In many traditional transactions, if a seller fails to perform as promised, the buyer is protected by his ability to withhold payment for the goods or services. This protection is lost when a consumer makes a purchase on credit, and the credit contract is sold to a third party. In this scenario, the consumer is obligated to pay even if he does not get what he paid for. To remedy this disconnect, the Federal Trade Commission (FTC) enacted the “Holder Rule,” 16 C.F.R. §433.2. Under the Holder Rule, any holder of a consumer credit contract is subject to the same claims and defenses that the consumer could assert against the seller to the extent the consumer has paid on the debt.
As written, the Holder Rule has one limitation: the consumer’s recovery “shall not exceed amounts paid” by the consumer under the contract. Notwithstanding, some courts have interpreted the Holder Rule to bar consumers’ claims against the lender unless the consumer can legally rescind the transaction or where the goods or services sold were nearly worthless. Rejecting these limitations, the FTC issued an opinion in May 2012 “affirm[ing] that the [Holder] Rule is unambiguous, and its plain language should be applied.” The opinion unequivocally states that “the [Holder] Rule places no limits on a consumer’s right to an affirmative recovery other than limiting recovery to a refund of monies paid under the contract.”
The California Court of Appeal, Third District, recently applied the “plain meaning” of the Holder Rule, and rejected the argument of the assignee of a consumer credit contract that the Holder Rule should be limited to the situation where “the seller’s breach of contract renders the transaction practically worthless to the consumer.” The decision, Lafferty v. Wells Fargo Bank, C067812, confirms that the assignee of a consumer credit contract stands in the shoes of the seller, i.e. it is subject to the same claims and defenses, limited only by the amount paid on the debt.
In Lafferty, Patrick and Mary Lafferty bought a motor home from Geweke Auto & RV Group that was financed with an installment contract. Geweke assigned the contract to Wells Fargo Bank in accordance with the terms of a separate dealer agreement. The Laffertys alleged that the motor home was defective, and demanded that it be repaired. Months passed, but the repairs were not made. The Laffertys informed Wells Fargo that they would stop making payments until the motor home was repaired. A couple of months later, the Laffertys disclaimed their ownership interest in the motor home. Wells Fargo took possession of the motor home and reported the Laffertys’ failure to pay to various consumer credit reporting agencies, although it took no action to collect any amount from the Laffertys.
The Laffertys sued Geweke, and sued Wells Fargo on grounds that it was the assignee of the credit contract, and “the FTC ‘Holder Rule’ and California state law mak[e] such a holder and/or assignee financer subject to any claims or defenses that might be asserted against the seller.” The trial court concluded, inter alia, that the Holder Rule limits claims by buyers against lenders that would otherwise lie only against the seller to cases in which little or no value was received by the buyer, and dismissed the case and awarded Wells Fargo attorneys’ fees.
On Feb. 4, 2013, the court of appeal reversed the judgment on the Consumer Legal Remedies Act and negligence causes of action, and reversed the trial court’s order awarding attorneys’ fees and costs to Wells Fargo. The appellate court addressed the split of authority as to the interpretation of the Holder Rule, and declined to follow the reported decisions of other jurisdictions that have departed from its plain meaning. The court reasoned that “the language of the statute is plain, and a plain reading does not frustrate the apparent purpose of the statute, and no absurdity results.”
Courts in other jurisdictions have come to a different conclusion in reliance in part on the FTC Statement of Basis and Purpose from Nov. 18, 1975. In this statement, the agency provided that “[c]onsumers will not be in a position to obtain an affirmative recovery from a creditor, unless they have actually commenced payments and received little or nothing of value from the seller.” It continued by stating that “[i]n a case of non-delivery, total failure of performance, or the like, we believe the consumer is entitled to a refund of monies paid on account.” As noted above, the FTC has since clarified that the plain language of the Holder Rule should be applied, and it did not intend for its 1975 statement to be used to impose limitations not stated in the rule.
The appellate court also disagreed with Wells Fargo’s contention that the Holder Rule is ambiguous and lenders would be surprised by a construction that deems “claims” to mean all claims and defenses. First, the court reasoned, Wells Fargo admitted in the trial court that the terms of the installment contract were unambiguous. Second, Wells Fargo’s construction would render “claims” superfluous because it endows the term with the same meaning as “defenses,” which is separately used in the Holder Rule. Third, there is no surprise given that, notwithstanding the split of authority, reported cases have adhered to the plain meaning of the Holder Rule for more than 30 years, including this appellate court in Music Acceptance Corp. v. Lofing, 32 Cal. App. 4th 610 (1995). In Music Acceptance, the borrower challenged an award to the lender by arguing that his proof of a breach of warranty claim against the seller should have barred the lender from recovering the unpaid balance on the debt. Applying the California Unruh Act, the Third District Court of Appeal agreed and reversed the award against the borrower. The appellate court also noted that “the same result obtains under federal law” due to the language of the Holder Rule.
Ultimately, Lafferty forecloses the possibility that the assignee of a credit contract may avoid the Holder Rule. It also provides a good reminder for such assignees to include express indemnification clauses in their agreements with dealers or other sellers to more easily seek reimbursement from the seller in the event of its wrongdoing.