Page 1
8 of 110 DOCUMENTS
Banking Law
Copyright 2009, Matthew Bender & Company, Inc., a member of the LexisNexis Group.
CHAPTER 119 Holders in Due Course in Consumer Transactions
5-119 Banking Law § 119.05
§ 119.05 Federal Trade Commission Rules
F.T.C. rules provide that consumer credit contract must contain notice provision stating holder is subject to
claims and defenses consumer may assert against seller; rules apply to contracts for sale of services as well
as tangible personal property
[1] Code
On January 26, 1971, the Federal Trade Commission ("F.T.C.") published for comment a trade regulation
rule that would preserve a buyer's claims and defenses.n1 Public hearings were held which resulted in the
publication of a revised rule on January 5, 1973.n2 Thereafter, further hearings were conducted, and a final
rule was published effective May 14, 1976.n3
The rule is applicable to a consumer credit contract, defined by the F.T.C. as any instrument that evidences,
or embodies, a debt arising from a purchase money loan, or a financed sale. A purchase money loan is any
cash advance made by a creditor to a consumer for a finance charge, with the advance being applied to the
purchase of goods or services from a seller who either refers consumers to the creditor, or is affiliated with
the creditor by common control, contract, or business arrangement. A financed sale is any sale to a consumer
for which credit is extended or arranged by the seller.n4
The F.T.C. rule provides that consumer credit contracts must contain a provision that subjects the holder to
claims and defenses of the consumer. The contract would then, under state contract law, subject any holder
of the instrument to the maker's claims and defenses.n5 The F.T.C. rule, known and referred to as the "Holder Rule," "essentially ... strips the ultimate holder ... of its traditional status as a holder-in-due-course and
subjects it to any potential defenses which the purchaser might have against the seller" (citation omitted).
The rule is addressed to the situation where a seller utilizes a procedure in financing a consumer sale that
"separate[s] the buyer's duty to pay for goods or services from the seller's reciprocal duty to perform as
promised." The Holder Rule "notifies all potential holders that, if they accept an assignment ... they will be
stepping into the seller's shoes."n6
An Ohio appeals courtn7 succinctly states the concept, substance and limitations of the Holder Rule. It is:
[A] preservation-of-claims-and-defenses clause that abrogates the holder-in-due-course
doctrine to protect consumers when purchasing goods or services on credit ... [It] shifts the risk
Page 2
5-119 Banking Law § 119.05
of seller misconduct to creditors ... [and makes] the holder of a retail installment contract, assigned under the FTC Holder Rule ... subject to any claim or defense [the debtor] could assert
against [the seller], provided the claim or defense is one arising out of or connected with the
original transaction ... while the FTC Holder Rule subjects an assignee of a consumer contract
to all the claims and defenses the consumer could have asserted against the seller, there is no
private right of action to enforce the FTC rule. (sic)n8
The final two points are the key points emphasized by the court, to wit: the defense must arise from, or be
connected with, the transaction between the debtor and original seller (holder of the retail installment contract) and the debtor cannot enforce the Holder Rule in a private action.n8.1
The rule is result-oriented, and achieves the intended goal without considering whether the instrument is negotiable, or whether the holder is a holder in due course. The rule makes it an unfair trade practice for a seller
or creditor to directly, or indirectly, take or receive a consumer credit contract that does not contain the following 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.n9
This notice is required in both situations described in Crisomia v. Parkway Mortgage, Inc.; that is, for a direct loan made by the creditor where there is a cooperative arrangement between the seller and lender/creditor and the loan is made by a lender to a consumer who uses the proceeds of the loan to make a purchase, and an indirect loan where a note is initiated by the seller who then sells and assigns the note to a financial institution.n10 The F.T.C. Holder Rule does not apply if there is a bona fide direct loan where the
proceeds are "incidentally" used as a means of financing a purchase by a consumer.n11 The Holder Rule applies to a "purchase money loan" that is defined as a cash advance that the consumer receives and is used to
buy the goods or services from a seller who then refers the consumer to the creditor or is affiliated with the
creditor,n12 and to a "financed sale" that is defined as the extension of credit to a consumer in connection
with a Credit Sale as defined in the Truth in Lending Act and Regulation Z; the Act and Regulation define a
"Credit Sale" as any sale in which the seller is a creditor.n12.1 A consumer is defined as a natural person
who seeks or acquires goods or services for personal, family, or household use.n13 The notice is as broad in
effect as state statutes that contained similar provisions. In the situations covered, the holder of an instrument
will not have the right to avoid defenses that a holder in due course could otherwise have avoided under the
Code.
As recognized by a federal district courtn13.1 under the Guidelines of the FTC Bureau of Consumer Protection "The requirement that a contract 'contain' the Notice is not satisfied if the text of the Notice is printed in
the contract in conjunction with additional recitals which limit or restrict its application Where the text of the
Notice is qualified by additional language, the contract fails to 'contain' the required Notice."n13.2
The required notice preempts any conflicting state laws.n14 The rule is applicable to contracts for the sale of
services, as well as sales of tangible personal property.n15 Inclusion of the required notice does not affect the
negotiability of the instrument.n16 The notice does affect the rights of the holder to enforce the instrument
and eliminates his ability to cut off personal defenses.n17 The rule is procedural, subjecting a holder to any
claims and defenses the purchaser may have against the seller.n18 The substantive claims and defenses that
might be asserted, such as breach of warranty or any other contractual breach, are governed by applicable
Page 3
5-119 Banking Law § 119.05
state law.n18.1 A Massacusetts state court held that the F.T.C. rule does not authorize an action or counterclaim by the consumer-debtor against a lender for recovery of money not paid on the note based upon alleged
fraudulent representations of the seller. Affirmative recovery against the lender cannot be had based on any
contract breach alleged against the seller.n19
However, a federal district courtn20 held that the F.T.C. rule could be used also as a "sword" and not just as
a "shield." The rule can be used affirmatively by a debtor against a creditor "where a seller's breach is so
substantial that a court is persuaded that rescission and restitution are justified..." under state law principles.
In effect, the consumer must show that he or she "received little or nothing of value..." Under the facts of the
case, the consumers could not establish this burden and their complaint against the creditor was dismissed.
But another federal district courtn21 concluded that the Holder Rule "does not limit affirmative claims only
to those circumstances where recission would be appropriate...the F.T.C intended to shift the risk of seller
misconduct from the consumer to the seller and assignees." The court also refers to a staff opinion letter of
the F.T.C. that rejects the reasoning of the court in Ford Motor Credit Co. v. Morgan, which, according to
the court, is the "foundation for most decisions holding that consumers may not bring affirmative claims..."
under the Holder Rule.
The issue was again raised by a Pennsylvania appeals court.n22 The court conducts a rather comprehensive
survey, citing to numerous sister court and federal court decisions that addressed the issue and concluded
either that the consumer cannot seek affirmative relief against the assignee unless the breach justified rescission, or the consumer received little or nothing of value, and those on the other side of the issue that ruled
that a consumer can seek affirmative relief without proving a rescission. This court agreed with those decisions that do not require the consumer to assert a claim for rescission or to otherwise demonstrate a failure of
performance, in order for the consumer to seek affirmative relief. Therefore, the court rejected the decision in
Ford Motor Credit Co. v. Morgan, which case the court describes as being "accepted as the seminal case."
The court specifically held that:
[P]ursuant to the FTC Holder Rule, a consumer-debtor may assert against a creditor-assignee of a consumer credit contract any and all affirmative claims for recovery, as well
as defenses, that the consumer-debtor would be entitled to assert against the seller had the contract not been assigned ... a consumer-debtor asserting an affirmative claim for recovery shall
not be required to demonstrate that he or she has received little or nothing of value or that rescission of the underlying contract is warranted.
Continuing the differing views and controversy on this issue, another federal district courtn23 held that a
consumer must show "substantial failure of performance" on the contract to use the Holder Rule offensively;
in order to obtain an affirmative recovery, the consumer must show "conduct warranting rescission."
This issue was again addressed by an appellate court in Nebraska.n23.1 The court concluded that the maximum recovery by a plaintiff, under the holder rule, cannot exceed the amount paid to the holder by that
plaintiff; the debtor's recovery cannot be more than the amount paid by the debtor because the holder rule
limits a debtor's recovery to that amount. The court also recognized that the holder/assignee is subject to the
same claims and defenses that a consumer can assert against the original lender/assignor of the consumer
installment contract. The court further also held that a consumer can seek equitable relief under both the state
Uniform Deceptive Trade Practices Act and Consumer Protection Act. The holder rule does not limit the type
of remedies that can be sought against an assignee.
In a federal appeals case,n24 the purchaser of a used car signed a retail installment contract that contained the
F.T.C. notice. The seller assigned the contract to a third party assignee. The purchaser then brought an action
Page 4
5-119 Banking Law § 119.05
alleging against the seller-assignor and assignee that the contract disclosure violated the federal Truth in
Lending Act. The court held that the disclosure was in violation of the TIL Act and implementing Regulation Z.n25 and therefore could be asserted against the seller. However, under the Act, the violation may be
asserted against an assignee only if the violation is apparent on the face of the disclosure statement.n26 The
court held that the violation was not apparent on the face of the disclosure on the contract, so that, under the
Act, it could not be asserted as a defense to payment against the assignee. The court then addressed the
F.T.C. notice and whether the consumer could assert the violation under it. On its face the "good faith safe
harbor" provision in the Act and F.T.C. notice are in conflict. The court held that the "good faith safe harbor"
provision of the Act would override the F.T.C. clause, so that the assignee was not subject to the consumer's
defenses related to the violations of the Act pursuant to the F.T.C. clause.
The F.T.C. rule imposes the obligation to ensure that the notice provision is included in the credit contract
upon the seller.n27 However, under certain circumstances, the creditor is also charged with a duty of ensuring compliance with the rule. This duty arises when the creditor and the seller of the goods are engaged in a
referral arrangement, or are affiliated with each other in the entire transaction. As stated by the F.T.C. in its
statement of purpose:
The four definitions of "Creditor," "Purchase Money Loan," "Contract," and "Business Arrangement" will reach every situation where a seller and a lender may be said to work cooperatively to finance consumer sales. We believe that the record in this proceeding supports application of the rule to all situations where concerted or cooperative conduct between sellers and
creditors is employed to facilitate the retail distribution of goods and services to consumers.
This is true without regard to the "type" of credit, loan or discount, which is used. The revised
rule goes exactly this far and no further.n28
A creditor and seller are affiliated where there is common control, as in a parent-subsidiary relationship, or
where both have common ownership.n29 An affiliation may result from "any oral or written agreement, formal or informal, between a creditor and a seller, which contemplates or provides for cooperative or concerted
activity in connection with the sale of goods or services to consumers or the financing thereof."n30 A business arrangement that results in an affiliation imposes upon the creditor the obligation of insuring compliance
with the rule. A business arrangement is "any understanding, procedure, course of dealing, or arrangement,
formal or informal, between a creditor and a seller, in connection with the sale of goods or services to consumers or the financing thereof."n31 The business arrangement must be ongoing and clearly related to financing.
Referrals usually occur where, without formal or preexisting agreement, a creditor and seller cooperate on a
continuing basis to refer purchasers from one to the other, the referrals relating to the actual financing of the
sale.n32 For there to be a requisite referral, the seller must perform some affirmative act that promotes the
granting of the loan.n33
A New Jersey appellate casen34 addressed the situation where a note subject to the FTC rule was executed
but it did not contain the requisite bold face notice.n35 The court held that the fact the notice was missing did
not affect the result, and that the Holder Rule was still applicable. The court justified this holding by stating
that the creditor was charged with notice of the requirement and it was its responsibility to insert the notice.
It was "inconceivable" to the court that the seller and creditor could "evade the remedial reach of the Holder
Rule simply because of that omission."
A bankruptcy courtn36 reached a contrary result. The court stated that where the notice is included, as a
matter of contract law, the holder waives any defenses available to a holder in due course. However, if the
Page 5
5-119 Banking Law § 119.05
notice is not included, the F.T.C. Holder Rule "provides no remedy for the consumer." In effect, the creditor
has then not waived its rights as a holder in due course to take the obligation free of personal defenses the
consumer may have against the seller. Citing from a federal district court case,n37 the court stated that
"[R]ights against subsequent holders are contractual and can only be enforced if the required language is included." If the seller omits the notice, the buyer/consumer will lose the qualified protection that the notice
would otherwise provide. The notice will not be implied in the contract (note or loan agreement). Editor's
Note: The weight of authority appears to support the rule in Crisomia v. Parkway Mortgage, Inc. and reject
the rule in Associates Home Equity Servs., Inc. v. Troup. Another decision, by a federal district court,n38
affirms this rule/holding. The court stated that the FTC regulation does not itself automatically insert the required language into a contract; the required Notice cannot automatically be read into a contract. Further (as
explained above in this subchapter) the FTC regulation does not give rise to a private cause of action; it can
only be enforced by the FTC itself.
As noted and explained below, this issue is addressed and resolved by the 2002 Amendments to Articles 3
and 4. However, the current version of revised Article 9 of the U.C.C. also provides rules that will achieve
the same result as the Holder Rule, where it is not included, as required, in the consumer contract. As stated
in Stoudt v. Alta Financial Mortg. n39 where the required notice is omitted in the note, it is implied pursuant
to Revised Article 9.
A federal court of appeals casen40 addressed the situation where the text of the Holder Rule is included in
the contract, although it is not required. The court held that a matter of contract law claims or defenses of the
consumer that could be asserted against the seller constitute valid claims or defenses against the assignee.
The National Conference of Commissioners on Uniform State Laws (N.C.C.U.S.L.) addressed this issue by
adding provisions in the 2002 Amendments to Articles 3 and 4, to revised Code Section 3-305, Defenses and
Claims in Recoupment. First, the title of the section is changed to add the following "Claims in Consumer
Transactions". The added sections adopt the holding and rationale of Associates Home Equity Servs., Inc. v.
Troup and Gonzalez v. Old Kent Mortgage Co. The added section does not specifically refer to the Holder
Rule by name or citation, although it is clear that the section applies to the Holder Rule; the added language
is broader in that it refers to any law other than as provided in Article 3, with respect to a consumer transaction.n41 The added subsection provides that:
(e) In a consumer transaction, if law other than this article requires that an instrument include a statement to the effect that the rights of a holder or transferee are subject to a claim or
defense that the issuer could assert against the original payee, and the instrument does not include such a statement:
(1) the instrument has the same effect as if the instrument included such a statement;
(2) the issuer may assert against the holder or transferee all claims and defenses that would
have been available if the instrument included such a statement; and
(3) the extent to which claims may be asserted against the holder or transferee is determined as if the instrument included such a statement.
(f) This section is subject to law other than this article that establishes a different rule for
consumer transactions.n42
Any question as to the applicability of the Holder Rule where it is not included in the note in a consumer
transaction, is eliminated. A subsequent holder of such an instrument is bound by the terms of the Holder
Rule Notice irrespective of whether it is or is not included in the instrument (credit contract) and the con-
Page 6
5-119 Banking Law § 119.05
sumer-maker can assert all claims and defenses against such subsequent holder. The revision "...ensures that
Section 3-305 is interpreted to accommodate relevant consumer protection laws."n43
An Iowa appeals courtn44 addressed the issue of personal jurisdiction with respect to the assignee of a retail
installment contract and whether jurisdiction is conferred on the assignee by virtue of the Holder Rule. The
court held that no such jurisdiction is granted; the holder rule "cannot constitute a per se grant of personal
jurisdiction." The relevant inquiry as to whether the assignee is subject to the court's jurisdiction is based
upon the minimum contacts test; that the assignee became such and became a holder of the contracts that
were entered into by residents of Iowa is but one factor to consider under this test.
The F.T.C. rule is applicable under its authority to credit unions, finance companies, and creditors other than
banks. However, the rule has been adopted by the Federal Reserve Board, and so applies to member banks as
well. On Nov. 15, 1979, the F.T.C. issued a proposed amendment to its basic rule for the preservation of
consumers' claims and defenses.n45 The proposed rule would extend the obligations previously placed on
sellers to all creditors except banks, although the rule could also be adopted by the Federal Reserve Board
subsequent to adoption by the F.T.C. In the opinion of F.T.C. officials, the placing of the obligation to include the requisite language in the credit contract upon all creditors would strengthen the original rule. The
proposed rule has been controversial partly because the Federal Reserve Board would also consider adoption
of a similar rule applicable to banks.n46 The proposed rule states:
"In connection with any Purchase Money Loan ... or any sale or lease of goods or services,
in or affecting commerce as 'commerce' is defined in the Federal Trade Commission Act, it is
an unfair or deceptive act or practice ... for a seller or a creditor, directly or indirectly, to take or
receive a consumer credit contract which fails to contain the following provision in at least ten
point, bold face type:
"This credit contract finances a purchase. All legal rights which the buyer has against the
seller arising out of this transaction, including all claims and defenses, are also valid against
any holder of this contract. The right to recover money from the holder under this provision is
limited to the amount paid by the buyer under this contract.
"A claim is a legally valid reason for suing the seller. A defense is a legally valid reason for
not paying the seller. A holder is anyone trying to collect for the purchase."n47
For inclusion in contracts required under state law to be written in Spanish, a Spanish provision is specified
in the amendment.n48 The proposal also provides:
"If a consumer indicates that all or a substantial portion of the proceeds of a loan will be
used to purchase goods or services from a specific seller, and the creditor and that seller are affiliated by common control or business arrangement, then the following may be added to the
provision required by [the rule]:
"This paragraph is applicable only if the proceeds of this loan are used primarily to purchase goods or services from [insert seller's name] or any other affiliated seller."n49
The proposed amendment has not, as of January 2001, been adopted.
Practical Hint: The FTC holder in due course rule requires the inclusion of a notice of the preservation of
claims and defenses in certain consumer credit contracts. This rule does not preempt state law that may also
Page 7
5-119 Banking Law § 119.05
address similar matters.n50 Additionally, state law will determine matters of enforceability and interpretation
of the contract, so that state law will complement the provision of the rule. As examples, procedural matters
relating to the bringing of an action and whether rescission or restitution is available to the consumer as
remedies, are determined by state law. Certain states prohibit the use of a negotiable instrument in a consumer transaction, while other states permit holder in due course status under specified circumstances, and still
other state statutes prohibit waiver of defense clauses in defined consumer transactions. A consumer may, in
some states, assert defenses in a direct loan transaction.n51 These matters are mentioned here for awareness
purposes, in that counsel faced with an issue of the rights of a consumer (as the maker of a note--signatory to
a consumer contract) and payee--seller, including holder in due course rights as it affects a consumer transaction, must review three areas of law to determine the respective rights and obligations of the parties: the Code
provisions on holder in due course (see chapters 116, 117 and 118), the FTC Holder Rule (see chapter 119),
and any other applicable state statutes (non-Code statutes) that address consumer rights in a consumer loan
transaction. Any more detailed discussion of the third category, that is: state statutes other than the Code, are
beyond the scope of this treatise.
For a more complete discussion of the FTC Holder Rule, including a list of state statutes that address the
various matters mentioned in the preceding paragraph and matters of administrative enforcement and civil
penalties, the reader is referred to Chapter 159 below.n52
[2] Revised Code
The Federal Trade Commission rules are effective under the revised Code which subordinates the Article 3
rights of holders in due course to the effects of the F.T.C. rules on such holders.n1 These provisions are consistent with the cases which held that the F.T.C. notice rules preempt state law which would include the
U.C.C.n2 Given that there is no difference in interpreting and applying the FTC Holder rule under the Code
and revised Code, all cases involving the Holder rule will be considered and discussed under the discussion
of the Code, above in § 119.05[1].
Legal Topics:
For related research and practice materials, see the following legal topics:
Antitrust & Trade LawConsumer ProtectionGeneral OverviewCommercial Law (UCC)Negotiable Instruments (Article 3)EnforcementDefenses & ClaimsCommercial Law (UCC)Negotiable Instruments (Article
3)EnforcementHolders in Due CourseExceptionsContracts LawDebtor & Creditor Relations
FOOTNOTES:
(n1)Footnote 1. 36 Fed. Reg. 1,211 (1971) .
(n2)Footnote 2.
38 Fed. Reg. 892 (1973) .
(n3)Footnote 3. Promulgation and Statement of Basis and Purpose, Notice of Proposed Amendment,
40 Fed. Reg. 53,506 (1975) . See also Statement of Enforcement Policy, 41 Fed. Reg. 34,594 (1976) ; Denial of Exemption for Two-Party Open-End Consumer Credit, 42 Fed. Reg. 46,509 (1977) . See Reagans v.
Mountainhigh Coach Works, Inc., C.A., 2006 Ohio 423, at *P11 (Ohio Ct. App. 2006). The court, citing 28
Stat. 717 (1914), 15 U.S.C.A. 41 as amended, observed that the rule is promulgated under the authority of the
F.T.C. "to prohibit unfair or deceptive acts or practices in commerce and to promulgate industry-wide rules
to accomplish that end." On appeal, the
Supreme Court, 881 N.E.2d 245 (Ohio 2008) , affirmed the
judgment of the lower appellate court and expanded on the explanation of the purpose of the rule by providing the background for the rule. The court observed that prior to the FTC rule, a lender, to whom a credit
contract for the sale of goods was transferred, could enforce the buyer's payment obligation even if the seller
failed to perform its obligations under the sales contract. Also, a buyer was obligated to pay the lender under
a consumer loan contract that directly financed the purchase of goods or services from the seller even though
Page 8
5-119 Banking Law § 119.05
the seller may be in breach of the contract. The court referred to the Guidelines on Trade Regulation Rule
Concerning Preservation of Consumers' Claims and Defenses, 41 Fed. Reg. 20,022, 20,023 (May 14, 1976) .
The FTC, the court further observed, promulgated the rule to address this problem that a consumer had an
obligation to pay even if the goods financed were defective or the seller was otherwise in breach of its obligations under the sales contract. The court referred to the Promulgation of Trade Regulation Rule and
Statement of Basis and Purpose, 40 Fed. Reg. 53,506, 53,522 (Nov. 18, 1975) . In Mitchell v. Church, 2006
Del. Super. LEXIS 295 (Del. Super. Ct. 2006) , the court stated the purpose of the F.T.C. Holder Rule (what
it describes as the history and operation of the rule) as follows: "the federal rule addresses predatory lending
practices, such as 'dragging the body.' The rule is intended to prevent loan companies from enforcing purchase money loans... without reference to the underlying transaction... .The Rule 'notifies all potential holders that, if they accept an assignment of the contract, they will be stepping into the seller's shoes.' " (Emphasis in the original.)
(n4)Footnote 4. 16 C.F.R. § 433.1(d). See Crisomia v. Parkway Mortgage, Inc. (In re Crisomia), 2001
Bankr. LEXIS 1469 (Bankr. D. Pa. 2001) . In this case, the instrument upon which suit was brought was a
purchase money loan in that the home improvement contractor contacted the mortgage company and arranged the financing used by the consumer to purchase the home improvements. As indicated by the court, in
this situation there is no privity of contract between the consumer-debtor and the creditor for the home improvements. Therefore, the F.T.C. Holder Rule, where it is applicable, protects the consumer to the extent the
consumer can withhold payment to the creditor where the consumer has contract defenses against the seller.
See Fifth Third Bank v. Roberts, 55 U.C.C. Rep. Serv. 2d 378 (Ohio Ct. App. 2004) . The court set forth the
substance of the F.T.C. holder rule and the definition of a "consumer credit contract" emphasizing that the
holder rule only applies where the obligation is a consumer credit contract. The holder rule was inapplicable
in this case--it involved a lease that did not fit the definition of a consumer credit contract
(n5)Footnote 5. U.C.C. §§ 3-104, 1-102(3). As stated in Ambre v. Joe Madden Ford, 881 F. Supp.
1182 (N.D. Ill. 1995) , the purpose of the rule was to address the anomaly under the holder in due course rule
where the creditor had a right to payment which was superior to the seller's right because the seller's right
was conditioned upon its performance but the creditor's rights were not so conditioned. "The FTC adopted its
rule to remedy this anomaly and to redistribute the cost occasioned by seller misconduct in credit transactions to the creditor rather than the consumer ... " Under the rule the consumer's duty to pay the creditor is
dependent upon the duty of the seller to perform. Various states also have local statutes similar to the F.T.C.
rule requiring notice that a holder of a retail installment contract is subject to defenses. See Thomas v. Ford
Motor Credit Co., 429 A.2d 277 (Md. 1981) ; Crisomia v. Parkway Mortgage, Inc. (In re Crisomia), 2001
Bankr. LEXIS 1469 (Bankr. D. Pa. 2001) (where notice is included the holder waives its holder in due course
defense as a matter of contract law). See also Ford Motor Credit Co. v. Morgan, 536 N.E.2d 587 (Mass.
1989) (F.T.C. rule cuts off creditor's rights as holder in due course; "the language operates not due to any
statute or regulation, but to the effect the notice has when it becomes part of the contract"); Green Tree
Consumer Disc. Co. v. Newton, 909 A.2d 811 (Pa. Super. Ct. 2006) (the court set forth the federal F.T.C.
holder rule and discussed its effects and also addressed the Pennsylvania Home Improvement Finance Act,
73 Pa. Stat. Ann. § 500-101 et seq .); Kaliner v. Mortgage Elec. Registration Sys. ( In re Reagoso), 2007
Bankr. LEXIS 2004 (Bankr. E.D. Pa. 2007) (citing and recognizing the rule set forth in Green Tree Consumer Disc. Co. v. Newton, but ruling that the Holder Rule did not apply under the facts of the case as it did not
involve a "consumer credit contract", but a mortgage loan). See Crews v. Altavista Motors, Inc., 65 F. Supp.
2d 388 (W.D. Va. 1999) . The court stated that the rule preserves consumer claims and defenses by cutting
off holder in due course status of a creditor. The rule, therefore, "acts as a shield for consumers, protecting
them from creditors by allowing non-payment when a seller has defrauded the consumer in any way." In
Lozada v. Dale Baker Oldsmobile, Inc., 91 F. Supp. 2d 1087 (D. Mich. 2000) , the court stated that a holder
that takes an assignment of a contract steps into the shoes of the seller and is then subject to claims or defenses that the debtor can assert against the seller. See Javorsky v. Freedom Driving Aids, Inc., 2001 U.S.
Dist. LEXIS 14078 (N.D. Ill. Aug. 30, 2001) . Citing Jackson v. South Holland Dodge, Inc., 312 Ill.App.3d
Page 9
5-119 Banking Law § 119.05
158, 726 N.E.2d 1146 (2000) , the court held that the "Holder Rule allows a consumer to assert the same
claims against an assignee-creditor as could be asserted against the original seller where the seller's breach is
so substantial that rescission is warranted." See Herrara v. The North & Kimball Group. Inc., 2002 U.S.
Dist. LEXIS 2640 (N.D. Ill. Feb. 20, 2002) , citing Javorsky v. Freedom Driving Aids, Inc., for the rule that
the Holder Rule only permits affirmative actions against the assignee where the breach by the seller is substantial so that it warrants rescission of the contract.
In Valentino v. Glendale Nissan, Inc., 2000 Ill App. LEXIS 940 (Dec. 1, 2000) the court, citing Ambre v.
Joe Madden Ford, iterated that the purpose of the F.T.C. rule "was to modify how the holder-in-due- course
rule affected consumer purchasers of goods or credit...it does not modify the priority of security interests in
the purchased goods, and it does not create new rights or defenses." The plaintiff purchased a car from a car
dealer; plaintiff signed a retail installment agreement to finance the purchase, that contained the F.T.C. required notice, and also granted a security interest in the car. The agreement was assigned to a bank. Plaintiff
attempted to revoke the agreement and she ceased making payments. The bank repossessed the car. The
court held that the F.T.C. rule does not determine priority of security interests--the purchase money security
interest of the bank and the possessory security interest of the plaintiff under U.C.C. § 2-711(3) upon her
revocation. Under Article 9 of the U.C.C., the bank's security interest had priority. The F.T.C. rule did not
"abolish" the right of the bank to repossess the car; it only " 'abrogated' the bank's holder in due course defense."
(n6)Footnote 6. Associates Home Equity Servs., Inc. v. Troup, 343 N.S. Super. 254 778 A.2d 529,
2001 N.J. Super. LEXIS 318 (July 25, 2001) . See Crisomia v. Parkway Mortgage, Inc. (In re Crisomia),
2001 Bankr. LEXIS 1469 (Bankr. D. Pa. 2001) . The court indicates that two situations are addressed by the
FTC Holder Rule. The first situation is where the seller makes the loan as the initial creditor and then assigns
it at a discount to a third party. The second situation is where the seller acts as a "conduit" in referring the
buyer to a consumer finance company which makes the loan for the purpose of the borrower buying the
goods. In both situations, the separation of the consumer's duty to pay from the seller's duty to perform occurs. See also Jane Kaufman Winn, Couriers Without Luggage: Negotiable Instruments and Digital Signatures, 49 S. Carolina L. Rev. 900 (1998). It is observed that the reason for this F.T.C. rule is that consumers
could not be expected to understand the fundamentals of negotiability and the risks assumed in a negotiable
instrument. The rule "transfer[s] the costs of fraud and malfeasance on the part of merchants to creditors..."
See Stoudt v. Alta Fin. Mortg., 2009 U.S. Dist. LEXIS 19297 (E.D. Pa. 2009) . The court explained,
"The Rule abrogates 'the holder in due course rule in consumer credit transactions, preserving the consumer's
claims and defenses against the creditor--assignee. The FTC Holder Rule was, therefore, designed to reallocate the cost of seller misconduct to the creditor, who is in a better position to absorb the loss or recover the
cost from the guilty party--the seller.'"
(n7)Footnote 7. Primus Auto Fin. Servs. v. Brown, 840 N.E.2d 254 (Ohio Ct. App. 2005) . Under the
facts, and applying these principles, the court held that the debtor could not raise a defense of fraud and misrepresentation by the automobile dealer, from whom the debtor purchased a car, against the finance company, assignee, in its action for a deficiency judgment, for the reason that the debtor did not raise the defense as
a compulsory counterclaim in the dealer's earlier action against him. Since the debtor was barred from raising
these compulsory counterclaims against the dealer, he is also barred from asserting them against the assignee.
See Vultaggio v. Afzali, 2005 Ohio 5902 (Ohio Ct. App. 2005) .
In State ex rel. Stenberg v. Consumer's Choice Foods, Inc., 755 N.W.2d 583 (Neb. 2008) , the court recited that the purpose of the holder rule ... was to modify the effect of the holder-in-due-course rule on consumer purchases of goods and services ... [the rule was] "designed to reallocate the cost of seller misconduct
to the creditor, who is in a better position to absorb the loss or recover the cost from the guilty party--the
Page 10
5-119 Banking Law § 119.05
seller." See Boulds v. Chase Auto Fin. Corp., 266 S.W.3d 847 (Mo. Ct. App. 2008) (the holder rule exists to
preserve consumer rights against holders).
(n8)Footnote 8. Primus Auto Fin. Servs. v. Brown, 840 N.E.2d 254, 256-257 (Ohio Ct. App. 2005) .
See United States v. Hollis, 2008 U.S. Dist. LEXIS 69779 . at *6 (W.D. Tex. 2008). The court recognized
that a consumer "may not seek to affirmatively enforce the regulation, as any alleged violation does not give
rise to a private cause of action, but only gives rise to enforcement by the FTC." The alleged violation in this
case was the lender's failure to include the mandated notice in the note.
(n9)Footnote 8.1. See Whittington v. Patriot Homes, Inc., 2008 U.S. Dist. LEXIS 29760 (W.D. La.
2008) . The court stated that a violation of the FTC regulation, where the creditor does not insert the required
notice, does not give rise to a private cause of action; the only remedy is an enforcement action by the FTC
itself. This case is discussed below in this subchapter with respect to the rights of a consumer where the notice is omitted. See also Tennessee v. Britlee, Inc., 2007 U.S Dist. LEXIS 80364 (M.D. Tenn. 2007) (no private cause of action).
(n10)Footnote 9. 16 C.F.R. § 433.2. See Green v. Levis Motors, Inc., Fed. Banking L. Rep. (CCH), P
100-394 (8th Cir. 1998). This provision is required for all consumer credit contracts, such as the one involved in this case, a retail installment contract to purchase a used car. See Lozada v. Dale Baker Oldsmobile, Inc., 91 F. Supp. 2d 1087 (D. Mich. 2000) . This contractual language is mandated by the F.T.C. Holder
Rule. The court, citing from the Federal Trade Commission, Preservation of Consumers' Claims and Defenses, Final Regulation and Statement of Basis and Purpose, 40 Fed. Reg. 53,505, 53,524 (1975) , stated
that the rule "is directed at the preservation of consumer claims and defenses..." under which a consumer can
assert "sale related claims and defenses..." against any holder of the note.
The purpose of the Holder Rule, as stated in Pratt v. North Dixie Manufactured Housing. Ltd., 2003
Ohio 2363 (Ohio Ct. App. 2003) , is to "abrogate the holder-in-due course doctrine in order to protect consumers when they are purchasing goods or services on credit and to reallocate the cost of any seller misconduct from the consumer to the creditor." See Reagans v. Mountainhigh Coach Works, Inc., C.A., 2006 Ohio
423 (Ohio Ct. App. 2006) ("consumer credit obligations should be subject to claims and defenses whenever
credit is arranged or secured in connection with a continuing relationship between a seller and a creditor...[the rule] protect(s) the consumer's right to assert against the creditor any legally sufficient claim or defense against the seller. The creditor stands in the shoes of the seller."); Rollins v. Drive-1 of Norfolk, Inc.,
2006 U.S. Dist. LEXIS 61197 (D. Va. 2006) (Holder Rule functions to abrogate the holder-in-due-course status of financing companies that have purchased retail installment sales contracts from retail sellers because
policy considerations show that the financing companies are in a better position to evaluate the risks of dealing with sellers than are consumers, and therefore it is appropriate for them to assume the risk of wrongful
business practices of the seller); Beemus v. Interstate Nat'l Dealer Servs., 823 A.2d 979, 2003 PA Super
177 (Pa. Super. Ct. 2003) (FTC Holder Rule has the force of law). In Bryant v. Mortgage Capital Resource
Corp., 2002 U.S. Dist. LEXIS 1566 (N.D. Ga. Jan. 14, 2002) the court addressed the goal of the Holder Rule
as not only the preservation of claims and defenses, but "also the establishment of a broader, market-based
incentive for creditors to inquire into the merchants from whom they purchase consumer installment paper
and to refuse to deal with those merchants whose conduct would subject the creditor to potential claims or
defenses." (citation omitted) In Ross v. Thousand Adventures, 675 N.W.2d 812 (Iowa 2004) , the court stated that the holder rule "is based on the understanding that contractual obligations are frequently transferred
as negotiable instruments, and seeks to protect consumers from being required to make payments under the
contract to a holder of the contract even though the consumer may have a valid defense to payment against
the original vendor of the contract." The holder rule is not applicable to a participant bank that is a party to a
participation agreement for the reason that the participant bank does not have a right to collect directly from
the consumer and that the participant bank does not fit within the definition of a "holder." As to this last
point, the court cites to the definition of a "holder" in U.C.C. § 1-201(2) Iowa Code § 554.1201(20) and further observes that a participation agreement is not a negotiable instrument. The decision was affirmed, as
Page 11
5-119 Banking Law § 119.05
modified, on appeal, in Ross v. Thousand Adventures of Iowa, Inc., 2006 Iowa App. LEXIS 752 (Iowa Ct.
App. 2006) . The court recited the same purpose of the Holder Rule as the lower court, but did not specifically address the ruling in the lower court that the Holder Rule is not applicable to a participant bank. The
court ruled that the Holder Rule "cannot constitute a per se grant of personal jurisdiction [over the assignee
of the retail installment contracts]." This issue is discussed later in this subchapter. See also Fifth Third
Bank v. Roberts, 55 U.C.C. Rep. Serv. 2d 378 (Ohio Ct. App. 2004) (holder rule "is designed to abrogate the
holder-in-due-course doctrine in order to protect consumers when purchasing goods or services on credit.");
Comer v. Person Auto Sales, Inc., 368 F. Supp. 2d 478 (M.D.N.C. 2005) (rule "protects consumers by preserving their claims and defenses against creditors and allowing non-payment in the face of a seller's fraudulent actions").
(n11)Footnote 10. Crisomia v. Parkway Mortgage, Inc. (In re Crisomia), 2001 Bankr. LEXIS 1469
(Bankr. D. Pa. 2001) . See Reagans v. Mountainhigh Coach Works, Inc., C.A., 2006 Ohio 423 (Ohio Ct.
App. 2006) aff'd 881 N.E.2d 245 (Ohio Sup. Ct. 2008) See also Mitchell v. Church, 2006 Del. Super.
LEXIS 295 (Del. Super. Ct. 2006) . The court held that the Holder Rule applied where a consumer signed a
conditional sales contract for home repairs (that contained the required notice) that was assigned to a third
party; the third party could not claim holder in due course status and is subject to defenses raised by the consumer.
(n12)Footnote 11. Crisomia v. Parkway Mortgage, Inc. (In re Crisomia), 2001 Bankr. LEXIS 1469
(Bankr. D. Pa. 2001) . Editor's Note: The distinction that is implied, and what is meant by the court when it
refers to a "bona fide direct loan" is a loan made by the third party (not the seller), usually a bank or finance
company, where there is no arrangement or referral to the lender by the seller; the consumer finds and selects
the lender without any participation by the seller. Where there is an arrangement between the seller and
lender, or a referral by the seller to the lender, as further discussed in this subsection, the loan is still "direct",
but is not a bona fide loan, and therefore is subject to the Holder Rule.
In Vultaggio v. Afzali, 2005 Ohio 5902 (Ohio Ct. App. 2005) , the court held that the Holder Rule did not
apply to a note issued in favor of a Credit Union to evidence a loan to the consumer who used the loan proceeds to purchase a vehicle on the internet auction site eBay from a seller. The seller mailed the vehicle title
to the Credit Union which then mailed a check for the purchase price to the seller. The rule applies to "consumer credit contracts," which are instruments which evidence a debt arising from a Purchase Money Loan
transaction or a financed sale. A purchase money loan is a cash advance received by a consumer that is used
to purchase goods or services from a seller who "(1) refers consumers to the creditor or (2) is affiliated with
the creditor by common control, contract or business arrangement." Section 433.1(d), Title 16, C.F.R. In this
case the Credit Union was not the seller and the seller did not refer the borrower to the Credit Union to obtain
financing. The seller and Credit Union were not affiliated by contract or business arrangement. No business
arrangement resulted from the act of the Credit Union in receiving the title and mailing a check to the seller.
Also, the loan was not a financed sale that is an extension of credit to a consumer in connection with a "Sale"
under the Truth in Lending Act and Regulation Z that requires the seller to also be the creditor. Under the
facts the Credit Union was not the seller, so that the loan is not a financed sale.
(n13)Footnote 12. 16 C.F.R. §§ 433.2(b) and 431.1(d). See Associates Home Equity Servs. v. Beatrice
Troup, 778 A.2d 529 (N.J. Super. App. Div. 2001) .
(n14)Footnote 12.1. 16 C.F.R. § 433.1(e). With respect to the definitions in the Truth in Lending Act
and Regulation Z, respectively, see 15 U.S.C. § 1602(g) and 12 C.F.R. § 226.2(a)(16).
Several cases recognize and acknowledge that the Holder rule does not apply to mortgage loans for the
purchase of real estate; a mortgage loan is not included in a "consumer credit contract". See Hancock v.
HomEq Servicing Corp., 2007 U.S. Dist. LEXIS 31051 (D.D.C. 2007) ; Woodsbey v. Easy Mortgage (In re
Page 12
5-119 Banking Law § 119.05
Woodsbey), 375 B.R. 145 (Bktcy. Ct. W.D. Pa. 2007) ; Stoudt v. Alta Fin. Mortg., 2009 U.S. Dist. LEXIS
19297 (E.D. Pa. 2009) ("the Rule is totally irrelevant outside the context of a consumer credit transaction.").
(n15)Footnote 13. 16 C.F.R. § 433.1(b). See subdivisions (c), (d), (i), (j) for definitions of "creditor,"
"purchase money loan," "consumer credit contract," and "seller."
(n16)Footnote 13.1.
La. 2008) .
Whittington v. Patriot Homes, Inc., 2008 U.S. Dist. LEXIS 29760, at *15 (W.D.
(n17)Footnote 13.2. See FTC Bureau of Consumer Protection's "Guidelines on Trade Regulation Rule
Concerning Preservation of Consumers' Claims and Defenses," 41 Fed. Reg. 20022 -27 (1976),
(n18)Footnote 14. Public Util. Comm'n v. United States, 355 U.S. 534 (1950) ; Brown v. Bates, 316
F. Supp. 897 (N.D. Ohio 1973) ; Felde v. Chrysler Credit Corp., 580 N.E.2d 191 (1991) (enables consumer
to assert defenses which otherwise would have been barred by U.C.C. § 3-302 if the assignee-creditor were a
holder in due course).
(n19)Footnote 15.
40 Fed. Reg. 53,524 (1975) .
(n20)Footnote 16. See Ambre v. Joe Madden Ford, 881 F. Supp. 1182 (N.D. Ill. 1995) . This case addressed the issue of the F.T.C. rule on the creditor's security interest and held that the F.T.C. rule modified
how the holder in due course rule affected a consumer's rights to assert defenses to payment; it did not modify the Code priority of security interest provisions. By analogy then the case supports the proposition that
the F.T.C. rule does not modify the rules on negotiability, but only the ability of the consumer- maker of a
note to overcome the holder in due course rule and assert personal defenses.
(n21)Footnote 17. See U.C.C. §§ 3-104, 1-102(3). See Leavings v. Mills, 2004 Tex. App. LEXIS 7783
(Aug. 26, 2004) (case discussed supra in § 112.12[2]). The court interpreted a retail installment contract that
contained the holder rule language (although the court does not cite to the holder rule itself). The court
acknowledges that under this language the transferee takes the instrument subject to the purchasers claims
and defenses. Practical Hint: Because the court also held that the retail installment contract and completion
certificate, together, constituted the note and that it was not a negotiable instrument, the rights of the parties
would be no different whether or not the note contained the holder rule language. The transferee of the
non-negotiable instrument was not a holder and therefore could not be a holder in due course, and would
therefore be subject to the purchaser's claims and defenses under the Code or revised Code, irrespective of
whether the note contained the holder rule language.
(n22)Footnote 18. See Antuna v. Nescor, 2002 Conn. Super. LEXIS 1003 (Apr. 1, 2002) . The court,
after noting that the F.T.C. rule mandates inclusion of the provision that it is subject to all claims and defenses, observes that the rule is designed to "prevent the seller of goods from cutting off the consumer's right
to assert claims and defenses against the seller's assignee...Its inclusion alters the content of the contact between the consumer and the holder of the consumer credit contract to protect consumers from the holder-in-due course doctrine." See Reagans v. Mountainhigh Coach Works, Inc., C.A., 2006 Ohio 423, at *P19
(Ohio Ct. App. 2006). The court explained that "the Rule does not create new rights or defenses. The words
'Claims and Defenses' which must appear in the Notice are not given any special definition...The phrase
simply incorporates those things which, as a matter of other applicable law, constitute legally sufficient
claims and defenses in a sales transaction. Appropriate statutes, decisions, and rules in each jurisdiction will
control, and the pertinent rules of law and equity, including rules of evidence, procedure, and statutes of limitations, will continue to apply." On appeal, the
Supreme Court, 881 N.E.2d 245, 252, 253 (Ohio 2008) ,
affirmed the judgment of the lower appellate court; it repeated the statement in the lower appellate court that
the FTC rule does not create new rights or defenses, and further held that "...under the rule, the 'consumer
may not assert [against] the creditor any rights he might have against the seller for additional consequential
damages and the like.' (citations omitted) The court quoted from 2 White & Summers, Uniform Commercial
Page 13
5-119 Banking Law § 119.05
Code (4th ed.1995), 189, Section 17-9, that "[E]ven if the buyer rejects [goods] and proves substantial damages, the maximum exposure of the creditor under the FTC rule is the amount already paid by the debtor."
(n23)Footnote 18.1. See Glovier v. Barton Homes, LLC, 452 F. Supp. 2d 657 (D. La. 2006) . The court
explaind that claims asserted within the meaning of the Holder Rule notice against the holder arise under
state law (in this case, Louisiana law). The Holder Rule only provides that the claims are not eliminated
where there is an assignment of the consumer credit contract to a person who otherwise could be a holder in
due course and therefore cut off claims or defenses that the consumer could assert against the original holder.
Accordingly, the court also held that the FTC Holder Rule does not create a federal private right of action
and does not give rise to federal question jurisdiction. With respect to this last point on federal jurisdiction
where the Holder Rule is in issue, see also Frischkorn v. Lake County Chrysler, Inc., 2006 U.S. Dist. LEXIS
74541 (D. Ohio 2006) .
(n24)Footnote 19. Ford Motor Credit Co. v. Morgan, 536 N.E.2d 587 (Mass. 1989) . See Carter v.
Atchley Ford, Inc., 2002 U.S. Dist. LEXIS 6095 (D. Neb. Feb. 20, 2002) . A car purchaser signed a retail installment agreement for the purchase of a car; the agreement was assigned to a finance company. The court
cited Ford Motor Credit Co. v. Morgan for the proposition that the "function of the rule is to allow consumers to stop payments, and, in limited circumstances...where equity requires, to provide for a return of monies
paid." Consumers cannot "obtain an affirmative recovery from a creditor." Therefore, the claim against the
finance company for violation of the Truth in Lending Act, 15 U.S.C.S. § 1601 et seq ., and the Nebraska
Consumer Protection Act, Neb. Rev. Stat. § 15-1601 et seq ., were dismissed. The consumer also alleged violations of the federal Computer Fraud Act, 18 U.S.C.S. § 1030 et seq . asserting that the defendants accessed
her credit files without her consent. This claim was independent of any claim under the retail installment
agreement; therefore, the finance company's motion to dismiss this claim was denied as material factual
questions existed as to whether it was a "violator" under the Act. In Johnson v. Long Beach Mortgage Loan
Trust 2001-4, 451 F. Supp. 2d 16 (D.D.C. 2006) , the court (in a footnote that is dicta because the court had
already concluded that the Holder Rule did not apply because the contract at issue was not a "consumer credit contract" as defined in the Rule) cited Ford Motor Credit Co. v. Morgan for the principle that the Holder
Rule does not afford an affirmative right of recovery. See Reagans v. Mountainhigh Coach Works, Inc.,
C.A., 2006 Ohio 423, at *P15-*P18 (Ohio Ct. App. 2006). The court held that the substance of the rule
limits the consumer to a refund of monies paid under the contract, in the event that an affirmative money recovery is sought...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 consumer [cannot] receive from the creditor an affirmative recovery which exceeds the
amounts of money the consumer has paid in...The limitation on affirmative recovery does not
eliminate any other rights the consumer may have as a matter of local, state, or federal statute...If a larger affirmative recovery is available against a creditor as a matter of state law, the
consumer would retain this right.
On appeal, the
Supreme Court, 881 N.E.2d 245 (Ohio 2008) , affirmed the judgment of the lower appellate court and acknowledged that the FTC notice limited the buyer's monetary recovery against the bank
to the amount paid by the buyers under the contract; the creditor's maximum exposure is the amount already
paid by the debtor. The Supreme Court further held that, based upon this principle of limited liability under
the Holder rule, that the lender-bank could not have derivative liability to the buyer for the buyers' judgment
against the seller for treble damages and attorney fees based upon the seller's misconduct under the Ohio
Consumer Sales Practices Act, Ohio Rev. Code Ann. 1345.01 et seq.
(n25)Footnote 20. Crews v. Altavista Motors, Inc., 65 F. Supp. 2d 388 (W.D. Va. 1999) . The facts
show that the buyers of a truck claimed that the dealer reneged on an agreement to provide a $500 rebate and
Page 14
5-119 Banking Law § 119.05
would only give the rebate if they signed a new Retail Installment Sales Contract at a higher annual percentage rate. They would not do this, as the new rate meant the interest would exceed the rebate. Since the consumer did not seek rescission of the contract, kept the truck and continue to use it, it obviously has value.
Further, their claims are not so large that they would exceed the amount of the debt. Therefore, they could
not maintain the action, affirmatively, for recover of funds from the creditor. See Schauer v. General Motors Acceptance Corp., 819 So. 2d 809 (Mar. 20, 2002) . The court cited Crews v. Altavista Motors, Inc. approvingly. Under the facts of this case, however, the consumer's claims against the finance company were
dismissed in that the consumer did not satisfy the burden of showing a substantial breach by the seller. The
consumer did not allege that he made payments to the finance company, or that "his claim was so large that it
exceeded the remainder of any debt owed to [the finance company], we do not believe he alleged the rare
situation where he could use this rule as a sword..." The court did reverse the lower court's dismissal of the
consumer's claim under the Florida Deceptive and Unfair Trade Practices Act, Fla. Stat. ch. 501.203(c), in
that the consumer alleged facts sufficient to show a violation of the Act by finance company, in that it willfully harassed him with respect to collection of the debt.
The court in Comer v. Person Auto Sales, Inc., 368 F. Supp. 2d 478 (M.D.N.C. 2005) , reviewed the decisions in Crews v. Altavista Motors, Inc., Ford Motor Credit Co. v Morgan, and Beemus v. Interstate National Dealer Services among others, and concluded that it is "persuaded...that to find the FTC Holder Rule
available to consumers without the limitations found by courts such as Morgan and Crews is to make the
creditor an absolute insurer or guarantor of the seller's performance...such a liability [is] contrary to the apparent purpose of the FTC Holder Rule...this court finds that a plaintiff's affirmative claims against a creditor
are limited." The court rejected the rule in Beemus v. Interstate National Dealer Services specifically referring approvingly to the dissent in that case. See Eromon v. Grand Auto Sales, Inc., 351 F. Supp. 2d 825
(N.D. Ill. 2004) (a plaintiff can state a claim against the holder of a note, under the holder rule, "where the
seller's breach would justify rescission and restitution.").
In Eromon v. Grand Auto Sales, Inc., 2004 U.S. Dist. LEXIS 15076 (N.D. Ill. Aug. 4, 2004) the consumer
entered into a contract to purchase a car that was assigned to a bank. The consumer sought damages for violations of the federal and state odometer laws. The court notes that under the holder rule a plaintiff may state
a claim against the holder of a note under circumstances where the seller's breach is so substantial that rescission and restitution are justified. Such a situation is present where there is a misrepresentation as to the
mileage on a car. Further, the court indicates that, even if the breach is not so substantial, the consumer is not
limited to only asserting a defense to payment if the consumer can prove that the assignee actually participated in the alleged scheme.
See Boulds v. Chase Auto Fin. Corp., 266 S.W.3d 847 (Mo. Ct. App. 2008) (facts discussed above in §
119.04[1]). The court also permitted a claim against the holder/assignee of a retail installment contract (for
the purchase of an automobile) for rescission of the contract on the ground of fraud based upon the consumer's claim that the seller failed to disclose the true state of the car. The court held that this claim could be asserted against the holder. Editor's Note: It is not totally clear that this holding was made with respect to the
FTC holder rule because the suit was also brought under the state statute that, similar to the holder rule, permit's a consumer to raise defenses against a holder that the consumer would have against the seller/assignor;
the court held that the affirmative claim of rescission could be brought against the holder, interpreting the
state statute. Notwithstanding these comments, this author thinks that the decision was intended by the court
to be equally applicable under the state statute and FTC holder rule. In support of this comment, is the statement by the court that under the holder rule the holder is put in the shoes of the seller.
(n26)Footnote 21. Lozada v. Dale Baker Oldsmobile, Inc., 91 F. Supp. 2d 1087 (D. Mich. 2000) . The
court cited to other cases that support the same proposition, that the F.T.C. rule contemplates that a consumer
can assert a claim affirmatively and recover damages where under the facts a recission is not warranted. In
Brooks v. O'Connor Chevrolet, Inc., 2003 U.S. Dist. LEXIS 19001 (N.D. Ill. Oct. 23, 2003) the plaintiff
Page 15
5-119 Banking Law § 119.05
signed a Retail Installment Contract for the purchase of a car with the dealer; the Contract was assigned to a
finance company. Plaintiff defaulted and the finance company repossessed the car. In her action against the
dealer and finance company, plaintiff alleged that they violated the Illinois Consumer Fraud and Deceptive
Business Act by fraudulently concealing information with respect to the history of the car (that it had been
previously rented and it was involved in an accident). Plaintiff argues that the finance company is liable under the FTC Holder Rule. The court held that the assignee (finance company) can only be liable if its "fraud
is active and direct." The finance company was held not liable under the facts of the case in that plaintiff did
not provide evidence that it "directly or actively committed any fraud against her..." (it had no knowledge of
the allegations the car was a rental and involved in an accident). In Associates Home Equity Servs. v. Beatrice Troup, 778 A.2d 529 (N.J. Super. App. Div. 2001) , the court, in a footnote, stated that "there is some
debate respecting the level of recovery under the Holder Rule when the consumer asserts an affirmative
claim against the creditor." The court then cites Crews v. Altavista Motors, Inc. and Lozada v. Dale Baker
Oldsmobile, Inc. However, the court does not further address the issue, stating that on the appeal the court
only was required to address whether the Holder Rule applied, but not to define the remedy of the consumer
if the Rule applied.
(n27)Footnote 22.
Beemus v. Interstate Nat'l Dealer Servs., 823 A.2d 979, 2003 PA Super 177 (Pa.
Super. Ct. 2003) . The court's rationale, in brief, is that the Holder Rule is unambiguous and does not, on its
face, limit the type of claims or defenses that a consumer may assert. The court stated that because the rule is
unambiguous it need not resort to the FTC Statement to explain this plain language. Therefore, the court
dismissed any relevance to the FTC Statement, Preservation of Consumers' Claims and Defenses, 40 Fed.
Reg. 53,506 (Nov. 18, 1975) (which is cited at the beginning of this subsection) that refers to affirmative action only being available where rescission is justified because the breach by the seller is substantial. The
court, instead, partially relies upon an F.T.C. opinion letter (F.T.C. Staff Opinion Letter, 9/25/99) that opines
that the assignee steps into the assignor's shoes and is subject to all claims and defenses, which are not limited only if the consumer receives no value.
(n28)Footnote 23. Costa v. Mauro Chevrolet, Inc., 390 F. Supp. 2d 720 (N.D. Ill. 2005) . In support of
this position, the court cited to the FTC official commentary that provides that
Consumers 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. In a case of non-delivery, total failure of performance, or the like, we believe that the
consumer is entitled to a refund of monies paid on account. 40 Fed. Reg. at 53,527 (1975).
The court also cited the decision in Irby-Greene v. M.O.R., Inc., 79 F.Supp.2d 630 (E.D. Va. 2000) , observing that the judge in that case performed an extensive survey of all cases (federal and state) concluding
that most courts reached the conclusion that "the primary purpose of the [FTC Holder] clause is to provide a
defense to claims brought by the creditor; any affirmative use of the clause has generally been limited to the
rare situation when the seller's breach renders the transaction practically worthless to the consumer." (sic)
See also Rollins v. Drive-1 of Norfolk, Inc., 2006 U.S. Dist. LEXIS 61197 (D. Va. 2006) . The court also
cited approvingly, and followed, the decision in Irby-Greene v. M.O.R., Inc. The issue addressed by the court
in Rollins was whether the consumer is required to assert a rescission claim to be able to invoke the affirmative use of the Holder Rule. Referring to the commentary to the Holder Rule (40 Fed. Reg. 53,527 (1975)) ,
the court held under the commentary it is not mandated that the consumer specifically request rescission and
restitution; it is sufficient that a court believes that these remedies are justified. The court explained that its
holding was "not simply careful parsing of the language, but instead [was] the direct reading of the words
used in the commentary."
Page 16
5-119 Banking Law § 119.05
This issue was addressed in Bellik v. Bank of Am., 373 Ill. App. 3d 1059 (Ill. App. Ct. 2007) . The court
affirmed the rule in Illinois that under the Holder Rule an affirmative action against an assignee can only be
maintained "where the seller's breach is so substantial that rescission is warranted." The court cited the Illinois Supreme Court decision in Jackson v. South Holland Dodge (cited earlier in this subchapter) in support
of this ruling. The court also held that the assignee of a retail installment contract does not have a duty to inquire as to whether the assignor has performed the terms of the agreement prior to accepting the assignment.
(n29)Footnote 23.1. In State ex rel. Stenberg v. Consumer's Choice Foods, Inc., 755 N.W.2d 583 (Neb.
2008) . The court relied upon the decision in Riggs v. Anthony Auto Sales, Inc., 32 F. Supp. 2d 411 (W.D.
La. 1899) , where that court stated that it is not the purpose of the holder rule to permit a consumer to recover
more than he has paid. The court quoted from Riggs, as follows: "A rule of unlimited liability would place
the creditor in the position of an insurer or guarantor of the seller's performance. This court does not construe
this to be the purpose of the FTC rule. Accordingly, this court holds that a creditor's derivative liability for
seller misconduct under the FTC rule is limited to the amount paid by the consumer under the credit contract... . [E]ach lender's liability is limited to the amount paid to it by that plaintiff."
(n30)Footnote 24. Green v. Levis Motors, Inc., n.7 supra. The court indicates that its holding is consistent with Courts of Appeal in the Seventh and Eleventh Circuits, citing Taylor v. Quality Hyundai, Inc.,
150 F.3d 689 (7th Cir. 1998) and Ellis v. General Motors Acceptance Corp., 160 F.3d 703 (11th Cir. 1998)
. See Javorsky v. Freedom Driving Aids, Inc., n.5 supra. The court, citing another Seventh Circuit Court of
Appeals case, Walker v. Wallace Auto Sales, Inc., 155 F.3d 927 (7th Cir. 1998) , stated that "...in the context of T.I.L.A. claims, the federal courts have rejected that the Holder Rule provides for enforcement of a
contract against the assignee. That is, T.I.L.A.'s limitation of assignee liability trumps the Holder Rule..." An
assignee cannot be liable for the T.I.L.A. claims that are asserted against the original seller "...unless the violation is apparent on the face of the documents assigned." The court also held that the assignee could not be
liable for claims asserted against the original seller under the Illinois Consumer Fraud and Deceptive Business Practices Act. See Herrara v. The North & Kimball Group. Inc., n.5 surpa. Recognizing this rule, the
court found that the TILA violations "...may have been apparent on the face of the assigned documents..." so
that the plaintiff stated a claim that could not be dismissed on the motion to dismiss.
See Eromon v. Grand Auto Sales, Inc., 2004 U.S. Dist. LEXIS 15076 (N.D. Ill. Aug. 4, 2004) . The court
held that TILA "expressly limits the liability of assignees to those defects apparent on the face of the loan
documents" (citation omitted). An assignee is protected from liability if it does not know of the alleged TILA
violation (it is not apparent on the face of the document). In effect, in such circumstances, as the court states,
the Holder Rule is "trumped," and the consumer cannot recover from the assignee. See also Vickers v. Interstate Dodge, 2004 La. App. LEXIS 2302 (Sep. 29, 2004) (assignee was not liable under TILA for violations that resulted from forged initials on the disclosure agreement--that accompanied the note--on the line
for choosing credit life insurance, because the assignee did not know of the forgery and it was not apparent
on the face of disclosure documents); Murry v. America's Mortgage Banc, Inc., 2004 U.S. Dist. LEXIS
12818 (N.D. Ill July 9, 2004) (court noted that the provision in TILA giving a consumer a right to rescind a
transaction as against any assignee "effectively abrogates the holder in due course rule, making any assignee
subject to all claims or defenses that the consumer could assert against the creditor unless the assignee" can
demonstrate that the TILA violation could not be ascertained on the face of the documentation-in this case, a
violation respecting an itemization of the amount financed).
(n31)Footnote 25. 15 U.S.C. § 1601 et seq . The violation was Regulation Z, 12 C.F.R. § 226.18(c)(iii),
with respect to itemization of the amount financed and disclosure of amounts paid to other persons on the
consumer's behalf. The court of appeals reversed the district court and held that the creditor-seller violated
Regulation Z by not itemizing an "upcharge."
(n32)Footnote 26. 15 U.S.C. § 1641(a). This section is referred to as the "good faith safe harbor" provision.
Page 17
5-119 Banking Law § 119.05
(n33)Footnote 27. Hayner v. Old Kent Bank, 2002 Mich. App. LEXIS 190 (Feb. 12, 2002) (unpublished opinion). The rule places the duty to put the notice on the loan agreement only on the seller; it does
not create a direct duty on the bank to do so. Since a "seller" is defined as a person who sells or leases goods
or services to a consumer, in the ordinary course of business, 16 C.F.R. § 433.1(j), the bank, to whom the log
home kit seller referred the buyer, was not a "seller." Accordingly, the consumer's claim against the bank
asserting that it violated the Michigan Consumer Protection Act, Mich. Comp. Law § 445.901, et seq . by not
including the F.T.C. notice in the note, was dismissed because the bank had no duty.
(n34)Footnote 28. 40 Fed. Reg. 53,525 (1975) . See also 40 Fed. Reg. 53,506, 53,508 (1975) , which
give the following example of facts that constitute a referral:
After a buyer selects an item for purchase and requests credit terms, the seller may refer the
buyer to a local loan outlet. Referral can and does include accompanying the buyer to the loan
office, remaining present while applications are processed and accepting a loan proceeds check
indorsed to both seller and buyer.
See Vultaggio v. Afzali, 2005 Ohio 5902 (Ohio Ct. App. 2005) . As discussed previously, no business
arrangement existed between the seller of a vehicle and borrower because the lender before making the loan
received the vehicle title from the seller and then sent the loan proceeds check to the seller.
(n35)Footnote 29.
41 Fed. Reg. 34,594, 34,595 (1976) .
(n36)Footnote 30. 16 C.F.R. § 433.1(f).
(n37)Footnote 31. 16 C.F.R. § 433.1(g).
(n38)Footnote 32.
41 Fed. Reg. 34,595 (1976) .
(n39)Footnote 33. Id. at 34,596.
(n40)Footnote 34. Associates Home Equity Servs., Inc. v. Troup, n.6 supra. See Vultaggio v. Afzali,
2005 Ohio 5902 (Ohio Ct. App. 2005) . The court cited to Assocs. Home Equity Servs. v. Troup, 343 N.J.
Super. 254, 778 A.2d 529 (N.J. App. Div.2001) , for the suggestion that notwithstanding a lender may incur
liability under the rule even though the holder rule language is not incorporated into the contract. The court
stated that "A financial institution may not 'evade the remedial reach of the FTC holder rule simply by omitting the required notice.' " Editor's Note: This statement is dicta in the case, as the court found that the
Holder Rule did not apply because the transaction was not a Purchase Money Loan transaction or a financed
sale, the two circumstances covered under the Rule.
(n41)Footnote 35. 16 C.F.R. § 433.2.
(n42)Footnote 36. Crisomia v. Parkway Mortgage, Inc. (In re Crisomia), 2001 Bankr. LEXIS 1469
(Bankr. D. Pa. 2001) . The court also cited Vietnam Veterans of America, Inc. v. Guerdon Industries, Inc.,
644 F. Supp. 951 (D. Del. 1986) and Armstrong v. Accrediting Council for Continuing Education & Training, 832 F. Supp. 419 (D.C. Cir 1993) in support of this holding. The court noted that in one case, Gonzalez
v. Old Kent Mortgage Co., 2000 U.S. Dist. LEXIS 14530 (E.D. Pa. Sept. 21, 2000) the court held that the
notice provision could be implied as a contract term. The court in Crisomia v. Parkway Mortgage, Inc., rejected this decision stating that it "goes beyond the regulatory scheme in allowing a private right of action
where none exists." See Pratt v. North Dixie Manufactured Hous., Ltd., 2003 Ohio 2363 (Ohio Ct. App.
2003) . The consumer signed a contract (note on a mobile home) that was assigned to a finance company.
The consumer alleged that the assignee was liable for violation of the Ohio Consumer Sales Practices Act.
The contract did not contain the "preservation of claims and defenses clause" required by the Holder Rule.
The court held that the assignee could not, therefore, be held "derivatively liable..." for violation of the Act.
Page 18
5-119 Banking Law § 119.05
See Fifth Third Bank v. Roberts, 55 U.C.C. Rep. Serv. 2d 378 (Ohio Ct. App. 2004) . The court recognized
the issue--can a "financial institution can be held liable for the derivative actions of the seller where the FTC
holder rule has been wrongfully omitted from a contract"--however, the court did not address the issue or
provide an opinion, in that the obligation involved in the suit was a lease that did not fit the definition of a
consumer credit contract, so that the holder rule was inapplicable in this case, regardless.
(n43)Footnote 37. Williams v. National School of Health Technology, 836 F. Supp. 273 (E.D. Pa.
1993) . See Hancock v. HomEq Servicing Corp., 2007 U.S. Dist. LEXIS 31051, at *35 (D.D.C. 2007) ,
where the court cited and adopted the rule set forth in Williams v. National School of Health Technology that
the Holder Rule "does not afford plaintiffs any relief and does not grant private parties a cause of action for
the failure to include the notice. Enforcement of the Federal Trade Commission Act and therefore the FTC
Holder Rule is left to the FTC."
(n44)Footnote 38.
Whittington v. Patriot Homes, Inc., 2008 U.S. Dist. LEXIS 29760 (W.D. La. 2008) .
(n45)Footnote 39. Stoudt v. Alta Fin. Mortg., 2009 U.S. Dist. LEXIS 19297 (E.D. Pa. 2009) . The court
cited In re Barker, 306 B.R. 339 (Bnkr. E.D. Ca. 2004) .
U.C.C. § 9-404(c) provides that
This section is subject to law other than this division which establishes different rule for an
account debtor who is an individual and who incurred the obligation primarily for personal,
family, or household purposes.
U.C.C. § 9-404(d) provides that
In a consumer transaction, if a record evidences the account debtor's obligation, law other
than this division requires that the record include a statement to the effect that the account
debtor's recovery against an assignee with respect to claims and defenses against the assignor
may not exceed amounts paid by the account debtor under the record, and the record does not
include such a statement, the extent to which a claim of an account debtor against the assignor
may be asserted against an assignee is determined as if the record included such a statement."
U.C.C. § 9-404, Official Comment 4 states that
Consumer Account Debtors; Relationship to Federal Trade Commission Rule. Subsections
(c) and (d) also are new. Subsection (c) makes clear that the rules of this section are subject to
other law establishing special rules for consumer account debtors...Subsection (d) 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 (the "Holder-in-Due-Course Regulations" ). Under subsection (d), a consumer account debtor has the same right to an affirmative recovery from an assignee of such a record as the consumer would have had against the assignee had the record contained the required notice."
(n46)Footnote 40.
Turner v. Cit Group/Sales Financing, Inc., 154 Fed. Appx. 2, 2005 U.S. App.
LEXIS 21048 (9th Cir. Sept. 26, 2005) . See Whittington v. Patriot Homes, Inc., 2008 U.S. Dist. LEXIS
29760 (W.D. La. 2008) .
Page 19
5-119 Banking Law § 119.05
(n47)Footnote 41. A new added definition of "Consumer Transaction" is added in the 2002 Amendments. "Consumer transaction" means a transaction in which an individual incurs an obligation primarily for
personal, family, or household purposes. U.C.C. § 3-103(a)(3) (2002 Amendments).
(n48)Footnote 42. U.C.C. § 3-305(e) and (f) (2002 Amendments).
(n49)Footnote 43. U.C.C. § 3-305, Proposed Comment 7 (2002 Amendments).
(n50)Footnote 44. Ross v. Thousand Adventures of Iowa, Inc., 2006 Iowa App. LEXIS 752 (Iowa Ct.
App. 2006) . In McKeown v. Gibson, 2008 U.S. Dist. LEXIS 52634 (D.S.C. 2008) , the court acknowledged
that there is no federal-question jurisdiction just because a contract for consumer credit includes a notice under the Holder Rule where the claims do not involve the Holder Rule but resolve around contract actions that
arise under state law.
(n51)Footnote 45.
44 Fed. Reg. 65,771 (1979) .
(n52)Footnote 46. Washington Fin. Reports No. 45 (Nov. 19, 1979), Bureau of National Affairs, Inc.,
Washington, D.C.
(n53)Footnote 47.
44 Fed. Reg. 65,771 (1979) .
(n54)Footnote 48. Id.
(n55)Footnote 49. Id.
(n56)Footnote 50. F.T.C. Advisory Ltr. (Oct. 12, 1976) Consumer Credit Guide (CCH) P 98,284.
(n57)Footnote 51. See § 159.03[4] infra for a further discussion of these issues and a listing of states
that fit into the specific categories.
(n58)Footnote 52. Ch. 159, "Preservation of Consumers' Claims and Defenses--FTC Trade Regulation
Rule", Banking Law (Matthew Bender).
(n59)Footnote 1. See supra § 119.02[2].
(n60)Footnote 2. See § 119.05[1], n.8 supra.