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Payday Lending and the FTC Credit Practices Rule

posted by Adam Levitin

Why doesn’t payday lending violate the FTC’s Credit Practices Rule (16 C.F.R. 444.2)?  That’s what I’m trying to figure out.  

The Credit Practices Rule prohibits taking or receiving directly or indirectly an assignment of wages in most circumstances.  (None of the exceptions appear applicable to the payday lending context.) The FTC has gone after some payday lenders for taking a formal direct assignment of wages, but that's an usual term for payday loans. Rather, I'm more interested in the question of an indirect wage assignment. I think there's a pretty good case that a payday loan is an indirect assignment of wages:

  • A payday loan is called a “payday loan”—it’s designed to ensure repayment from the borrower’s wages;
  • the loan’s maturity is usually designed to match with pay periods;
  • usually the only “underwriting” is verification of the borrower’s employment;
  • the loan is “secured’ with either a post-dated check or authorization for an ACH debit with the date set for…payday.  

That sure looks to me like an indirect assignment of wages—the loan is designed to enable the lender to be repaid from the borrower’s wages without having to go to court and get a judgment and a garnishment order (i.e., a judicial wage assignment).  

I’m curious to hear readers thoughts on whether this sounds right or whether I’m missing something.  Please limit comments to the legal interpretation issue—I’m not looking to open a discussion on the merits of payday lending, just to understand if it violates the FTC Credit Practices Rule or if not, why not.  

Comments

If you read the whole rule, you will find that it contains three exceptions to the prohibition:

(3) Constitutes or contains an assignment of wages or other earnings unless:
(i) The assignment by its terms is revocable at the will of the debtor, or
(ii) The assignment is a payroll deduction plan or preauthorized payment plan, commencing at the time of the transaction, in which the consumer authorizes a series of wage deductions as a method of making each payment, or
(iii) The assignment applies only to wages or other earnings already earned at the time of the assignment.

Postdated checks are revocable by means of a stop payment (3)(i), and (3)(ii) allows for the timely ACH withdrawals.

I add that your description of loan maturity: "the loan’s maturity is usually designed to match with pay periods" would satisfy (3)(iii).

Jardinero1:

I don't think that 3(iii) is satisfied because the assignment is taken/received at the start of the pay period, not at the end, so the wages have not yet been earned.

As for 3(ii), it contemplates a series of deductions, not a single deduction. Most payday products are single payment, not installment. So I don't think 3(ii) does the trick.

3(i) might be the explanation, if you think a stop payment order is a revocation and "the assignment by its terms is revocable at the will of the debtor." Is it? I read the FTC CPR as requiring an express revocability clause, but that might be overreading. The payday contracts I have seen don't state anything one way or the other about revocability. In any event, a stop payment order is not a permanent cancellation of a check; it only last 6 months. Is that a revocation? 6 months and 1 day later, the lender can cash the check.

One can also do stop payment on an ACH, and ACH stop payments don't expire at 6 months (they used to but there was a NACHA rule change in 2010 to align NACHA rules with Reg E). Stop payment forms usually require that the ACH authorization be revoked in the manner provided for in the contract. I don't know if payday loan contracts say anything about this.

Adam, I think you're right. The postdated check or ACH authorization serves the same function as the classic wage assignment prohibited by the FTC rule, i.e. to insure payment from the borrower's wages in the event of default. I've also wondered about the prohibition on mandatory electronic transfers in Sec. 913 of the EFTA, with regard to ACH-based payday loans. As far as revocability, the typical payday loan contract provides that stopping payment on a check is a breach or a default. http://www.aocg.com/resources/NM1-CASH%20ADVANCE%20CONTRACT.pdf . I imagine loans secured by EFT payment have similar provisions.

I agree with Adam, but 3(i) does not stipulate that the revocation is permanent. Also, we know nothing of the particulars of the loan agreement. The agreement may stipulate how the assignment is revocable. Without reading the contract, we don't know.

On 3(iii), that would depend on how much pay the borrower has accrued, how far in arrears the borrower is paid and the value of the loan at the time of the assignment. For instance if a borrower wants 500 dollars and has already earned 700 dollars at the time of assignment then 3(iii) would be satisfied.

Alan,

In the contract, which you link to, I don't see an assignment. Nothing in the contract says that the loan coincides with a payroll period. It specifies, on page one, only that the loan is to be paid off, in cash, at a specific date in the future. Then, at the end of page two it requests a check made out on the day of the contract, not in the future. There is no postdate, and no reference to a pay period, so I don't think there is an assignment either.

If the check bounces, there is little the lender can do to collect on it, other than harass the check writer, because the loan specifies payment in cash. Most states stipulate that bounced checks must be written in direct exchange for goods or services in order for fraud or theft by check to occur. So there is no chance of prosecution there either. The top of page two describes the means the lender will pursue to collect on the loan, not the check.

A check is not an assignment of funds. UCC § 3-408; NIL § 187. Indeed, there is some case authority that assignment of bank accounts is impossible. Gibralter Realty Co. v. Mt. Vernon Trust Co., 276 N.Y. 353, 115 ALR 322 (1938); Deposit Protection Board v. Dalia [1994] 2 AC 367.
The previous commenter's allusion to revocability is also on point.

Interesting comments. Adam's argument does require looking to function rather than form. It is certainly true that the payday loan contract is not literally an assignment of wages in the hands of the employer, and the check or AH authorization is an order to pay, not an assignment of the bank's obligation to the borrower. Also, even if the contract engages the borrower not to stop payment on a check or prevent the electronic debit, the borrower could "revoke" the functional wage assignment by stopping the direct deposit of wages from the employer to the bank without violating the loan contract. Nevertheless, from the least sophisticated consumer standpoint, the borrower could easily have the impression that her directly deposited wages are automatically used to pay the loan if she does not pay the loan in cash. That is exactly the in terrorem effect of wage assignments that the FTC rule was enacted to prevent.

Alan,

One other thought: the check which is left with the lender does not necessarily correspond with the account where the wages are deposited. There is nothing, in the sample you provided, which says that must be the case.

Another question is how the demand for a check, at closing, impacts the overall validity of the loan contract. What consideration does the lender offer for the check? If the check bounces and the lender sues to collect on the loan, can the borrower say, "you can't sue me, just re-deposit the check you demanded from me at closing"?

Adam,

while there does seem to be a dearth of law on this, you might want to look at:

F.T.C. v. PayDay Financial LLC, 2013 WL 5442387 (D.S.D. Sept. 30, 2013 - CIV 11-3017-RAL)
"In Count IV, the FTC alleges that the Defendants violated the Credit Practices Rule by using an unlawful wage assignment clause in their loan contracts."

Of course there isn't a private right of action under the Credit Practices Rule so it is of limited use to individuals.

My point here, as Alan notes, is that the "indirect" language in the CPR suggests a functional analysis, and I think there's a pretty good functional case. Most of the responses so far point to formal issues on why it's not an assignment. I don't think that resolves the functional issue.

The FTC case cited by IgnatzEsq involves a formal wage assignment. What I'm questioning is what an "indirect wage assignment" means in the context of the CPR. The fact that a check is not an assignment for UCC purposes (or even under the NIL--wasn't that a prehistoric statute?) doesn't really answer whether there is an indirect assignment.

(1) It seems to me that the real problem here is the absence of private enforceability, which has resulted in a paucity of interpretations and case law. The FTC doesn't exactly have an unlimited enforcement budget or staff.

(2) As an extension to the "wages" issue, consider payday loans issued to senior citizens whose only income is Social Security... which are otherwise exempt from levies and most other seizures not related to back taxes. And, to make it even more fun, throw in a private pension...

What is an "indirect assignment" of wages? Maybe we are hunting a creature that does not exist.

if the payday loan is not an indirect assignment of wages, then what is?

Thanks Chris, but a real definition or some examples would help a layman like myself. The only example of a payday loan we have seen is the one provided by Alan White, above. Except for the word Payday at the top, there is nothing in it that suggests an assignment of wages. If the word payday was not at the top, would you think that any kind of assignment was made?

Functionally, a loan secured by an assignment would be low risk and would command a very low interest rate. The example provided by Alan charges 470 percent interest which is not suggestive of a secured loan, but an extremely high risk, unsecured loan.

Actually payday is relatively low risk. Loss rates (default rates aren't meaningful in this context) are around 5-6% for storefront lenders. Probably higher for on-line. The whole point of payday is that it is functionally secured by the right to draw on the borrower's bank account, which enables collection without the time and cost of obtaining a judgment. The APRs are sky high because of the annualization factor (~26x) and the high fixed or semi-fixed costs (funds, overhead) relative to the small loan size.

Many loans are secured by the right to draw on a borrowers bank account. I don't see how the right to draw on an account constitutes an assignment of wages, which I thought was the question.

The rates don't reflect an assessment of certainty of payment. As a counter example, in the insurance business, where I work, I obtain premium finance loans for some of my clients. The policy is assigned to the loan company and if the borrower misses a payment the loan company cancels the policy and retains the unearned premium which is refunded. The loan company never loses, even when the borrower defaults. These are typically small loans, ranging from 500 to 10,000 dollars and the interest charged on these secured loans ranges from 12 to 30 percent, with the small loans garnering the higher rates. The premium terms are typically 3 to 9 months. If a payday loan was secured by an assignment of wage, then I feel that the rates would be closer to that range.

In my experience, most employers now withhold at least one week's wages. Thus a paycheck dated on Friday covers work performed through the previous Friday, Saturday, or Sunday. Therefore, under exception 3(iii), noted in the first comment above, there is at least some money that the borrower has already earned and that is due to the borrower at the time the loan is made.

Very good question, and good comments by others. In this brief note, I raise two issues: (1) what, exactly, is an "assignment of wages," and (2) what did Congress mean by "indirectly"? The former question is the more interesting in this context.

First, a wage assignment is not an economic principle; it is a well-settled legal (or illegal) arrangement as a result of which a third party (i.e., other than the employer or employee) obtains rights *as against the employer*. Those rights include the notion that no other person may, by non-judicial means, cut off the assignee's ability to obtain payment once the employee has earned his wages. Quaere whether either of these elements is present in a payday-loan transaction. As others have pointed out, at most the creditor obtains a right to charge the employee's checking account (which, under the U.C.C., doesn't constitute an "assignment"), if the employee has funds in it, and if the employee hasn't stopped payment, and if the employee hasn't directed his paycheck to another bank. This doesn't seem much like an "assignment," even in economic substance.

A related and more academic question is the meaning of "indirectly." While Adam has thoughtfully suggested a possible meaning of "having similar economic effect," I think it means something else: effectuated by deceit or ruse. I think what Congress had in mind was a practice whereby creditors could require a debtor to have his wages paid to a third party under the creditor's control or in privity with the creditor who would pay the creditor first and then disburse to the debtor. The legislative history is not helpful here but these kinds of practices were common in the past. This is now actually an interesting scenario if a payday lender requires, as a condition of making an advance, that the borrower designate a particular prepaid card, over which the lender has control, as the destination for the borrower's wages.

There's a lot going on here. Thanks for raising the question.

Jardinero1 said

"If the check bounces, there is little the lender can do to collect on it, other than harass the check writer, because the loan specifies payment in cash. Most states stipulate that bounced checks must be written in direct exchange for goods or services in order for fraud or theft by check to occur. So there is no chance of prosecution there either. "

Unfortunately, there are many places where the district attorney will prosecute in such situations.

Many district attorneys have created special units to prosecute bad checks. "Check diversion units" is the term of art here. These are usually funded from the fines imposed when they get convictions (almost always guilty pleas). In these places, threatened and actual prosecutions for post-dated checks do occur

Putting in a stop payment order is not free. Revoking the classic wage assignment is as close to free as you can get - cost of sending a letter

Adam,

I'm late to the game on commenting on this, but I think that an important point hasn't been raised. The Rule states that it is unlawful for certain entities to "indirectly or directly to take or receive" an obligation that constitutes a wage assignment.

I think there's a plain-language argument that the phrase "indirectly or directly" applies to the manner in which the obligation is taken or received, not the nature of the obligation itself. For example, under this reading, a lender or retail installment seller could not obtain a wage assignment through a third-party intermediary that would otherwise be exempt from the Rule.


Adam, I think you're right.

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