Can defect claims be asserted against the finance company holding a retail installment contract?

Q.  I bought a used car with a warranty. I signed a retail installment contract, which the dealer assigned to a finance company.  I returned  the car to the dealer because it broke down within the warranty period and the dealer could not make it run. He said that it needed a new engine, which would cost more than the car was worth.  I have all of the problems documented. The finance company is now treating it as a repossession and demanding that I pay the deficiency.  What are my rights?

A.  You have a defense to repayment.  

At common law, the assignee of a nonnegotiable chose in action (such as a retail installment contract for the purchase of goods and services) takes subject to claims against the creditor prior to assignment.  This rule did not apply if a negotiable instrument, such as a note, was given in payment. A person taking the note before it was overdue and without notice of defenses could claim holder in due course status. In addition, banks began including provisions in retail installment contracts that waived the assertion of claims and defenses against the holder.

To prevent consumers from being held liable for defective goods and services, the Federal Trade Commission issued a regulation in 1975 which negates holder in due course status in any case where a contract with a consumer for the sale of goods or services is assigned, or the seller of the goods or services arranges financing or refers the consumer to the financing source, most claims for defective performance can be asserted against any holder of the contract. 16 C.F.R. part 433.

The regulation requires that consumer credit contracts contain one of two notices. The first, in 16 C.F.R. §433.2(a), applies to assigned contracts and states:

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.

The second, in 16 C.F.R. §433.2(b), applies to cases where the seller “(1) refers consumers to the creditor or (2) is affiliated with the creditor by common control, contract, or business arrangement.” 16 C.F.R. §433.1(d). “Contract” includes “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.” 16 C.F.R. §433.1(f). “Business arrangement” means “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.” 16 C.F.R. §433.1(g). Thus, the second notice is required if the seller has referred two or more consumers to the creditor or has any sort of arrangement to facilitate financing through the creditor, such as form documents, advertising, or computer access.

The second notice provides:

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 WITH THE PROCEEDS HEREOF. RECOVERY HEREUNDER BY THE DEBTOR SHALL NOT EXCEED AMOUNTS PAID BY THE DEBTOR HEREUNDER.

Furthermore, the current version of Article 9 of the Uniform Commercial Code prevents evasion of these provisions by omission of the notice. 810 ILCS 5/9-404(d) provides:

(d) Omission of required statement in consumer transaction. In a consumer transaction, if a record evidences the account debtor's obligation, law other than this Article 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.

The official UCC comments make clear that this encompasses the FTC regulation:

4. 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. An “account debtor who is an individual” as used in subsection (c) includes individuals who are jointly or jointly and severally obligated. 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.

Thus, complaints against the seller may generally be asserted against the party financing the sale of goods or services, unless the consumers obtained the financing on their own.

The FTC regulation abrogating the holder in due course rule has met with some hostility from courts, and there are some older cases stating that the defect or problem had to be such as to warrant revocation of acceptance or rescission in order for it to be assertable under the FTC-required notice.  However, in 2012 the FTC issued an advisory opinion (2012 WL 12883292, May 3, 2012) stating that “consumers must have the right to recover funds already paid under the contract if such recovery is necessary to fully compensate the consumer for the misconduct—even if rescission of the transaction is not warranted,” and specifically disapproving the contrary decisions  as wrong. Most recent decisions give effect to the FTC opinion.

It is still necessary for the consumer to prove that the goods were in fact defective.  

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