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Ask a Lawyer: Liability of Financers in Consumer Transactions

In its recent case against a consumer named Gloria Tavares, Salem Savings Bank seeks to enforce a promissory note transferred by a seller who allegedly committed fraud in the underlying consumer transaction. In this week’s “Ask a Lawyer,” guest writer Lydia Lach considers when a financer may be liable for the misconduct of the seller.

How does a bank or similar financial institution become involved in a consumer dispute?

Sellers of consumer goods or services often accept payment by promissory note or installment1 contract, in which the consumer agrees to pay the purchase price in a series of partial payments over time. Rather than wait to receive payments, the seller often immediately transfers such notes or installment contracts to a financial institution (the financer or transferee), which purchases the notes or contracts at a discount. Once that transfer happens, the consumer has to make payments to a third-party financer.

But what if the seller in the original consumer sales transaction defaults on his performance? For example, what if the transaction is unconscionable, because it unreasonably favored2 the seller and offered the consumer no meaningful choice in the transaction? If there is such misconduct by the seller, is the consumer still obliged to pay off his debt to the transferee?

Historically, the answer has been yes. For promissory notes, the common law protected the transferee/financer by developing the Holder in Due Course Doctrine (HDC). A holder in due course is a person who acquires the note in good faith, for value and without notice of any defense3 to the instrument. An HDC receives a note free of liability on most claims and defenses that arise in consumer transactions; that is, an HDC takes free of such claims and defenses. Thus, traditionally, a transferee has not been subject to any claims or defenses that a consumer has against a seller who failed to perform.

What about consumers who had signed installment contracts rather than promissory notes?

For installment contracts, transferees developed a similar technique for insulating themselves from consumer claims or defenses. Specifically, transferees protected themselves by requiring consumers to sign waiver of defenses clauses. These provisions stated that even if the consumer had any claims or defenses against the seller, he or she would not bring such claims or defenses against the transferee.

How did the law respond to these methods for insulating the transferee?

Traditionally, the courts have ruled in favor of transferees. HDC status provided protection for transferees who had accepted promissory notes, and waiver of defenses clauses provided protection for those accepting installment contracts.

What effect did this have on consumers?

This approach sometimes had grave consequences for consumers. By upholding the legitimacy of both techniques for insulating the transferee, commercial law encouraged the cut-off of consumer claims and defenses. As a result, consumers could not avoid repaying loans by relying on claims or defenses that they had against the seller. Instead, they were required to repay debts to financers even where there had been seller misconduct.

Because such a result often seemed unfair to consumers, the courts and the Federal Trade Commission developed rules to protect consumers facing the possible cut off of their claims and defenses. These rules will be addressed in a future column.

1UK: instalment
2UK: favoured
3UK: defence

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