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Federal R eserve Bank OF DALLAS W IL L IA M H. WALLACE DALLAS. TEXAS 7 5 2 2 2 F IR S T V IC E P R E S ID E N T A N D C H IE F O P E R A T IN G O F F IC E R October 21, 1988 Circular 88-72 TO: The Chief Executive Officer of all member banks, bank holding companies and others concerned in the Eleventh Federal Reserve District SUBJECT Slip sheet with amendments to the Staff Guidelines on Regulation AA, Subpart B — The Credit Practices Rule DETAILS The Board of Governors of the Federal Reserve System has published amendments in slip-sheet form to Regulation AA, Subpart B, effective August 1, 1988. The new slip sheet should be inserted in Volume 2 of your Regulations Binders. ENCLOSURES The slip sheet is enclosed. MORE INFORMATION For more information, please contact Dean A. Pankonien at (214) 651-6228. Sincerely yours, For a dditional copies of any circular please c o n ta c t the Public A ffairs D ep artm en t at (214) 6 5 1 -6 2 8 9 . Banks and others are encouraged to use the follow ing incom ing W A TS numbers in contacting this Bank (800) 4 4 2 -7 1 4 0 (in trastate) and (800) 5 2 7 -9 2 0 0 (interstate). This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) B oard o f G overnors o f th e F ederal R eserve System Amendments to the Staff Guidelines on Regulation AA, Subpart B, The Credit Practices Rule* Effective November 1, 1986, the following questions and answers have been added or amended: INTRODUCTION 3. Scope; enforcement. * * * The Federal Deposit Insurance Corporation has enforce ment responsibility for insured state-chartered banks that are not members of the Federal Reserve System. SECTION 227.11—Authority, Purpose, and Scope Q ll( c ) - 2 : Industrial loan companies. A re in dustrial loan companies subject to the Board’s rule? A: Industrial loan companies that are insured by the Federal Deposit Insurance Corporation are covered by the Board’s rule. through a nonprofit trust (as the rule does not apply to nonprofit organizations). Q 1 2 (b )-la: Business entities as cosigners. If a partnership or a corporation cosigns a con sumer credit obligation, is such an entity a cosigner for purposes of the rule? Must the bank provide a cosigner notice? A: No, the rule applies only to natural per sons who are cosigners. Consequently, the rule does not require a bank to provide a co signer notice when a partnership, corporation, or other business entity serves as a cosigner on a consumer credit obligation. Q 1 2 (b )-lb : Dealer guarantee. W here a bank and an automobile dealer, for example, enter into an agreement whereby the bank purchas es a consumer credit obligation from the deal er and the dealer guarantees the obligation, m ust the bank provmc a cosigner notice to the dealer? A: No, the rule is not intended to apply in such recourse agreement situations where the bank is purchasing dealer paper. SECTION 227.12— Definitions Q 12(a)-10: Lease transactions. Are consum er lease transactions covered by the rule? A: The rule covers only consumer credit obli gations. A lease transaction would be covered by the rule only if the transaction is a credit sale as defined in Regulation Z. Q 1 2 (a )- ll: Trusts. A re extensions of credit made to a consumer through a trust covered by the rule? A: Yes, such extensions of credit are covered by the rule, unless the credit is being extended • The complete guidelines, as amended effective August 1, 1988, consist of— • the pamphlet dated January 1986 (see inside cover) and • this slip sheet. SECTION 227.13—Unfair Credit Contract Provisions Q13-3: Refinancings and renewals— original credit obligation entered into prior to effective date o f rule. Assume that a bank entered into a credit obligation prior to the effective date of the rule and that the credit obligation con tained a provision ultimately prohibited by the rule. Assume further that the credit obli gation is refinanced after the effective date of the rule. May the refinanced obligation con tain the prohibited provision, or is the refi nancing subject to the rule? Does the same hold true for renewals of the original credit obligation? 1 R egulation A A (S taff G uidelines) A: A refinancing or renewal entered into after the effective date of the rule is subject to the rule and, therefore, may not contain a con tract provision prohibited by the rule. Q13-4: Open-end account—fu tu re advances made under the plan. If a bank entered into an open-end credit obligation with a consumer prior to the effective date of the rule and that agreement contained contract provisions ulti mately prohibited by the rule, may the bank enforce those contract provisions as to future advances made under the plan after January 1, 1986? A: Yes, contract provisions ultimately pro hibited by the rule can be enforced in such a situation since the advances are being made as part of an open-end agreement that was en tered into before the effective date of the rule, and the rule is not intended to have retroac tive effect. (See, however, Q 15-8.) Q13-5: Prohibited provisions in cosigner agreement. May a bank include any of the provisions prohibited by the rule in the docu ments obligating a cosigner on a consumer credit obligation (for example, in a guaranty agreement)? A: A bank may not include any of the prohib ited provisions in the documents obligating a cosigner. The agreement between the bank and the cosigner, even if executed separately, is part of the consumer credit obligation and is therefore subject to the rule’s prohibitions. Q 13(b)-3: Language o f contract provision lim iting applicability o f waiver. If a bank’s consumer credit contracts contain a clause that states “ I waive my state property exemp tion to the extent the law allows,” would such a clause be permitted under the rule? A: No, in spite of the limiting language “to the extent the law allows,” the clause is an overly broad waiver and, therefore, would be prohibited by the rule. A clause in a consumer credit contract providing that the consumer waives an exemption “as to property that se cures this loan,” for example, would be a per missible waiver-of-exemption provision under the rule. Q 13(c)-5: Offer o f a commission as security. Is the rule’s prohibition against a bank’s tak ing an assignment of a consumer’s future wag es violated if a bank takes as security for a loan a consumer’s commission (for example, a real estate agent’s commission) that has been earned but not yet received by the consumer? A: No, this would not be a prohibited wage assignment since the consumer’s commission has already been earned at the time of the as signment; the fact that it has not yet been re ceived by the consumer does not affect its treatment under the rule. Q 13(d)-5: Refinancings— releasing a portion o f security interest. When a bank has entered into a purchase-money loan transaction se cured by household goods and then advances additional funds to the consumer in subse quent refinancings of that transaction, is the bank required to release a proportionate am ount of the security interest in the house hold goods, as the original loan amount decreases? A: The rule does not require a proportionate reduction of the security interest as the origi nal loan amount decreases; such may be re quired, however, by state law. Q 13(d)-10: Security interest in substituted household goods. Does a bank violate the rule by retaining a security interest in household goods that have been substituted by the con sumer for household goods in which the bank originally had a permissible purchase-money security interest? A: A security interest in substituted house hold goods would violate the rule’s prohibi tion on taking a non-purchase-money security interest in household goods unless the goods were substituted pursuant to a warranty; as such, the goods would be considered part of the original purchase-money transaction for purposes of the rule. R egulation A A (S taff G uidelines) SECTION 227.14— Unfair or Deceptive Practices Involving Cosigners The reference to section 226.16 in the answer to Q14-1 should be changed to section 227.16. Q 14(b)-13: Continuing guaranties. When must a bank give the cosigner notice to a guarantor who has executed a guaranty not only for the original loan, but also for future loans of the primary debtor? Must a cosigner notice be given to the guarantor with each subsequent loan to the primary debtor? A: The cosigner notice should be provided before the guarantor becomes obligated on the guaranty—that is, at the time the guaranty is executed. The cosigner notice need not be givien to the guarantor with each subsequent loan made to the primary debtor, since the cosign er is already obligated under the original con tract to guarantee future indebtedness. How ever, since the guarantor is being asked to guarantee not only the original debt, but also the future debts of the primary obligor, the cosigner notice should be modified to accu rately reflect the extent of the guaranty obliga tion. For example, the first sentence of the co signer notice could read “You are being asked to guarantee this debt, as well as all future debts of the borrower entered into with this bank through December 31, 1987.” Q 14(b)-13a: Continuing guaranties—openend plan. If a cosigner executes a guaranty on an open-end credit plan (that is, one guar anteeing all advances made under the plan), does the bank have to modify the cosigner no tice to indicate that all advances made under the plan are being guaranteed? A: No, the bank is not required to modify the cosigner notice since the future advances are all being made as part of the same open-end credit plan. Q 14(b)-14: Renewal or refinancing o f credit obligation. W hat happens when a credit ob ligation involving a cosigner is renewed or re financed? Must a bank give the cosigner an other notice at the time of the renewal or refinancing? A: If under the terms of the original credit agreement the cosigner is obligated for renew als or refinancings of the credit obligation, a bank would not be required to give another cosigner notice at the time of each renewal or refinancing. SECTION 227.15—Unfair Late Charges Q15-2 Skipped payments. W hat happens if a consumer misses or partially pays a monthly payment and fails to make up that payment month after month? May the bank assess a delinquency charge for each month that pass es in which the consumer fails to make the missed or “skipped” payment or to pay the outstanding balance or the partial payment? A: Yes, the rule does not prohibit the bank from assessing a delinquency charge for each month that the skipped payment remains outstanding. Q15-5a: Allocation o f excessive payment. As sume that beginning in January a consumer’s payment on an installment loan is $40 a month. The consumer pays only $35 of a $40 January payment and a late charge of $5 is imposed on the account. If the following m onth’s payment is for $45, may the creditor use the extra $5 to pay off the late charge and impose another late charge since the previous m onth’s payment is still deficient $5. A: If a consumer’s payment could bring the account current except for an outstanding late charge, no additional late charge may be imposed. Effective August 1, 1988, the following ques tions and answers have been added: SECTION 227.13—Unfair Credit Contract Provisions Q 13(a)-2: Language lim iting confession-ofjudgm ent provision. If a bank uses m ultipur pose credit contracts, may the bank include a confession-of-judgment clause with qualifying language indicating that the clause is not ap plicable in a consumer-purpose loan—such as, “You confess judgment to the extent the law allows,” or “This clause applies only in business-purpose loans”? 3 R egulation A A (S taff G uidelines) A: No. Given the public-policy purpose of the rule, a bank may not have a confession-ofjudgment clause in a consumer credit con tract, even with limiting language. Therefore, when a multipurpose form is used for a consumer-purpose loan, the bank must cross out, blacken in, or otherwise indicate clearly the removal of the prohibited clause from the loan document. Q 13(d)-3a: Refinancing (new creditor)— original loan purchase money. On the same facts as those detailed in Q 13(d)-3, assume that the consumer refinances the loan with a different bank. May that bank acquire the se curity interest of the purchase-money lender in household goods without violating the rule? A: Yes, the bank may acquire the security in terest of the purchase-money lender without violating the rule. 4 SECTION 227.16—State Exemptions Q 16(b)-3. Exemptions granted. W hat states have been granted an exemption from the Board’s rule? A: The state of Wisconsin was granted an ex emption from all provisions of the Board’s rule effective November 20, 1986, for transac tions of $25,000 or less. The state of New York was granted an exemption from the co signer provisions o f the Board’s rule effective January 21, 1987, for transactions of $25,000 or less. In both Wisconsin and New York, transactions over $25,000 are subject to the Board’s rule, but compliance with state law is deemed compliance with the federal law. The state of California was granted an exemption from the cosigner provisions of the Board's rule effective August 1, 1988. These exemp tions do not apply to federally chartered institutions.
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