1976, August, Pg. 1076. The Holder in Due Course Rule; A Practical Guide to Compliance.

• Author: by F. Kelly Smith

5 Colo.Law. 1076

Colorado Lawyer

1976.

1976, August, Pg. 1076.

The Holder in Due Course Rule; A Practical Guide to Compliance

1076Vol. 5, No. 8, Pg. 1076The Holder in Due Course Rule; A Practical Guide to Complianceby F. Kelly SmithF. Kelly Smith is an attorney with the Denver Regional Office of the Federal Trade Commission. 1077The Federal Trade Commission (the Commission) promulgated the final draft of its Trade Regulation Rule entitled "Preservation of Consumers' Claims and Defenses" (the Rule) on November 14, 1975.(fn1) The Rule, which is commonly called the Holder in Due Course Rule, became effective on May 14, 1976. Because the Rule affects most consumer-financed transactions, it has been the subject of numerous inquiries from lawyers, businessmen, and the general public.

This article answers the most frequently asked questions the Commission staff has encountered. The analysis is only that of the author, supported by Commission staff publications,(fn2) informal public inquiry responses, and numerous staff briefings. These views have not been formally adopted by the Commission and should, therefore, not be construed to alter or amend the original text of the Rule or the Statement of Basis and Purpose published with it.

TEXT OF THE RULE

§ 433.1 Definitions(a) Person. An individual, corporation, or any other business organization.

(b) Consumer. A natural person who seeks or acquires goods or services for personal, family, or household use.

(c) Creditor. A person who, in the ordinary course of business, lends purchase money or finances the sale of goods or services to consumers on a deferred payment basis; provided, such person is not acting, for the purposes of a particular transaction, in the capacity of a credit card issuer.

(d) Purchase money loan. A cash advance which is received by a consumer in return for a "Finance Charge" within the meaning of the Truth in Lending Act and Regulation Z, which is applied, in whole or substantial part, to a purchase of 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.

(e) Financing a sale. Extending credit to a consumer in connection with a "Credit Sale" within the meaning of the Truth in Lending Act and Regulation Z.

(f) Contract. 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.

(g) Business arrangement. 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.

(h) Credit card issuer. A person who ex-

1078tends to cardholders the right to use a credit card in connection with purchases of goods or services.(i) Consumer credit contract. Any instrument which evidences or embodies a debt arising from a "Purchase Money Loan" transaction or a "financed sale" as defined in paragraphs (d) and (e).

(j) Seller. A person who, in the ordinary course of business, sells or leases goods or services to consumers.

§ 433.2 Preservation of Consumers' Claims and Defenses, Unfair or Deceptive Acts or PracticesIn connection with any sale or lease of goods or services to consumers in or affecting commerce as "commerce" is defined in the Federal Trade Commission Act, it is an unfair or deceptive act or practice within the meaning of Section 5 of that Act for a seller, directly or indirectly, to:

(a) Take or receive a consumer credit contract which fails to contain the following provision in at least ten point, bold face, type:

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.

or, (b) Accept, as full or partial payment of such sale or lease, the proceeds of any purchase money loan (as purchase money loan is defined herein), unless any consumer credit contract made in connection with such purchase money loan contains the following provision in at least ten point, bold face, type:

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.

GENERAL BACKGROUND OF THE RULE

Since the end of World War II credit institutions have increasingly become an important partner in the consumer goods and services market.(fn3) Without such institutions' extension of credit, many consumers would be unable to buy the goods and services they need or want. Businesses would also find it difficult to survive in the competitive marketplace without the credit institutions. Indeed, in many cases the same credit institution finances both the consumer's purchases and the businessman's inventory.

The commitment to the use of consumer credit has not occurred without abuse. The particular abuse which the Commission addressed at the beginning of its rulemaking proceedings in 1971(fn4) was the inequality of obligations between sellers and buyers generated by operation of the holder in due course doctrine.(fn5)

Under the common law of contracts, the seller and buyer are mutually bound to certain standards of performance. The buyer is obligated to pay for goods or services, whereas the seller is obligated to assure satisfactory performance of those goods or services by the terms of explicit or implicit warranties. But when buyer and seller contract for goods and services using certain credit devices, the balance of obligations normally created

1079by the contract may be destroyed.The seller may insulate himself from his obligations to the buyer by participating in either of two general categories of consumer credit transactions. In the first type of transaction, the seller is the initial creditor. He may use an installment sales contract, or, if permitted, a promissory note executed in conjunction with the sales contract. When the seller assigns or discounts the contract or promissory note to a third-party good...