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What Is "Credit"? AfterPay, Earnin', and ISAs

posted by Adam Levitin
A major issue in consumer finance regulation in mid-20th century was what counted as “credit” and was therefore subject to state usury laws and (after 1968) to the federal Truth in Lending Act. Many states had a time-price differential doctrine that held that when a retailer sold goods for future payment, the differential between the price of a cash sale and that of credit sale was not interest for usury law purposes. State retail installment loan acts began to override the time-price doctrine, however, and the federal Truth in Lending Act and regulations thereunder eventually made clear that for its purposes the difference was a “finance charge” that had to be disclosed in a certain way. 
 
Today, we seem to be coming back full circle to the question of what constitutes “credit.” We’re seeing this is three different product contexts: buy-now-pay-later products like Afterpay; and payday advance products like Bridgit, Dave, and Earnin’; and Income-Sharing Agreements or ISAs (used primarily for education financing). Each of these three product types has a business model that is based on it not being subject to some or all “credit” regulation. Whether those business models are well-founded legally is another matter.
 
Let me briefly recap what is “credit” for different regulatory purposes and then turn to its application to the types of products.

The first thing to know is that there is not just a single definition of “credit” for federal statutory purposes. (I’m not going to get into the state question.) The overarching federal statute, the Consumer Financial Protection Act, defines it as:

 
No definition of “debt” is given in the CFPA. A similar definition of “credit" appears in the Equal Credit Opportunity Actand the Fair Credit Reporting Act(which references ECOA):
 
the right granted by a creditor to a debtor to defer payment of debt or to incur debts and defer its payment or to purchase property or services and defer payment therefor.
 
As with the CFPA, ECOA and FCRA do not define “debt.” But whereas the CFPA definition of “credit” does not reference a term “creditor” or “debtor,” the definition in ECOA/FCRA does, and ECOA/FCRA defines “creditor” as:
 
any person who regularly extends, renews, or continues credit; any person who regularly arranges for the extension, renewal, or continuation of credit….
 
In other words, ECOA carves out the casual creditor. Thus, If I lend you $10 for lunch, I am not a creditor for ECOA purposes ... unless I do so regularly.
 
The Fair Debt Collection Practices Actdoes not define “credit,” but it has an even broader definition of “creditor” that references debt:
 
any person who offers or extends credit creating a debt or to whom debt is owed…
 
“Debt” is then defined by the FDCPA as:
 
any obligation or alleged obligation of a consumer to pay money arising out of a transaction in which the money, property, insurance, or services which are the subject of the transaction are primarily for personal, family, or household purposes, whether or not such obligation has been reduced to judgment.
 
Truth in Lending’s definition of “credit” is quite similar to CFPA and ECOA/FCRA: 
 
the right granted by a creditor to a debtor to defer payment of debt or to incur debt and defer its payment.
 
The TILA definition of “creditor” is quite different, however:
 
The term ‘creditor’ refers only to a person who both (1) regularly extends, whether in connection with loans, sales of property or services, or otherwise,consumer credit which is payable by agreement in more than four installments or for which the payment of a finance chargeis or may be required, and (2) is the person to whom the debt arising from the consumer credit transactionis initially payable on the face of the evidence of indebtedness or, if there is no such evidence of indebtedness, by agreement. 
 
Got that? Credit is generally defined as the right to defer payment of an obligation. But sometimes it has to be granted by a “creditor,” and “creditor” is defined substantially differently by statute. In particular, TILA requires either a possible finance charge or payment in more than four installments.
 
Buy-Now-Pay-Later Products
 
This finance charge or four-installments provision is key for buy-now-pay-later products like Afterpay. Afterpay allows the consumer to purchase goods now and pay over 4 equal installment payments. So it’s within the 4-installment part of the “creditor” definition. And Afterpay does not have a charge if you pay on time. It only has a late fee. Late fees are excluded from the finance charge if it is for “actual, unanticipated late payment.” So if borrowers are anticipated to pay off the Afterpay advance within the four installments, no problem—no finance charge, and not a “creditor” for TILA, and therefore not subject to TILA disclosure rules, TILA error resolution rules, or TILA unauthorized transaction liability limitation rules. Of course, if most consumers are paying late, then Afterpay’s late fee would be a finance charge, so it would be a creditor, extending credit and subject to TILA. (I have no reason to believe that this is the case).
 
Note, however, that even though Afterpay is not subject to TILA, it is still subject to ECOA, FCRA, FDCPA, and the Consumer Financial Protection Act.
 
Payday Advance Products.
 
A similar story emerges for payday advance products like Brigit, Dave, and Earnin’. Some of these products (e.g., Earnin’) advance the borrower a small sum, payable in, say a month. The lender has an ACH debit authorization to pull the money from the borrower’s bank account on the due date. Earnin’ doesn’t charge for its service, but does solicit tips. That’s not finance charge, and it’s one installment. Not a TILA creditor. Note, however, that the NY Dep’t of Fin. Services is investigating whether the future advances are contingent upon tipping, which might change the TILA (and state usury law) analysis and also raise deception issues. (Again, I have no reason to believe that this is the case.)
 
Dave has a different model—it has a monthly fee for eligibility for advances, but no fee for a specific advance. Again, outside the scope of the finance charge definition and thus from the TILA definition of creditor. So payday advance products aren’t “credit” for TILA, meaning they do not have to comply with disclosure, error resolution, and unauthorized transaction liability rules, but they certainly are "credit," for ECOA, FCRA, FDCPA, and the CFPA and therefore subject to those statutes.  
 
Income-Sharing Arrangements
 
That brings us to Income-Sharing Arrangements or ISAs. These are commonly used for education finance. The basic idea is that the provider (lender?) advances funds to the consumer for tuition/living expenses. The consumer commits to paying the provider a percentage of his or her future income over and above a minimum amount. The total number of payments, payment time and/or amount of payment is often capped. The idea is that the more you earn, the more you pay—if you get a degree and can’t get a job, you will owe nothing, but if you’re making bank, you’ll owe more than if you have a middling job.
 
ISAs are conceptually quasi-equity financing of education, but emphasis on the quasi—it’s more like participating preferred shares, in that if there’s enough to pay the common equity (the consumer) a dividend, then the preferred shares must be paid a dividend. While we often call preferred shares equity, they’re really a hybrid of equity and debt features. 
 
Whether ISAs are credit is critical to their viability. ISAs are priced differently depending on school and/or major. A computer science major is likely to have to pay a lower percentage than an anthropology major. One might imagine a pricing differential between students at an HBCU or minority-serving institution and at other schools. If ISAs are credit for ECOA purposes, there’s likely, therefore, to be major disparate impact issues.
 
So are ISAs credit? ISA providers and their lawyers don't think so.  For CFPA purposes, there are two possible ways it could be. First, for ISAs provided by the school itself (such as Perdue University), the answer is clearly yes. “Credit” is “the right granted by a person to a consumer to…purchase…services [education] and defer payment for such purchase.” If a school is the ISA provider, it’s definitely credit for the CFPA, which means UDAAP prohibitions apply. I think the answer is also the same if the provider is affiliated with the school, as the CFPA has an anti-evasion provision in its definition of "financial product or service".
 
Second, for ISAs provided by third-parties, the question is whether the ISA is a “right granted by a person to a consumer to defer payment of a debt” or to “incur debt and defer its payment”. (To be sure, the language about “purchase property or services and defer payment for such purchase does not necessarily refer to a purchase from the person…).
 
So is there a “debt”? There is clearly an obligation to repay an advance of funds if certain conditions obtain. Is a contingent repayment obligation a debt? None of the federal credit statutes, other than the FDCPA, tell us what a "debt" is. FDCPA tells us that a debt is an obligation to pay money and doesn’t have to be reduced to judgment. That indicates that there can be some level of dispute or contingency without affecting the status of “debt” Now, FDCPA’s definition doesn’t control for CFPA, ECOA/FCRA, or TILA, but it’s instructive. The same too for the Bankruptcy Code, which defines a debt as "liability on a claim,” and “claim” as a:
 
right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed,legal, equitable, secured, or unsecured.
 
Thus, ISA obligations would be dischargeable in bankruptcy under the regular student loan discharge standard.  The broad bankruptcy definition of "debt," like that of the FDCPA, gives a pretty strong indication that “debt” ought to include contingent obligations to pay, especially as both statutes could will apply to the same contingent obligation.
 
So there's good reason to think that some, if not all, ISAs involve a debt and are therefore "credit," for various federal regulatory purposes.  The most natural read of the statutes is that ISAs are credit and subject to the full panoply of federal consumer finance regulations. Certainly from a purposivist angle, ISAs are financing, and it’s hard to think that Congress was OK with discriminatory equity financing, but not discriminatory debt financing. It’s not possible to reach a definitive legal conclusion at this point about whether ISAs involve “debt," but I do not know how ISAs can confidently claim not to be “credit.” I cannot imagine a law firm responsibly issuing an opinion letter that these are not “debt,” but perhaps some might if paid enough. 
 
If ISAs are "debt," and therefore "credit," then there are serious compliance issues for ISA providers for TILA, ECOA, and FCRA purposes, and, if any ISA obligations go into collection, for collectors of ISA obligations under FDCPA. This isn't to say that the industry cannot be viable, but it will have to undertake some substantial changes.  
 
I suspect what is going on is an attempt by the ISA industry to get the camel’s nose under the tent and become too-big-to-fail. If the ISA industry gets large enough before facing the regulatory question, the industry will be able to push back against any regulatory attempts by pointing to potential disruption and reliance of consumers upon the product. Frankly, this is an issue the CFPB should be getting out ahead on. The Bureau should be issuing regulatory guidance on ISAs as part of its regulation of the private student lending market. Alternatively, the Bureau could undertake a rule making defining “debt” under the CFPA.
 
More generally, the emergence at this moment of three product classes all dancing around the definition of “credit” under federal statutes, suggests that it might be time to reopen the issue both with regulatory guidance and formal rulemaking, as well as possibly legislatively.  At the very least, a minimum baseline should be to apply the TILA error resolution provisions and unauthorized transaction liability rules to any product that allows deferred payment.

Comments

Jim Hawkins (Houston) has a working paper looking at earned wage advance products that deals with some similar issues. These products loan you money against wages already earned but not yet paid. As such, I believe they've all taken the stance that they are not credit products at all.

This is quite good - I think that one issue (could be big or not)revolves around the likelihood of being obligated to make a payment - e.g. if there are 10 students in the pool but statistically half of them will not even repay the initial funding is this still credit - and to be clear - they are not failing to live up to the contract , they are satisfying the terms of the contract.

In the 1990s, deferred-presentment providers (now commonly called payday lenders) also claimed not to be making loans. I give more details on their claims and also the time-price doctrine in my book, City of Debtors: A Century of Fringe Finance (Harvard, 2018).

But rather than test their legal claims and run the risk of being categorized as lenders subject to state lending laws, the deferred-presentment industry lobbied states to adopt special legislation to regulate just their products. Wage advance providers are doing the same in California right now with SB 472, which would regulate the industry and also "prohibit delivery of earned but unpaid income from being construed as a credit transaction under state law." https://legiscan.com/CA/text/SB472/2019

When I was in law school the reading materials for one of my courses was a case from Georgia where there had been an ethics complaint against lawyers from establishment firms who had been involved in a campaign against salary buyers. As the scheme worked at the time, the worker got $5 from the "salary buyer" in exchange for selling the right to get $6 when he got paid. This was during the Depression. or maybe just afterwards. The salary buyers claimed that usury laws didn't apply because they weren't lending money, they were buying the future wages at a discount. Or something like that, I don't remember the details because the reason that this case was in our materials was for the ethics opinion not the consumer protection aspect. The lawyers for the salary buyers had complained that the other lawyers had solicited clients, or stirred up litigation, or something like that, but the ruling was that what the establishment lawyers was doing was ok. When I read the case I thought it was old and musty, but by now I think that there may have been more time between when I read the case and now, than the gap between the time the case was decided and when I read.

Anyway, people who are patting themselves on the back for cleverly finding a way around consumer protection laws need to "honor" their predecessors, who were pretty devious also. Sadly, with the rise of the law and economics crowd and general Milton Friedman laissez faire ideology, too many regulators and judges are willing to go along with the clever evasions.

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