Opinion ID: 455766
Heading Depth: 2
Heading Rank: 3

Heading: The FTC's Exercise of Unfairness Authority Under Section 5(a)

Text: 64 Applying the three-part consumer unfairness standard, the Commission found that HHG security interests and wage assignments were unfair creditor remedies because they caused substantial, unjustified consumer injury. Our analysis begins with a review of the Commission's reasoning with respect to each of the three criteria set out in the consumer unfairness standard.
65 In elaborating the term substantial injury in its Policy Statement, the Commission stated that in most cases substantial injury would involve monetary harm and that ordinarily emotional impact and other more subjective types of harm would not make a practice unfair. See Policy Statement at 36. The Commission further clarified that it is not concerned with trivial or merely speculative harms. Id. An injury may be sufficiently substantial, however, if it does a small harm to a large number of people, or if it raises a significant risk of concrete harm. Id. at n. 12. With these guidelines 18 in mind, we turn to the specific injuries found to result from HHG security interests and wage assignments. 66 (a) Security interests in household goods. In return for credit, consumers may be required to give a non-possessory security interest in their household goods and personal effects. These goods may be seized by the creditor in the event of a default. See Credit Practices Rule, 49 Fed.Reg. at 7761. Such non-possessory security interests were not recognized at common law and are of comparatively recent origin. Id. Based on the rulemaking record, the Commission found the practice of securing loans with non-purchase, non-possessory security interests in household goods to be widespread, with finance companies being the preeminent users. Id. at 7762. HHG security interests may be created by simply checking a box labelled chattel mortgage or by other general provisions in the text of standard form contracts, thus, giving consumers little notice of the nature and extent of the collateral they are pledging. Id. 67 Based on evidence in the record, including the testimony of a large majority of industry witnesses, the Commission found that HHG security interests have little, if any, economic value to creditors. The creditors cannot ordinarily recover their loss on default by seizing and selling the goods. Consequently actual seizure of household goods by creditors is rare. The Commission summarized its findings as follows: 68 The record reflects the fact that creditors rarely engage in actual repossession of household goods. When it does occur, the furniture and other items seized frequently have little or no economic value; occasionally, the act of seizure appears to be undertaken for punitive or psychological deterrent effect. 69 Id. at 7763 (footnotes omitted). 70 Although the household goods are of little value to creditors and are rarely seized, when seizure does occur the Commission found that it can have severe economic consequences for the consumer. The consumer, most likely already enmeshed in a financial crisis, loses the possession and use of household necessities such as furniture, appliances, linens and kitchenware. While the monetary gain realized by the creditor upon seizure and sale of goods is minimal to nonexistent, the replacement cost to the consumer is substantial, not to mention the sentimental value of the possessions and psychological impact of the loss on the consumer. Thus seizure often imposes a cost on the consumer which is seriously disproportionate to any benefit the creditor obtains. Id. 71 The Commission further found that even in the absence of actual seizure, HHG security interests still resulted in injury to consumers. Creditors rely on HHG security interests primarily as a psychological lever to seek payment and to persuade consumers to take other actions the creditors may deem appropriate.... Id. The Commission recognized that not all creditors use threats of seizure to coerce consumer response but concluded that the preponderance of evidence supports a conclusion that such threats are commonplace. 19 Id. at 7764. Because the loss occasioned by the seizure of household goods is so profound, threats of seizure in themselves are uniquely harmful and disruptive to the consumer and the family. 20 Id. The injury resulting from threats or suggestions of seizure is not limited to psychological harm. Consumers threatened with the loss of their most basic possessions become desperate and peculiarly vulnerable to any suggested ways out. As a result, creditors are in a prime position to urge debtors to take steps which may worsen their financial circumstances. Id. The consumer may default on other debts or agree to enter refinancing agreements which may reduce or defer monthly payments on a short-term basis but at the cost of increasing the consumer's total long-term debt obligation. Consumers may also forego assertion of valid defenses, set-offs or counterclaims in their haste to reach acceptable repayment agreements so as to avoid the perceived imminent seizure of their property. Id. at 7764-65. In sum, consumers at risk of losing their household necessities will take steps which substantially worsen their overall financial condition. 72 (b) Wage assignments. A wage assignment allows the creditor, upon filing with the debtor's employer, to receive all or a portion of the debtor's wages directly from the employer. Wage assignments, unlike wage garnishments, do not require a judgment and can be filed without any judicial review of the creditor's claim. The Commission found that wage assignments were used primarily by small loan and finance companies in California, Illinois, Michigan and New York. Id. at 7757. Although estimates varied, the Commission concluded that wage assignments are prevalent in states where they are permitted and are used in a significant number of consumer transactions. Id. 73 The Commission found wage assignments particularly harmful to consumers because they can be invoked without the due process safeguards of a hearing and opportunity to present defenses. 21 Id. Although some states provide debtors some statutory procedural protections allowing them to prevent effectuation of a wage assignment by serving a notice of defense on the employer and creditor, the Commission found such protective schemes generally ineffective, due to lack of awareness and understanding on the part of the debtor. [D]espite the existence of state statutes, many wage assignments result in collection by creditors even when there have [sic] been a breach of warranty, fraud, or other violation of law that may constitute a defense to payment. Id. at 7758. 74 The rulemaking record further established that wage assignments injure consumers by detrimentally injecting the creditor into the employment relationship. Employers are hostile to wage assignments due to added administrative costs and burdens and the fear that the employee's job motivation and performance will suffer as a result of the reduction in wages. Id. Moreover, employers tend to view the consumer's failure to repay the debt as a sign of irresponsibility. As a consequence many lose their jobs after wage assignments are filed. 22 Even if the consumer retains the job, promotions, raises, and job assignments may be adversely affected. Id. 75 Wage assignments are usually invoked at a time when the debtor is already experiencing severe financial hardship. Loss of a substantial portion of wages tends to cause further disruption of family finances and may even put at risk the wage earner's ability to provide necessities for the family. Id. at 7758-59. Even when wage assignments are not actually invoked, consumer injury may still result. As with HHG security interests, the Commission found that creditors use wage assignments as in terrorem devices to coerce consumers to pay. The invocation of a wage assignment or just simply the threat of invocation may lead a debtor to enter into costly refinancing, to improvidently default on other obligations, or to forego valid defenses. Thus consumers will act against their own best economic interests to avoid the greater potential injury of having creditors contact their employers and risk losing their jobs. [C]reditors exploit that fear despite the fact that job loss would be economically counterproductive to the creditor. Id. at 7758. The Commission, thus, concluded: 76 In the absence of procedural safeguards, the potential for severe, substantial disruption of employment, the pressure that results from threats to file wage assignments, and the disruption of family finances constitute significant consumer injury. State law is inconsistent and does not offer sufficient protection to prevent this consumer injury. 77 Id. at 7759. 78 The harms to consumers resulting from the use of HHG security interests and wage assignments identified by the Commission on the basis of the rulemaking record are neither trivial or speculative nor based merely on notions of subjective distress or offenses to taste. The use of HHG security interests and wage assignments result in or create a significant risk of substantial economic and monetary harm to the consumer as well as potential deprivations of their legal rights. Hence the Commission clearly met its first criterion of establishing substantial consumer injury.
79 The Commission recognizes that most business practices entail a balancing of costs and benefits to the consumer. Therefore the Commission will not find that a practice unfairly injures consumers unless it is injurious in its net effects. Policy Statement at 37. To make this cost-benefit determination, the Commission examines the potential costs that the proposed remedy would impose on the parties and society in general. In the present case, the Commission made the following assessment: 80 The potential costs of most significance in this proceeding include increased collection costs, increased screening costs, larger legal costs and increases in bad debt losses or reserves. Increased creditor costs generally would be reflected in higher interests to borrowers, reduced credit availability, or other restrictions such as increased collateral or down payment requirements. 81 49 Fed.Reg. at 7744 (footnotes omitted). 82 In weighing the costs and benefits of the Credit Practices Rule to consumers and the credit industry, the Commission first noted that the potential cost of eliminating HHG security interests and wage assignments is diminished by the presence of other remedies retained by creditors under the Rule. Creditor remedies unaffected by the Rule include the right to take purchase-money security interests which allow for repossession of the particular item purchased, to obtain a deficiency judgment or bring a suit directly on the debt, and to garnish the debtor's wages. 23 Thus, [t]he remedies subject to the rule must be evaluated in light of their more incremental contribution to deterring default or reducing other creditor costs given remedies that remain available. Id. at 7744-45 (emphasis added). 83 Of course, to the extent HHG security interests and wage assignments actually reduce creditor costs, consumers will theoretically benefit by the greater availability of credit at a lower cost. In short, the crucial issue before the Commission was whether prohibiting HHG security interests and wage assignments would decrease availability and increase the cost of credit to consumers and, if so, whether this cost was outweighed by the benefits of the Rule to the same consumers (the benefits being the avoidance of the harms incurred by consumers as a result of the use of HHG security interests and wage assignments). Based on record evidence, the Commission concluded that the Rule would have only a marginal impact on the cost or availability of credit, and that this marginal cost was clearly overshadowed by the much greater risks to consumers resulting from the use of HHG security interests and wage assignments. See infra pp. 985-988. Thus we find that the Commission satisfied the second prong of the three-part consumer injury test set out in its Policy Statement.
84 The requirement that the injury cannot be reasonably avoided by the consumers stems from the Commission's general reliance on free and informed consumer choice as the best regulator of the market. Normally we expect the marketplace to be self-correcting, and we rely on consumer choice--the ability of individual consumers to make their own private purchasing decisions without regulatory intervention--to govern the market. Policy Statement at 37. As long recognized, however, certain types of seller conduct or market imperfections may unjustifiably hinder consumers' free market decisions and prevent the forces of supply and demand from maximizing benefits and minimizing costs. In such instances of market failure, the Commission may be required to take corrective action. Such corrective action is taken not to second-guess the wisdom of particular consumer decisions, but rather to halt some form of seller behavior that unreasonably creates or takes advantage of an obstacle to the free exercise of consumer decisionmaking. Id. at 37. 85 The Commission found that the injuries occasioned by the use of HHG security interests and wage assignments are not reasonably avoidable by consumers for two interrelated reasons: (1) consumers are not, as a practical matter, able to shop and bargain over alternative remedial provisions; and (2) default is ordinarily the product of forces beyond a debtor's control. 49 Fed.Reg. at 7744. The Commission identified a confluence of factors which create an obstacle to the free exercise of consumer decisionmaking and which creditors are able to use to their advantage. 86 First, the Commission found that most creditors rely on standardized form contracts with boilerplate provisions defining the rights and duties of the parties. Id. at 7745-47. The Presiding Officer's Report concludes: 87 Creditors universally make use of standardized forms in extending credit to consumers. These forms are prepared for creditors or obtained by them, and the completed contract is presented to the prospective borrower on a take it or leave it basis. The primary reason for this is simply that it is not feasible to conduct the transaction in any other way. 88 P.O. Report, J.A. at 395. The Commission acknowledges that standard form contracts are a business necessity for small-loan creditors. 49 Fed.Reg. at 7744. The Commission further found, however, that due to certain characteristics of the consumer credit market, it could not reasonably conclude that the mix of remedies included in the contracts reflects consumer preferences. Id. at 7744, 7746. Whereas consumers may bargain over terms such as interest rates, and the amount or number of payments, their ability and incentive to bargain over the boilerplate remedial provisions is substantially limited. Id. at 7746-47. 89 Several aspects of the credit transaction combine to prevent consumers from making meaningful efforts to search, compare, and bargain over remedial provisions. As noted, standard form contracts are presented on a take it or leave it basis. While there are differences in the kinds of contracts offered by different creditors, certain creditors, namely finance companies serving higher-risk borrowers, are most likely to include HHG security interests and wage assignments. Furthermore while the incidence of use of these provisions may differ across different regions of the country, contracts offered by creditors of a given class in local areas are often substantially identical. Id. at 7746. Given the substantial similarity of contracts, consumers have little ability or incentive to shop for a better contract. 90 Consumers' ability to shop and bargain is further constricted by the fine print and technical language used in the contracts. Id. at 7747. Moreover, consumers are limited in their ability to seek explanations from lenders since inquiries about remedies are likely to make creditors wary and hesitant to grant a loan. Finally, [i]n some cases, comparison is impossible because the creditor refuses to give out the loan contract until the borrower seems ready to sign it. Id. 24 91 Consumers' limited ability and incentive to search out better contracts is compounded by creditors' lack of incentive to advertise or compete on the basis of remedies. Id. Consumers' lack of understanding of contractual terms is the first obstacle. Before competing on the basis of exclusion or inclusion of particular contract terms, creditors would have to educate the consumer as to the ramifications of the inclusion of a particular clause and why a contract excluding the clause is preferable. Such an educational effort would entail substantial costs and would tend to create a free-rider problem with competing creditors reaping benefits from the advertising creditor's educational efforts. The second disincentive to creditors is the problem of adverse selection. If a creditor advertised less onerous remedies, the creditor is likely to attract a disproportionately greater share of those debtors who intend to or who are most likely to default. 92 The Commission also relied upon the fact that default is a relatively infrequent occurrence and generally not within consumers' control. Id. at 7747-48. Consumers could avoid the injuries attendant on the use of HHG security interests and wage assignments if they avoided defaulting on their payments. Relying principally on two large complementary survey studies 25 of the causes of default, the Commission concluded that default is ordinarily the product of forces beyond the debtor's control. Default is usually precipitated by unforeseeable and unavoidable events that reduce income (e.g., job loss or pay reduction) or increase demands (e.g., incapacitation, relocation, unplanned emergency expenses, marital separation or divorce). When these events, outside the debtor's immediate control, occur default is generally an involuntary response. 26 Id. at 7747. The unforeseeable and unavoidable nature of default not only make the implementation of the creditor remedies unavoidable but also limit consumers' incentive to search for contracts which do not include particular remedies. Since consumers do not expect to default, the invocation of particular creditor remedies seems remote and speculative at the time of contracting and thus is not a material element in the consumer's decision. Instead consumers quite reasonably focus their attention on the more immediate terms such as interest rates and payments. Id. at 7746. 93 On the basis of the foregoing analysis, the Commission concluded that consumers cannot reasonably avoid the inclusion of HHG security interests and wage assignments in credit contracts or their implementation. We conclude that the Commission's finding of unavoidable injury comports with the criteria set out in the Commission's Policy Statement. 94