulation Rule Concerning Preservation of Consumers’ Claims and Defenses (Holder in Due Course Rule), May 4, 1976.
4 The Federal Trade Commission determined that it constitutes an unfair and deceptive practice for a seller, in the course of financing a consumer purchase of goods or services, to employ procedures that make the consumer’s duty to pay independent of the seller’s duty to fulfill his or her obligations. Id. at 4.
5 Fla. Stat. §516.31(1) & (2).
6 Law Office of David J. Stern, P.A. v. Security National Servicing Co., 969 So. 2d 962, 968 (Fla. 2007) (“As a general rule, the assignee of a nonnegotiable instrument takes it with all the rights of the assignor, and subject to all the equities and defenses of the debtor connected with or growing out of the obligation that the obligor had against the assignor at the time of the assignment.”); State v. Family Bank of Hallandale, 667 So. 2d 257, 259 (Fla. 1st DCA 1995)(“The assignee steps into the shoes of the assignor, and is subject to all equities and defenses that could have been asserted against the assignor had the assignment not been made.”); Dependable Ins. Co. v. Landers, 421 So. 2d 175, 179 (Fla. 5th DCA 1982).
7 Florida East Coast Railway Co. v. Eno, 128 So. 622, 626 (Fla. 1930).
8 Fla. Stat. §679.4041(1) (formerly §679.318 (2001)); Ederer v. Fisher, 183 So. 2d 39 (1965).
9 First New England Financial Corp. v. Woffard, 421 So. 2d 590, 595 (Fla. 5th DCA 1982); Dependable Ins. Co. v. Landers, 421 So. 2d 175, 179 (Fla. 5th DCA 1982) (Fla. Stat. §679.318(1), the predecessor to Fla. Stat. §679.4041 (2003), “is a codification of the common law rule regarding assignments, putting the assignee in the shoes of the assignor insofar as the asserted claims may defeat or reduce the assignee’s claim against the debtor.”); Fla. Stat. §679.4041, Official Comment 2, (2003) (“Subsection (a), like former Section 9-318(1), provides that an assignee generally takes an assignment subject to defenses and claims of an account debtor. Under subsection (a)(1), if the account debtor’s defenses on an assigned claim arise from the transaction that gave rise to contract with the assignor, it makes no difference whether the defense or claim accrues before or after the account debtor is notified of the assignment.”). See also Citibank v. Mincks, 135 S.W.3d 545 (Mo. Ct. App. 2004) (Common law principles compel the conclusion that Citibank, as credit card issuer and assignee of the consumer’s contract with the merchant, stands in the shoes of the merchant and can occupy no better position than the merchant if the consumer sued the merchant directly.).
10 Fla. Stat. §679.4041(1).
11 Fla. Stat. §679.4031(4); Fla. Stat. §679.4041 (3) & (4). “Subsection (d) is new. It applies to rights evidenced by a record that is required to contain, but does not contain, the notice set forth in Federal Trade Commission Rule 433, 16 C.F.R. part 433 (Holder in Due Course Regulations). Under this subsection, an assignee of such a record takes subject to the consumer account debtor’s claims and defenses to the same extent as it would have if the writing had contained the required notice. Thus, subsection (d) effectively renders waiver-of-defense clauses ineffective in the transactions with consumers to which it applies.” Official Comment number 5 to Fla. Stat. §679.4031.
12 Fla. Stat. §679.4031, and Official Comment 3 (formerly §679.206(1)). This section refers to defenses in §673.3031(2), which appears to be a typographical error, and should refer to §673.3051(2).
13 Official Comment #3 to Fla. Stat. §679.4031. The Holder in Due Course Rule (HIDC rule) is a part of U.C.C. art. 3, “Negotiable Instruments,” codified at Fla. Stat. Ch. 673. HIDC is specifically defined in Part III of U.C.C. art. 3, which is Fla. Stat. §§673.3011 through 673.3121. However, the HIDC rule defined in U.C.C. art. 3, Part III, is subordinate to the provisions of U.C.C. art. 9, “Secured Transactions,” codified at Fla. Stat. Ch. 679. See Fla. Stat. §673.1021(2) (“If there is a conflict between this chapter and chapter 674 or chapter 679, chapters 674 and 679 govern.”), and §673.3021(7) (“This section is subject to any law limiting status as a holder in due course in particular classes of transactions.”). Therefore, in the typical case in which a dealer enters into a RISC with a consumer that is secured by a lien, the provisions of U.C.C. art. 9, Fla. Stat. Ch. 679, apply and control over the provisions of article III (the HIDC rule).
14 Fla. Stat. §673.3051(1). These defenses are commonly referred to as “real defenses.” See official comment 1.
15 Mutual Finance Co. v. Martin, 63 So. 2d 649 (Fla. 1953) (adopting close connection rule and citing policy justifications for rule); Ramadan v. Equico Lessors, Inc., 448 So. 2d 60 (Fla. 1st DCA 1984); Rehurek v. Chrysler Credit Corp., 262 So. 2d 452 (Fla. 2d DCA 1972); First New England Financial Corp. v. Woffard, 421 So. 2d 590, 593 n.4 (Fla. 5th DCA 1982) (“The close connection theory supplies an exception to the holder in due course doctrine where the financial institution has a close working relationship with the seller in a consumer credit transaction.”).
16 Homer, The Odyssey, Book XII (800 B.C., Samuel Butler trans.).
17 Federal Trade Commission Staff Guidelines on Trade Regulation Rule Concerning Preservation of Consumers’ Claims and Defenses (Holder in Due Course Rule), May 4, 1976.
18 16 C.F.R. §433.2.
19 Fla. Stat. §679.4031(4) and official comment 5, and Fla. Stat. §679.4041(4) and official comment 4.
20 Tinker v. Day Maria Porsche Audi, Inc., 459 So. 2d 487,492 (Fla. 3d DCA 1984), rev. den., 471 So. 2d 43 (Fla.1985) (not only does the FTC notice clause entitle the buyer to withhold the balance of the purchase price owed to the creditor when the seller’s contractual duties are not fulfilled, but it gives the buyer a complete defense should the creditor sue for payment). See also Schauer v. GMAC, 819 So. 2d 809, 813 (Fla. 4th DCA 2002); Florida Automobile Finance Corp. v. Reyes, 710 So. 2d 216 (Fla. 3d DCA 1998) (In a suit by an assignee/lender against an automobile buyer for payment on the assigned note, the buyer was entitled to raise fraud as a defense to payment because the note contained the FTC holder notice, which made the lender subject to the claims and defenses that the buyer could have asserted against the dealer.); First New England Financial v. Woffard, 421 So. 2d 590, 593 (Fla. 5th DCA 1982) (“This provision allows a consumer to set up, against one who finances a purchase, those claims and defenses which could be asserted against the seller of goods.”).
21 15 U.S.C. §1666i(a); 12 C.F.R. §226.12(c) (Regulation Z).
23 Fla. Stat. §679.4041(2).
24 Schauer v. GMAC, 819 So. 2d 809 (Fla. 4th DCA 2002) (FTC rule normally used as shield, unless consumer is seeking monies paid on account “where a seller’s breach is so substantial that a court is persuaded that rescission and restitution are justified.”).
25 FTC Guidelines on Trade Regulation Rule concerning preservation of consumers’ claims and defenses, 41 Federal Register 20022-20027 at 20023. See also Simpson v. Anthony Auto Sales, 32 F. Supp. 2d 405 (W.D. Louisiana 1998) (citing FTC Guidelines on Trade Regulation Rule concerning preservation of consumers’ claims and defenses, 41 Federal Register 20022-20027 at 20023).
26 Fla. Stat. §672.717.
27 Fla. Stat. §680.508(6).
28 Fla. Stat. §672.721 & 680.505(4).
29 Schauer v. GMAC, 819 So. 2d 809, 812 (Fla. 4th DCA 2002) (allegations that GMAC willfully harassed debtor and his family with respect to the collection of his debt state a cause of action under FDUTPA).
Ian D. Forsythe is a member of the law firm of Hilyard, Bogan & Palmer, P.A., in Orlando. He is a civil trial attorney and has experience representing individuals with consumer disputes, as well as defending law enforcement officers and law enforcement agencies in civil rights cases in state and federal court. He received his B.A. in finance from the University of South Florida, and his J.D., cum laude, from Stetson University College of Law.