Payday Loan Bar Association
Annual Conference
Hyatt Regency Monterey Hotel
Monterey, California
November 12, 2010
WTF Does “Abusive” Mean?
Catherine M. Brennan
Mark J. Furletti
Steve Schaller
WTF Does “Abusive” Mean?
Questions Presented
What does “abusive” means of Section 1031(d)(2)(B) of Title X?
Where did this language come from?
What is the legislative history of this language?
Did Congress have specific harms in mind that it wants to deter as
“abusive”?
Are there any other statutes that use “abusive,” or any court decisions
construing it or adopting it?
What is an “unreasonable advantage” and can it be made “reasonable”
through mitigating actions by the lender (e.g., disclosures)?
What payday lending practices might be abusive?
What We Hope to Cover
1. Overview of Title X
2. What Legislative History?
3. Federal Guidance
4. State Guidance
5. Lender Mitigation!
6. What Consumer Advocates Want
What Title X Does
Title X specifically applies to any person offering or providing a
payday loan.
Title X creates a Consumer Financial Protection Bureau
(“Bureau”).
The Bureau will have authority to issue rules prohibiting “unfair,
deceptive, or abusive acts or practices” that opens the door for
the Bureau to regulate financial product terms it doesn’t like.
What My Mom Thinks
Abusive Means
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Physical or psychological mistreatment
Improper treatment or usage
Misuse
Wrongly used
Misapplied
Powers of the Bureau
The Bureau may prescribe rules applicable to a covered person or
service provider identifying as unlawful, unfair, deceptive, or abusive
acts or practices in connection with any transaction with a consumer for
a consumer financial product or service, or the offering of a consumer
financial product or service. Rules under Section 1031 may include
requirements for the purpose of preventing such acts or practices. In
prescribing rules under Section 1031, the Bureau must consult with the
Federal banking agencies, or other Federal agencies, as appropriate,
concerning the consistency of the proposed rule with prudential,
market, or systemic objectives administered by such agencies.
What Title X Doesn’t Do
 No Usury Cap: The Bureau has no authority to establish a usury limit
applicable to an extension of credit offered or made by a covered person to
a consumer, unless explicitly authorized by law. Section 1027(o).
 So, high interest rates cannot be abusive. Some 15 states and the military
already limit interest to 36%.
 Section manifests congressional intent that the Bureau cannot set interest
rates.
 Would interest rates may be taken into account along with other factors in
determining that a loan product is “abusive”? No doubt.
Deceptive Rulemaking
Authority
What is Deceptive?
A material representation, omission or
practice that is likely to mislead the
reasonable consumer, to the consumer’s
detriment.
Unfairness Rulemaking
Authority
The Bureau cannot declare an act or practice in connection with a transaction
with a consumer for a consumer financial product or service, or the offering of a
consumer financial product or service, to be unlawful on the grounds that such
act or practice is unfair, unless the Bureau has a reasonable basis to conclude
that:
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the act or practice causes or is likely to cause substantial injury to
consumers not reasonably avoidable by consumers; and
countervailing benefits to consumers or to competition does not outweigh
such substantial injury.
In determining whether an act or practice is unfair, the Bureau may consider
established public policies as evidence to be considered with all other evidence.
Such public policy considerations cannot serve as a primary basis for such
determination.
Abusive Rulemaking
Authority
The Bureau cannot declare an act or practice abusive in connection with the
provision of a consumer financial product or service, unless the act or practice:


materially interferes with the ability of a consumer to understand a
term or condition of a consumer financial product or service; or
takes unreasonable advantage of:
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–
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a lack of understanding on the part of the consumer of the
material risks, costs, or conditions of the product or service;
the inability of the consumer to protect the interests of the
consumer in selecting or using a consumer financial product
or service; or
the reasonable reliance by the consumer on a covered
person to act in the interests of the consumer.
Where Else Do We See
“Abusive” in Federal Law?
 Telemarketing Sales Rule
 SEC Guidance
Telemarketing Sales
Rule
“Abusive” has been used in the Telemarketing and Consumer Fraud and
Abuse Prevention Act. 15 U.S.C. §§6101 et seq.
This is the Act that directed creation of the FTC’s Telemarketing Sales
Rule. The Act tells the FTC to regulate deceptive or abusive telemarketing acts
and practices. In one of the Federal Register Notices where the FTC
published a Statement of Basis and Purpose explaining the rule, it took the
position that, under the TSR, it would apply the FTC’s “unfairness” standard
to the term “abusive” in order to give that term some meaning.
Some lobbied to keep the term “abusive” out of Title X(duplicative of
“unfair”), but that didn’t happen.
SEC’s $1,000,000 Rule
In general, only an “accredited investor” may invest in a
hedge fund or other securities offering not subject to
particular Exchange Act protections. Regulation H, 17
C.F.R. §230.501(a), defines “accredited investor” as
including:
-
Any natural person whose individual net worth, or joint
net worth with that person’s spouse, at the time of his
purchase exceeds $1,000,000;
Dodd-Frank amends law to require exclusion of home
equity from calculation.
What Do the States Say?
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State law definitions of abusive
State elder financial abuse laws
State unfair and deceptive acts and practices
laws
Behavioral law & econ and state laws
State Law Definitions of “Abusive”
Generally Not Helpful
Peters v. State, 166 Ala. 35, 38 (Ala. 1910) (finding violation of state
law against sending an “abusive letter which tended to provoke a
breach of the peace”)
Dear Sirs: I wish to call your attention to the above matter
and to remind you that it is unpaid. If you knew how
contemptible you appear in this matter, you would pay
this bill at once. If you do not pay this bill in a short time,
I shall have to proceed in some other way to collect it. I
know how worthless and contemptible you are, but
this is news to you. Yours very truly, M. Peters.
State Law Definitions of “Abusive”
Generally Not Helpful
People v. Dietze, 75 N.Y.2d 47, 50 (N.Y. 1989) (finding that
defendant used “abusive language” but holding that law banning
such language was unconstitutional)
Complainant and her son, both mentally retarded, walked down a
public street in the Town of Norfolk. Defendant came to her
doorway with a friend and, while facing the street, referred to
complainant as a “bitch” and to her son as a “dog,” and said
that she would “beat the crap out of [the complainant] some
day or night on the street.” With that, complainant fled in tears
and reported the incident to authorities.
State Law Definitions of “Abusive”
Generally Not Helpful
Haw. Rev. Stat §412:3-114.5
“Financial abuse” means financial
abuse or economic exploitation
State Law Definitions of “Abusive”
Generally Not Helpful
Peters v. State, 166 Ala. 35, 38 (Ala. 1910)
[A]buse is defined as: “To use improperly, or
excessively, * * * to treat ill, use injuriously, hurt; to wrong
in speech, reproach coarsely, disparage, revile, malign.”
And “abusive” is defied as: “Employing harsh
words, or ill treatment, hurtful, harsh, vituperative
scurillous, wrongly used, improper.”
Statutes Protecting the Elderly
and Benefit/Harm
California Financial Abuse of Elderly Law – Cal. Wel. & Inst.
Code §15610.30
A person or entity shall be deemed to have taken, secreted,
appropriated, obtained, or retained property for a wrongful use
if, among other things, the person or entity takes, secretes,
appropriates, obtains, or retains the property and the person or
entity knew or should have known that this conduct is
likely to be harmful to the elder or dependent adult.
Statutes Protecting the Elderly
and Benefit/Harm
Missouri Financial Exploitation of the Elderly Law – Mo. Rev.
Stat. §570.145
A person commits the crime of financial exploitation of
an elderly or disabled person if such person knowingly and by
deception, intimidation, or force obtains control over the elderly
or disabled person’s property with the intent to permanently
deprive the elderly or disabled person of the use, benefit or
possession of his or her property thereby benefiting such
person or detrimentally affecting the elderly or disabled
person.
Statutes Protecting the Elderly
and Benefit/Harm
Rhode Island Exploitation of an Elder Law – R.I. Gen. Laws
§11-68-2
Knowingly…obtains or uses, endeavors to obtain or
use, or conspires with another to obtain or use an elder
person’s funds, assets, or property with the intent to
temporarily or permanently deprive the elder person of the
use, benefit, or possession of the funds, assets, or
property…by a person who knows or reasonably should
know that the elder person lacks the capacity to consent.
Statutes Protecting the Elderly
and Benefit/Harm
Alaska Elder Abuse Law – Alaska Stat. §
44.21.415(g)
“Fraud”
means…exploitation
of
another person or another person’s
resources for personal profit or advantage
with no significant benefit accruing to
the person who is exploited.
Abusive as
Unconscionability “Light”
Ohio’s UDAP, O.R.C. § 1345(B):
(B) In determining whether an act or practice is
unconscionable, the following circumstances shall be taken into
consideration:
(1) Whether the supplier has knowingly taken advantage of
the inability of the consumer reasonably to protect the
consumer’s interests because of the consumer’s physical or mental
infirmities, ignorance, illiteracy, or inability to understand the language
of an agreement; …
Abusive as
Unconscionability “Light”
Ohio courts have been reluctant to find unconscionability based
on the inability of a consumer to protect him/herself. See, e.g.,
Equicredit Corp. of Amer. v. Jackson, 2004 Ohio 6376 (Ohio Ct. App.
2004) (home-secured loan for new siding)
Jackson’s difficulty in understanding the terms of this
contract does not necessarily prove that she was unable to
reasonably protect here interests. She herself admitted that she
could have asked her daughter for help. She also admitted that
she never even tried to read the terms of the contracts she was
entering into. Her ‘inability to reasonably protect her
interests’ was as much the result of her own actions as it was
any mental condition that may hay have had preventing her
from understanding the contracts….
Abusive as
Unconscionability “Light”
Wilson v. World Omni Leasing, Inc., 540 So.2d
713, 717 (Ala. 1989)
Rescission of a contract for
unconscionability is an extraordinary
remedy usually reserved for the
protection of the unsophisticated and
the uneducated.
Abusive as
Unconscionability “Light”
Fiesta Dance Clubs v. Bailey, 597 S.W.2d 532 (Tex. Ct. Civ. App.
1980) (finding UDAP violation where dance school took
“advantage of the lack of knowledge, ability, experience or
capacity of a person to a grossly unfair degree”)
“The jury could properly infer from the evidence that
plaintiff was a lonely widow who lacked the knowledge, ability,
experience or capacity to withstand the premeditated attention
lavished upon her by defendants, who purposely took
advantage of her vulnerability to a grossly unfair degree.”
Abusive as
Unconscionability “Light”
Larry DiMatteo & Bruce Louis Rich, A Consent Theory Of
Unconscionability: An Empirical Study Of Law In Action, 33 Fla. St. U.L.
Rev. 1067, 1071 (2008)
In order to determine if there is a relationship between the
court’s decision and the presence of an unsophisticated, uneducated,
low socio-economic status party, we calculated cross tabulations of
the cases that indicated a party was of unsophisticated, uneducated,
low socio-economic status. Results revealed that in 85% of the cases
involving an unsophisticated/uneducated/low socio-economic
status party, the court found unconscionability, suggesting [the
h]ypothesis is supported.
Behavioral Law & Econ and
State Laws
 Oren Bar-Gill & Elizabeth Warren, Making Credit Safer, 157 U. Pa.
L. Rev. 1 (2008) (lays out case for CFPB and examines PDLs)
 Oren Bar-Gill, Seduction by Plastic, 98 Nw. U. L. Rev. 1373 (2004)
 Karen E. Francis, Rollover, Rollover: A Behavioral Law & Economics
Analysis of the Payday Loan Industry, 88 Tex. L. Rev. 611 (2010)
 Other big names in behavioral law and econ field: Cass Sunstein,
Ronald Mann and Christine Jolls
Behavioral Law & Econ and
State Laws
Behavioral law and econ literature argues that, because of fierce
competition, financial products are designed to exploit
weaknesses in consumers:
 Imperfect self control: leaving consumers unable to resist
the temptation to take path of least resistance/lowest
immediate cost
 Optimism bias: leading consumers to think they will have
more excess cash or fewer expenses in the future
 Hyperbolic discounting: causing consumers to accept paying
substantial costs in the future to have the (modest)
immediate benefit of having cash in their pocket today
Behavioral Law & Econ and
State Laws
These weaknesses necessitate
according to Barr-Gill:
government
intervention
These welfare costs[, i.e., costs created by consumers not
acting in their own best interest,] provide a prima facia case for
legal intervention. The underestimation bias that underlies the
identified welfare costs also qualifies the no-intervention
presumption of the freedom of contract paradigm. If a
contracting party misconceives the future consequences of the
contract, then the normative power of contractual consent is
significantly weakened.
Behavioral Law & Econ and
State Laws
What kind of intervention?
“Perhaps the most dangerous feature of the payday
loan product is the loan rollover”
- Bar-Gill & Warren
Behavioral Law & Econ and
State Laws
What kind of intervention?
State laws signal a number of potential candidates for further
regulation:
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Rollovers
ACH authorizations
Multiple concurrent loans
And other things that are clearly not “deceptive” or “unfair”
but that cause people to act in way that a behavioral
economist might say is irrational or not in their self interest
Behavioral Law & Econ and
State Laws
What kind of intervention?
 Not necessarily an APR cap: “[P]rice regulation via usury caps is
fraught with well-known problems.” Barr-Gill
 Prominent Generic Disclosures: See Marianne Bertrand & Adair
Morse, Information Disclosure, Cognitive Biases and Payday Borrowing, U.
Chicago Booth School of Bus. Working Paper (finding that
disclosure of rollover fees reduced future loan amounts by 23%
and reduced future loan take up by 11%)
 “Individualized disclosures”:
fees/charges paid
YTD
(or
lifetime-to-date)
What’s “Abusive” in Other
Products?
Onerous Prepayment Penalties
Balloon Payments
Steering into higher cost loans
Equity Stripping/Flipping
Making Loan without Ability to Repay
Coercive EFTs
Responses to What’s Abusive
in Other Products?
Onerous Prepayment Penalties – ban them
Balloon Payments – ban them
Steering into higher cost loans – ban it
Equity Stripping/Flipping – ban it
Making Loan without Ability to Repay – ban it
Also, many state high cost loan laws require counseling,
etc. before agreeing to a high cost loan
Rollovers
 Rollovers an obvious target for an abusive practice
 Akin to loan flipping, which many high-cost loan laws
ban without some “net tangible benefit”
 Some combinations of interest rates and rollovers are
highly likely to be non-welfare-enhancing; therefore
arguably “abusive” or “unfair” – consumer advocates
likely to argue that rollovers themselves are abusive
because of the “cycle of debt” dilemma
What Consumer
Advocates Say
 This is one of the few industries where the
product is designed for overuse or the business
model fails.
 The industry recognizes this fundamental flaw and
says that consumers should not overuse the
product.
 If people truly used the product on an isolated
basis, consumer advocates could live with the
product.
What Abusive Looks Like
Retired nursing home aid on fixed income takes out a
$550 payday loan to help pay for “unusual” moving
expenses to move closer to family
Retired nursing home aid ends up paying over $2,700
in interest
How does this happen? Rollovers?
Consumer Advocates Hate
Rollovers
 Lenders “have deliberately built tricks
and traps” into the product to “ensnare
families in a cycle of high-cost debt.”
 No disclosure can fix the fundamental
problem of reuse – disclosures in this
regards are used to “obfuscate rather
than inform”
What about Net Tangible
Benefit?
 Anti-flipping prohibitions in high-cost loan laws allow
lenders to overcome presumption of flipping for
certain loans if they can show a “net tangible benefit”
to borrowers, such as a lower interest rate or
elimination of a prepayment penalty
 Consumers advocates will fight this with regard to
payday loans, because they argue that there can be no
net tangible benefit to becoming ensnared in the cycle
of debt
What Else is Abusive?
Documenting Ability to Repay
 No doc loans have been characterized as abusive
 Payday loans are not always made on the underwriting
conclusion that a customer can repay the loan
 Is this abusive?
 For payday lending to profit the lender, the lender
counts on the customer not being able to repay –
product has unaffordable repayment terms. Is this
abusive?
Some Scenarios for Payday Lending
Guidance from the Bureau
Restrictions a la the FDIC’s Payday Guidance
1.
2.
3.
4.
5.
6.
Limits on the number and frequency of extensions, deferrals, renewals
and rewrites
Ban additional advances to finance unpaid interest and fees
Ban simultaneous loans to the same customer
Cooling off/waiting periods between the time a payday loan is repaid and
another application is made
Establish the maximum # of loans per customer within a designated time
period (e.g., one year)
Only one loan outstanding at a time
Possible Bright Line Rule
 No payday loans to customers who had a payday loan
outstanding at any lender for a total of 3 months during the
prior 12 months.
 When a customer has used payday loans for 3 months or more
in the past 12 months, the lender must refer them to or offer
an alternative longer term product that better suits the
customer.
 Lenders must consider the total use of payday loans at all
lenders in applying this rule.
Other Tests of What’s
Abusive
Suitability Test
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Is this a suitable product for the consumer’s needs?
Requires inquiry into why consumer gets the loan
Effects Test
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What impact/effect does the loan have on the
consumer’s well-being? What’s the financial impact of
the loan?
But This is Only Speculation
 The Act does not address rollovers or any other substantive
aspect of payday lending. The Bureau can make regulations
with respect to payday loans.
 No other language in Title X gives the Bureau authority to
proscribe rollovers or any other feature of payday or small
loans.
 Consumer groups will use “abusive” as a basis for urging
proscription of some unspecified number of consecutive
rollovers, possibly four or more, at the very least.
Contact Information
Catherine M. Brennan
Hudson Cook, LLP
7250 Parkway Drive, 5th Floor
Hanover, MD 21076
 410-865-5405
 cbrennan@hudco.com
Mark J. Furletti
Consumer Financial Services Group
Ballard Spahr LLP
1735 Market Street, 51st Floor
Philadelphia, PA 19103-7599
 215-864-8138
 furlettim@ballardspahr.com