Consumer protection legislation and regulation
Some common law and a considerable variety of state and federal legislation and regulation restrain or prohibit consensual security in the consumer context or otherwise regulate consumer credit transactions in which such security is taken. Article 9 explicitly affirms the applicability of such common law, legislation and regulation (U.C.C. 9-201(b)) and subordinates the provisions of Article 9 to such law (U.C.C. 9-201(c)). We offer here a very small sample of such consumer protection law, not a substitute for careful research of state and federal law when representing a client.
The Uniform Consumer Credit Code contains several examples. Like the Uniform Commercial Code (U.C.C.), the Uniform Consumer Credit Code (U.C.C.C) is a product of the National Conference of Commissioners on Uniform State Laws. Unlike the Uniform Commercial Code, only a handful of states have adopted the Uniform Consumer Credit Code. Nonetheless, many states have adopted legislation that affords consumer debtors protections that are analogous to, or at least confront some of the same issues as, the provisions in the U.C.C.C. One set of restrictions imposed by the U.C.C.C concerns cross-collateral agreements. In Problem.Cross Collateral we consider the manner in which the U.C.C.C. treats the kind of transaction confronted by the court in Williams v. Walker-Thomas Furniture.
One important federal regulation, the F.T.C. Credit Practices Rule, prohibits certain kinds of security interests in household goods. We explore that regulation more fully in Commentary.FTC Rule and Problem.FTC Rule. For a variety of reasons, some state legislation also interferes with freedom in the market place by prohibiting a seller or lender from taking any security interest in certain kinds of collateral under defined circumstances. A legislature may segment the loan market to reserve to specified lenders the right to make certain kinds of loans or it may conclude that a consensual lien on certain collateral will give a creditor too much leverage (to force payment or unfavorable refinancing). For example, consider the California automobile dealer selling an automobile to a consumer under the terms of a retail installment contract, or the California small loan company making a $2,500 loan to help a debtor pay uninsured medical expenses. May either take a deed of trust on the debtor's home to secure payment? See Cal. Civ. Code Section 2984.2, part of California's Automobile Sales Finance Act and Cal. Financial Code 22330, part of California's legislation governing "consumer loans." Other states may have analagous restrictions. See, e.g., Wisconsin Consumer Act 422.417 (3)(a), (b) (prohibition of consensual security interests in clothing and enumerated household items and prohibition of security interest in real property if the obligation secured is a consumer loan of less than $1,000); New York Personal Property Law 314 (prohibition of security interest in real property, or any personal property other than the motor vehicle being sold, in connection with retail installment sale of motor vehicle); Cal. Civ. Code 1799.97 (restrictions on use of religious books, artifacts and materials as security if worth less than $500).
Much legislation, both state and federal, requires specific types of disclosure to the debtor of the nature and effect of granting a security interest. Again, we mention but a few examples. In consumer credit transactions, federal truth in lending law requires that a creditor who regularly extends credit to consumers disclose the taking of a secuirty interest by means of a written disclosure. The disclosure must be given prior to consummation of a transaction, must be "clear and conspicuous," and must (together with related credit data) be segregated from all other written information relating to the transaction. In residential mortgage transactions, the disclosures must be mailed within three business days after a creditor receives a credit application from a prospective debtor. And in some transactions in which a creditor obtains a security interest in a debtor's principal dwelling the federal truth in lending law provides the debtor with a limited right to rescind the transaction and requires a specified notice of the right to rescind.
In the same spirit of disclosure, state legislation may require comparable or additional disclosure. For example, Cal. Civ. Code 2971 requires a creditor to give the following written disclosure to a customer applying for a home equity loan: "This home equity loan that you are applying for will be secured by your home and your failure to repay the loan for any reason could cause you to lose your home!" This disclosure must be made in a separate written document accompanying the application or must be conspicuously appear on the application and must be given to the customer at or shortly after the time the customer applies for the loan. As another example, Cal. Civ. Code 1916.7 sets forth an extensive notice that must be given verbatim by a creditor to a borrower applying for a 30+ year adjustable rate loan secured by owner occupied real property that contains four or fewer residential units.
Some legislation governs matters incidental to the granting of security. For example, in connection with financing of the purchase of residential property, lenders may offer or may require the borrower to purchase private mortgage insurance - - insurance which will pay the lender in the event of the borrower's default. The lender's need for such insurance of course declines as the borrower's equity in the property rises both because with greater equity the borrower is less likely to default and because in the event of default the value of the property clearly becomes sufficient to cover the debt on foreclosure. Accordingly, as the borrower's equity rises, so does the unfairness of continuing premium payments, especially if made by a borrower not sophisticated enough to understand or not thinking to remember that the insurance is becoming unnecessary. Federal legislation, The Homeowners Protection Act of 1998, Public Law 105-216 (July 1998), following in the footsteps of earlier state legislation addressing the same concern (e.g. Cal. Civ. Code 2954.6, 2954.65, 2954.7), protects the borrower against making continuing premium payments on private mortgage insurance once it is no longer necessary to protect the lender. The legislation provides, for example:
A requirement for private mortgage insurance in connection with a residential mortgage transaction shall terminate with respect to payments for that mortgage insurance made by the mortgagor . . . on the . . . date, . . . with respect to a fixed rate mortgage, . . . on which the principal balance of the mortgage, based solely on the initial amortization schedule for that mortgage, . . . is first scheduled to reach 78 percent of the original value of the property securing the loan [if the mortgagor is current on the payments required by the terms of the residential mortgage transaction].
In 1998, Freddie Mac sought Congressional authority to offer borrowers alternative and less costly loss protection mechanisms (reserve escrow accounts eliminating some of the overhead reflected in private mortgage insurance premiums) estimated to save over 4 million households $1.4 billion premium payments annually. Lobbyists for the private mortgage insurance industry persuaded Congress to delay action on the request pending hearings in 1999. San Jose Mercury News, Section F, p. 10F, October 24, 1998.