Opinion ID: 1210758
Heading Depth: 1
Heading Rank: 5

Heading: The K.S.A. 16a-2-401(9)(b) Origination Fee

Text: Our function in reviewing a statute is easily stated. It is to construe the language so as to give effect to the intent of the legislature. There is no invariable rule for the determination of that intention. The legislature has instructed us that [w]ords and phrases shall be construed according to the context and the approved usage of the language. K.S.A. 77-201 second. Technical words and words and phrases that have acquired a peculiar meaning in law are to be construed according to their peculiar and appropriate meanings. K.S.A. 77-201 second. Federal Truth-in-Lending Act (TILA), Regulation Z, 12 C.F.R. § 226 (1998) is incorporated in the UCCC by K.A.R. 75-6-26(c), K.S.A. 16a-3-206, and K.S.A. 16a-6-117. Here, the legislature is presumed to have expressed its intent through the language of the UCCC and K.S.A. 16a-2-401(9)(b). We must give effect to the intent of the legislature as expressed rather than determine what the law should or should not be. Brown v. U.S.D. No. 333, 261 Kan. 134, 142, 928 P.2d 57 (1996). (1) Lenders are permitted to call origination fees prepaid finance charges in loan documents. The focus of our analysis is on the legislature, both federal and state. The TILA (Regulation Z) applies to virtually all consumer loans. 12 C.F.R. § 226.1(c). Thus, state legislatures must consider the implications of Regulation Z when they tinker with their own consumer loan statutes. Why not simply call the origination fee here an origination fee? The answer can be found in a detailed analysis of Regulation Z. The discussion that follows will demonstrate that: (a) origination fees are considered prepaid finance charges under the TILA; (b) the legislature knew that to be true when it passed K.S.A. 16a-2-401(9)(b); and (c) the origination fees charged by Associates fit the definition of a prepaid finance charge. (a) An origination fee is a prepaid finance charge under the TILA (Regulation Z). The exact term origination fee is not found in Regulation Z. However, origination fees are considered a type of finance charge. Gonzales admits as much when he states, For purposes of disclosure, loan companies are required to treat the Origination Fee as a finance charge. A finance charge is defined as the cost of consumer credit as a dollar amount. 12 C.F.R. § 226.4(a). 12 C.F.R. § 226.4(a) explains that a finance charge includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit. An origination fee meets the Regulation Z definition of a finance charge. An origination fee is a charge by the creditor and payable by the debtor. 12 C.F.R. § 226.4(a). An origination fee is an incident to or a condition of the extension of credit as well. Origination fees may be charged and paid directly or indirectly. Under 12 C.F.R. § 226.4(b)(3), an example of a finance charge includes loan fees and similar charges. A prepaid finance charge necessarily includes the definition of finance charge above, but more specifically means any finance charge paid separately in cash or by check before or at consummation of a transaction, or withheld from the proceeds of the credit at any time. 12 C.F.R. § 226.2(a)(23). Thus, it follows that a loan fee/origination fee paid up front or withheld from the proceeds of the loan is in fact a prepaid finance charge under Regulation Z. (b) The legislature knew that origination fees were considered prepaid finance charges under Regulation Z when enacting K.S.A. 16a-2-401(9)(b). The legislature named origination fee a nonrefundable prepaid finance charge in K.S.A. 16a-2-401(9)(b). The legislative history of K.S.A. 16a-2-401(9)(b) demonstrates why. The statute, which is not part of the Model Uniform Act, was adopted in 1988. L. 1998, ch. 85 and 86. Since 1986, lenders have been permitted to charge origination fees on consumer loans secured by real estate. K.S.A. 16a-2-401(9)(a). Testimony before the 1988 legislature advocated the need for a way to offset the expenses of making small loans. The legislature apparently recognized lenders were reluctant to make small loans because the finance charges alone were insufficient to cover the loan processing costs. Testimony from the financial service industry suggested that without such changes, the small loan market would dry up in Kansas. K.S.A. 16a-2-401(9)(b) was added to allow lenders to recoup their costs by charging a loan origination fee labeled a nonrefundable prepaid finance charge. (Minutes of the House Committee on Commercial and Financial Institutions, March 24, 1988.) The label seems to be deliberate. Relevant discussion on the topic can be found in the Senate committee minutes of February 18, 1998, on Senate Bill 552. There, the Senate considered proposed technical or clean up amendments to various sections of the UCCC, including K.S.A. 16a-2-401. While it was Senate Bill 507 which ultimately allowed the origination fee Gonzales complains of, both bills (on the same day) made changes to 16a-2-401 during the same legislative session. Senate Bill 552 labeled the 3% nonrefundable origination fee on consumer loans secured by real estate, permitted since 1986, a nonrefundable prepaid finance charge. The committee minutes of February 18, 1998, reveal that there was thoughtful discussion concerning origination fees. The committee considered moving the sections on origination fees to 16a-2-501, which enumerates additional charges such as insurance, official fees, and taxes. This suggestion was quickly disposed of due to Regulation Z. As previously explained, under the TILA (Regulation Z) origination fees are considered finance charges. See 12 C.F.R. § 226.4(b)(3). 12 C.F.R. § 226.18(c)(iv) of Regulation Z mandates disclosure of the prepaid finance charge. The committee was concerned that if the statute was amended to include origination fees as additional charges (in 16a-2-501) but lenders were required to disclose the origination fee as the prepaid finance charge under Regulation Z, the amendment might lead to confusion. Specifically, the minutes read: If it is put in state law as not a finance charge, but lenders have to disclose it as a finance charge under the truth in lending, it becomes confusing. See Minutes of Senate Committee on Financial Institutions and Insurance, February 18, 1988, p. 2. The committee ultimately decided to keep the origination fees (for loans secured by real estate) in 16a-2-401 as a nonrefundable prepaid finance charge. During the same committee hearings, when considering Senate Bill 507 allowing origination fees for loans not secured by real estate, the committee logically added this new origination fee to section 16a-2-401 as subsection (9)(b) and once again labeled the origination fee a nonrefundable prepaid finance charge. The 12 C.F.R. § 226.18(c)(iv) Regulation Z disclosure requirement suggests that the legislature purposely used the term prepaid finance charge. There is an absence of any legislative discussion tending to support Gonzales' contention that the fee was intended to apply only to the original set up of a consumer's loan file with the lender. Gonzales advances no support for his reading of K.S.A. 16a-2-401(9)(b) other than a general legislative intent to aid and protect consumers. Gonzales' contention that the statute does not permit a lender to call an origination fee a prepaid finance charge lacks merit. Under the statute, the origination fee is an amount not to exceed the lesser of 2% of the amount financed or $100. K.S.A. 16a-2-401(9)(b). The amount financed in the August and December Loan Agreements exceeded $5,000. Both loans say that Gonzales is being charged $100 in prepaid finance charge[s]. Similarly, the agreements disclose the fact that prepaid finance charges will not be rebated in the event of prepayment. See 12 C.F.R. § 226.18(k)(2) (1988). Gonzales did not pay the origination fee up front. The origination fee charged here was withheld from the proceeds of Gonzales' loan. (c) The origination fee was withheld from the proceeds of the loans to Gonzales. We acknowledge that it is difficult to determine how the origination fee is paid from the face of the loan documents. However, we do not attribute the difficulty to an attempt to deceive on the part of Associates. The difficulty arises because of state legislation and the rigid disclosure requirements of Regulation Z. Gonzales' loan documents contain certain disclosures mandated by Regulation Z. The documents also contain certain definitions of the terms on the documents; also mandated by Regulation Z. For the purposes of our discussion, the two most important disclosures a creditor must make under Regulation Z are (i) the amount financed and (ii) the itemization of the amount financed. See 12 C.F.R. § 226.18(b) and (c). (i) Amount Financed: The amount financed must be disclosed using that term, and a brief description such as the amount of credit provided to you or on your behalf. 12 C.F.R. § 226.18(b). The amount financed is calculated by: (1) Determining the principal loan amount ...; (2) Adding any other amounts that are financed by the creditor and are not part of the finance charge; and (3) Subtracting any prepaid finance charge. (Emphasis added.) 12 C.F.R. § 226.18(b)(1)-(3). The amount financed is disclosed on Gonzales' loan documents. The amount financed is also defined as the amount of credit provided to you or on your behalf. 12 C.F.R. § 226.18(b). This definition was on Gonzales' loan documents, as Regulation Z requires. The amount financed does not include the prepaid finance charge, also as mandated by Regulation Z. (ii) Itemization of Amount Financed Creditors must include a separate written itemization of the amount financed. 12 C.F.R. § 226.18(c). This statement includes four things: (1) the amount of any proceeds distributed directly to the consumer; (2) the amount credited to the consumer's account with the creditor; (3) any amounts paid to other persons by the creditor on the consumer's behalf; and (4) the prepaid finance charge. The prepaid finance charge is not a part of the amount financed. The fact that the prepaid finance charge is included in the itemization of amount financed is, thus, counter-intuitive, but inclusion is what 12 C.F.R. § 226.18(c) requires. With the Regulation Z requirements in mind, we now turn to Gonzales' loan documents. Our question is how the $100 origination fee was paid here. The formula for calculating the amount financed provides part of the answer. A creditor must take the principal loan balance and subtract, among other things, the origination fee to arrive at the amount financed. The amount financed on Gonzales' December Loan Agreement is $5,458 (rounded). Thus, Associates had to take the principal amount of the loan and subtract the $100 fee to arrive at $5,458. Unfortunately, this calculation was not done on the loan documents themselves. Therefore, no principal amount of $5,558 appears on the December Loan Agreement. However, $5,558 is noted on the August Loan Agreement where Associates employees marked the old August note Made Again. There, Associates recorded the loan number of the December Loan Agreement, the date, and the amount of the new loan: $5,558. Gonzales' December loan was for $5,558, not $5,458. Associates subtracted the origination fee from the principal loan amount. In doing so, Associates withheld the origination fee from the proceeds of the loan. Should Associates be faulted for not showing this principal amount on the loan documents? We think not. We believe the Regulation Z disclosure requirements for the forms could be improved; however, federal form improvement is not a state judicial function. The model loan form endorsed by the TILA does not contain such a disclosure. Associates' loan forms track with the model form, and each disclosure made on the model form was made by Associates. See 12 C.F.R. pt. 226, app. H. We next consider payment of the origination fee. The origination fee is part of the principal, but not part of the amount financed for interest purposes. In other words, no interest is charged on the origination fee of the loan. The origination fee is a part of the cost of the credit to the consumer. As such, it is reflected in the annual percentage rate or APR. The yearly interest rate on Gonzales' December loan was 22.50%; however the APR was 23.91%. This 1.41% difference is where the $100 origination fee is reflected. Gonzales acknowledged this, saying: The stated interest rate on the loan was 22.5% and the effective annual percentage rate with the addition of the origination fee came to 23.92%. This reflection of the origination fee in the APR as a finance charge is also mandated by Regulation Z. 12 C.F.R. § 226.22(a)(1). Thus, the origination fee is properly reflected in the APR as a 1.41% increase. Admittedly, when a consumer refinances, the unpaid portion of the origination fee is rolled over into the new loan. Only then does a consumer pay interest on an origination fee. The loan documents told Gonzales he was being charged a prepaid finance charge of $100. The documents also told him that the prepaid finance charge would not be rebated. (2) Lenders are permitted to base the amount of the origination fee on the entire amount financed. According to Gonzales' definition, (1) no credit is extended in a refinancing, and (2) if a loan is refinanced with the same lender without new money advanced, the amount financed is redefined as zero. We disagree. Gonzales' interpretation appears to contradict both the UCCC and TILA, Regulation Z. See K.S.A. 16a-1-301(4); 12 C.F.R. § 226.18(b). K.S.A. 16a-1-301(4)(b) and (c) define amount financed as follows: Amount financed means the total of the following items: .... (b) in the case of a loan, the net amount paid to, receivable by, or paid or payable for the account of the debtor, plus the amount of any discount excluded from the finance charge (paragraph (b) of subsection (18) of section 16a-1-301); and (c) in the case of a sale or loan, to the extent that payment is deferred and the amount is not otherwise included and is authorized and disclosed to the customer: (i) Amounts actually paid or to be paid by the creditor for registration, certificate of title, or license fees, and (ii) permitted additional charges (section 16a-2-501). We conclude Associates acted within the letter of K.S.A. 16a-2-401(9)(b) in charging a $100 origination fee for Gonzales' August and December loans because the amount financed in each case exceeded $5,000. Our conclusion is supported by the language of K.S.A. 16a-2-504, which specifically contemplates refinancing of consumer loans. K.S.A. 16a-2-504, adopted from the Model Code in 1973, authorizes refinancing of the unpaid balance by agreement with the consumer. The statute provides that the amount financed resulting from the refinancing shall be comprised of the total of the unpaid balance and the accrued charges on the date of the refinancing. The Kansas Comment to 16a-2-504 says, in part: The amount financed for the new transaction is equal to the unpaid balance of the old transaction plus accrued charges at the date of refinancing. (Emphasis added.) Any unaccrued interest in a precomputed transaction must be credited to the consumer before calculating the amount financed in a refinancing. Regulation Z, 12 C.F.R. § 226.20(a) provides that [a] refinancing is a new transaction requiring new disclosures to the consumer. We will not rewrite K.S.A. 16a-2-401(9)(b) to say that (1) the statutory origination fee may be charged on only part of the amount financed and (2) amount financed means the amount of credit extended excluding credit extended to refinance previously incurred debt with the same lender. K.S.A. 16a-2-401(9)(b) permits the creditor to receive an origination fee with any such loan, which includes loans that are in whole or in part refinancings of existing loan balances. We note in reviewing the record, correspondence in 1994 between William Caton, Kansas Consumer Credit Commissioner, and Keith Jones, President of Kansas Association of Financial Services (KAFS) concerning origination fee/prepaid finance charges on refinanced consumer loans. It was attached without comment to Gonzales' motion in opposition to summary judgment. In the correspondence the Commissioner opined that the industry's practice of charging prepaid finance charges on the entire principal of a refinanced loan within a short time period of the original loan is unconscionable. He suggested a policy that would charge a prepaid finance charge only on the new money portion of the refinanced loan within a specific time period. He did not wish to address the issue statutorily, but preferred the industry to stop the practice and police itself voluntarily. K.S.A. 16a-6-111 authorizes the Commissioner to file civil actions to restrain a creditor from enforcing unconscionable terms. The Commissioner is given broad investigative powers over the consumer loan industry. See K.S.A. 16a-2-305 (examination and investigation) and K.S.A. 16a-6-104 (powers of administrator). The KAFS responded, saying that as an informal understanding, effective January 2, 1995, its members would charge the K.S.A. 16a-2-401(9)(a) and (b) fees on new money only on consumer loans refinanced by the same lender within the first 6 months of the term of the loan. After 6 months no voluntary K.S.A. 16a-2-401(9)(b) origination fee restriction would be imposed. Neither the district judge in his findings and conclusions nor the parties in their briefs or at argument on appeal reference the correspondence; thus, it plays no role in resolving this case. We do note, however, that only one of Gonzales' loans would have violated this voluntary 6-month rule. Only 4 months had passed when Associates made their last (December) loan to Gonzales. They charged him a $100 origination fee. Gonzales never made a payment on the December loan. The UCCC has continued to receive legislative oversight. The 1997 Kansas Comment to K.S.A. 16a-1-101 says, in part: The U3C has been amended several times since its enactment in 1973; indeed, amendment has become an almost annual process. (See the Revisor's Note for Chapter 16a for the origin of the Kansas Comments.) The UCCC may be inadequate for failing to require explicit disclosure of either the disadvantages or advantages of refinancing versus taking out a new loan. If so, the remedy lies with the legislature.