Threatening Clouds Over TIL

Much as we moan about compliance examinations and regulatory burden in general, the biggest dose of it seems to come from the courts. The most recent blow is a serious one and involves the definition of creditor. The bottom line is a ruling on which party is liable in dealer-originated loans and the ruling could shake the foundations of credit.

Borrower bought a car, and arranged for financing through the dealer. As any lender that purchases dealer paper knows, there are two ways for the customer to get a loan. First, they can shop around to creditors, including their friendly bank, for a loan and then come back to the dealer with loan papers in hand. Or, they can apply for their credit to the dealer. The dealer actually closes the loan and sells it immediately to a third party, such as a finance company or a bank. Banks are currently facing unpleasant scrutiny involving this practice in the context of lending discrimination. Now, however, the U. S. federal courts have tossed in a Regulation Z whammy.

According to the "wisdom" of the Fifth Circuit Court of Appeals, the dealer that made and sold the loan and to whom the credit is originally payable is not the creditor. Instead, the car dealer is a mere arranger of credit. With this reasoning, guess who is holding the liability bag? That's right: the bank! Now, here's what is truly terrifying about this decision. As the purchaser of dealer paper, the bank thinks that it is buying subject to the condition that it is liable only for any violations of TIL that are apparent on the face of the documents. But under this ruling, the bank purchasing the dealer paper is not the purchaser but the creditor. That makes the bank liable for anything - including hidden things - that the dealer did to violate Regulation Z.

Is any bank purchasing dealer paper totally 100% confident that the dealer included and disclosed all of the fees that they charged and did so properly on the TIL disclosure? After this ruling, the purchasing bank may be liable for any such invisible omissions.

Here's what the court actually did. It decided that the car dealer "assigns" loans but does not make them. The purchasing entity is the one that lends the money to the consumer to enable him to purchase a vehicle. By deciding that the car dealer assigned rather than sold the paper, the court changed the entire meaning of Regulation Z.

The court supported their argument that it was the purchasing creditor, not the originating car dealer, that would have the right to repossess the car if the purchaser defaulted.

The court looked at how the money flows, using the legal reasoning of "show me the money." The court appears to have ignored the careful foundation laid in Regulation Z to look to the contract for determining the creditor and the nature of the credit obligation.

Also disturbing is the reliance that the court placed on an earlier case, Ford Motor Credit Co. V. Cenance, 452 U.S. 155 (1981). Note the date of that case, because the date is critical. That case was decided on facts and a regulation that preceded "Simp" - the major revision to the Truth in Lending Act and Regulation Z.

Alan Dombrow, whose memory is long and deep regarding anything pertaining to Regulation Z, observes that before "Simp" took effect, the arranger of credit was considered the creditor in some jurisdictions but not others, regardless of to whom the obligations was originally payable. Thus, the same arrangement had different consequences in different jurisdictions.

In the process of revising Truth in Lending, Congress worked on this issue with the goal of making Truth in Lending more uniform. Congress introduced the concept of basing the definition of credit on the entity to whom the obligation was initially payable. Although this became law in 1980, it did not take effect until October 1982. Thus, the law on which the Banner case relies (Ford Motor v. Cenance) is different from the law on which Banner should have been decided.

Copyright © 1998 Compliance Action. Originally appeared in Compliance Action, Vol. 3, No. 16, 12/98