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F ederal R e se r v e Bank OF DALLAS W ILLIAM H. W ALLACE DALLAS. TEXAS 75222 F IR S T VICE P R E S ID E N T November 18, 1986 C ir c u la r 86-94 TO: The Chief Executive O fficer of a l l member banks and others concerned in the Eleventh Federal Reserve D i s t r i c t SUBJECT Update of staff guidelines on the Credit Practices Rule — Regulation AA DETAILS The Board of Governors of the Federal Reserve System has published an update to i t s guidelines on the C redit P ra c tic e s Rule, which ap p lies to a l l banks and t h e i r s u b s i d i a r i e s , concerning u n f a i r or deceptive a c ts or p r a c tic e s in the extending of consumer c r e d i t . The updated guidelines became e f f e c t i v e November 1, 1986. The r u l e applies to a l l consumer c r e d i t o b lig a tio n s except f o r the purchase of real property. The r u le p r o h ib it s banks from using c e r t a i n remedies to enforce consumer c r e d i t o b lig a tio n s and from imposing a l a t e charge p r a c tic e c a l le d pyramiding. I t provides p r o te c tio n s f o r cosigners in consumer c r e d i t t r a n s a c t i o n s . ATTACHMENTS The m aterial as published in the Federal R egister is a ttach ed . MORE INFORMATION For f u r t h e r information, please co n ta c t Sharon Sweeney of t h i s Bank's Legal Department a t (214) 651-6228. Sincerely yours, For additional copies of any circular please contact the Public Affairs Department at (214) 651-6289. Banks and others are encouraged to use the following incoming WATS numbers in contacting this Bank (800) 442-7140 (intrastate) and (800) 527-9200 (interstate). This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) 39646 Federal Register / Vol. 51, No. 210 / Thursday, October 30, 1986 / Rules and Regulations 12 CFR Part 227 [R eg. AA] Unfair or Deceptive Acts or Practices; Update of Staff Guidelines on the Credit Practices Rule AGENCY: Board of Governors of the Federal Reserve System. ACTION: Update of staff guidelines on the Credit Practices Rule. SUMMARY: The Board is publishing an update to the staff guidelines on the Credit Practices Rule, Subpart B of Regulation AA (Unfair or Deceptive Acts or Practices). The rule prohibits banks from using certain creditor remedies in connection with a consumer credit obligation, from using a late charge practice commonly referred to as pyramiding, and from obligating a cosigner prior to providing a required notice explaining the cosigner’s obligations. EFFECTIVE DATE: November 1 ,1 9 8 6 . FOR FURTHER INFORMATION CONTACT: Adrienne D. Hurt, Susan ]. Kraeger, or Heather Hansche, Staff Attorneys, Division of Consumer and Community Affairs, Board of Governors of the Federal Reserve System, Washington, DC 20551 at (202) 452-3867 or (202) 452 2412; or Eamestine Hill or Dorothea Thompson, Telecommunications Device for the Deaf (TDD) at 9202) 452-3544. SUPPLEMENTARY INFORMATION: (1) Background On March 1,1984, the Federal Trade Commission (FTC) adopted its Credit Practices Rule, effective March 1,1985,pursuant to the authority granted the FTC under Sections 18(a)(1)(B) and Federal Register / Vol. 51, No. 210 / Thursday, October 30, 1986 / Rules and Regulations 5(a)(1) of the Federal Trade Commission Act (FTC Act), 15 U.S.C. 57a(a)(l)(B) and 15 U.S.C. 45(a)(1). Under this statute the FCT is authorized to promulgate rules that define and prevent "unfair or deceptive acts or practices” in or affecting commerce with respect to extensions of credit to consumers. Section 18(f) of the FTC Act, 15 U.S.C. 57a(f), provides that, whenever the FTC promulgates a rule prohibiting acts or practices which it has deemed to be unfair or deceptive, the Board of Governors of the Federal Reserve System must adopt a substantially similar rule prohibiting such acts or practices by banks. The Board must adopt a rule within 60 days of the effective date of the FTC’s rule unless the Board finds that such acts or practices by banks are not unfair or deceptive, or that the adoption of similar regulations for banks would seriously conflict with essential monetary and payments systems policies of the Board. In April 1985, the Board adopted a rule substantially similar to the FTC’s Credit Practices Rule (50 FR16695), thereby amending the Board’s Regulation AA, Unfair or Deceptive Acts or Practices (12 CFR Part 227). The Board modified certain provisions of the FTC’s rule in order to take into account the needs and characteristics of the banking industry. The Board’s rule went into effect on January 1,1986. (2) Summary of the Rule The Board's rule applies to all consumer credit obligations other than those for the purchase of real property. It prohibits banks from using certain remedies to enforce consumer credit obligations. Under the rule, banks may not include these remedies in their consumer credit obligations, and if banks purchase obligations that contain a prohibited provision(s), banks are prohibited from enforcing the provision(s). The prohibited provisions are: (1) Confessions of judgment; (2) waivers of exemption; (3) wage assignments; and (4) nonpossessory, nonpurchase money security interests in household goods. In addition, the rule prohibits a certain late charge practice, and provides protections for cosigners in consumer credit transactions. The Board's rule applies to all banks and their subsidiaries. Institutions that are members of the Federal Home Loan Bank System and nonbank subsidiaries of bank holding companies are covered by the rules of the Federal Home Loan Bank Board and the FTC, respectively. (3) Staff Guidelines Staff guidelines on the Board’s Credit Practices Rule were issued in November 1985 (50 FR 47036). The staff guidelines are in question and answer format. The questions are identified by hyphenated numbers. The first part of the number indicates the regulatory section; the second part, the sequential order of a particular question within that section. For example, 13(d)-l indicates the first question in § 227.13(d). Headings are included to make it easier for users to locate questions. The guidelines focus on material of general application that will be useful to most banks, and are expected to be the vehicle for answering questions about the rule. The guidelines will be updated annually, as necessary. This first update addresses new questions that have arisen under the rule and amends certain questions and answers that were issued in November 1985. (4) Explanation of Revisions to Guidelines Following is a brief description of the revisions to the staff guidelines on the Board’s Credit Practices Rule: Introduction The last sentence of the scope and enforcement section has been changed to accurately reflect that the Federal Deposit Insurance Corporation has enforcement responsibility under the Credit Practices Rule for insured statechartered banks that are not members of the Federal Reserve System. Section 227.11 A uthority, purpose, and scope. Question ll(c)-2 has been added to this section. Section 227.12 Definitions. Questions 12(a)-10,12(a)-ll, 12(b)-la, and 12(b)-lb have been added to this section. Section 227.13 Unfair credit contact provisions. Question 13-4,13-5,13(b)-3,13(c)-5, and 13(d)-10 have been added to this section. Question 13-3 had been revised to address the application of § 227.13 to a renewal (as well as a refinancing) of a credit obligation entered into prior to the effective date of the rule. Language has been added to Ql3(d)-5 to explain that with regard to subsequent refinancings of a purchase money loan transaction secured by household goods in which additional funds are obtained, while the rule does not require a bank to release a proportionate amount of the security interest taken in the household goods as the loan amount decreases, certain state laws (for example, in those states that have adopted the Uniform Consumer Credit Code) may impose such a requirement. Editorial changes were 39647 also made to Ql3(d)-5 with no change in substance intended. Section 227.14 Unfair or deceptive practices involving cosigners. Question 14(b)-13a has been added to this section. A technical amendment was made in Q14-1 to accurately reflect the provision of the rule cited in the first sentence of the answer. The answer to Ql4(b)-13 on continuing guaranties has been revised to make it clear that where a cosigner executes a continuing guaranty, a bank should modify the cosigner notice to accurately reflect the extent of the guarantor's obligation. If, for example, the guaranty applies to all future debts, the first sentence should indicate that the cosigner is being asked to guarantee not only that loan, but also the future debts of the borrower (up to a certain date or amount, as appropriate). The answer to Ql4(b)-14 has been revised to make it clear that if a cosigner is obligated under a consumer credit agreement for refinancings as well as renewals of an obligation, a bank is not required to give a cosigner notice upon each renewal or refinancing (since the cosigner is already obligated), even if the cosigner is required to execute a new note for each renewal or refinancing. Section 227.15 Unfair late charges. Question 15-5a has been added to this section. Question 15-2 has been revised to address partial payments as well as skipped payments; skipped payments and partial payments are treated the same way under § 227.15. List of Subjects in 12 CFR Part 227 Banks, Banking, Consumer protection, Credit, Federal Reserve System, Finance. (5) Text of revisions The revisions to the staff guidelines on the Credit Practices Rule read as follows: Introduction * * * * * 3. Scope; enforcement. The Board’s rule applies to all banks and their subsidiaries. Institutions that are members of the Federal Home Loan Bank System and nonbank subsidiaries of bank holding companies are covered by the rules of the Federal Home Loan Bank Board and the FTC, respectively. The Board has enforcement responsibility for state-chartered banks that are members of the Federal Reserve System. The Office of the Comptroller of the Currency has enforcement 39648 Federal Register / Vol. 51, No. 210 / Thursday, October 30, 1986 / Rules and Regulations responsibility for national banks. The Federal Deposit Insurance Corporation has enforcement responsibility for insured state-chartered banks that are not members of the Federal Reserve System. 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 Section 227.11 Authority, Purpose, and the rule and that the credit obligation Scope. contained a provision ultimately * * * * * prohibited by the rule. Assume further Qll(c)-2: Industrial loan companies. that the credit obligation is refinanced Are industrial loan companies subject to after the effective date of the rule. May the Board’s rule? the refinanced obligation contain the A: Industrial loan companies that are prohibited provision, or is the insured by the Federal Deposit refinancing subject to the rule? Does the Insurance Corporation are covered by same hold true or renewals of the the Board’s rule. original credit obligation? A: There is no distinction in the Section 227.12 Definitions. treatment of renewals and refinancings 12(a) “Consumer” for purposes of the rule. A refinancing or * * * * * renewal entered into after the effective Ql2(a)-10: Lease transactions. Are date of the rule is subject to the rule consumer lease transactions covered by and, therefore, may not contain a the rule? contract provision prohibited by the A: The rule covers only consumer rule. credit obligations. A lease transaction Q13-4: Open-end account—future would be covered by the rule only if the advances made under the plan. If a bank transaction is a credit sale as defined in entered into an open-end credit Regulation Z. obligation with a consumer prior to the Ql2(a)-ll: Trusts. Are extensions of effective date of the rule and that credit made to a consumer through a agreement contained contract provisions trust covered by the rule? ultimately prohibited by the rule, may A: Yes, such extensions of credit are the bank enforce those contract covered by the rule, unless the credit is provisions as to future advances made being extended through a nonprofit trust under the plan after January 1,1986? (as the rule does not apply to nonprofit A: Yes, contract provisions ultimately organizations). prohibited by the rule can be enforced in such a situation since the advances are 12(b) “Cosigner” being made as part of an open-end * * * * * agreement that was entered into before Ql2(b)-la: Business entities as the effective date of the rule, and the cosigners. If a partnership or a rule is not intended to have retroactive corporation cosigns a consumer credit effect. (See, however, Q15-8.) obligation, is such an entity a cosigner Q13-5: Prohibited provisions in for purposes of the rule? Must the bank cosigner agreement. May a bank include provide a cosigner notice? any of the provisions prohibited by the A: No, the rule applies only to natural rule in the documents obligating a persons who are cosigners. cosigner on a consumer credit obligation Consequently, the rule does not require (for example, in a guaranty agreement)? a bank to provide a cosigner notice A: A bank may not include any of the when a partnership, corporation, or prohibited provisions in the documents other business entity serves as a obligating a cosigner. The agreement cosigner on a consumer credit between the bank and the cosigner, obligation. even if executed separately, is part of Ql2(b)-lb: Dealer guarantee. Where a the consumer credit obligation and is bank and an automobile dealer, for therefore subject to the rule’s example, enter into an agreement prohibitions. whereby the bank purchases a consumer credit obligation from the dealer and the 13(a) Confession of Judgment * * * * * dealer guarantees the obligation, must the bank provide a cosigner notice to the 13(b) Waiver of Exemption dealer? * * * * * A: No, the rule is not intended to apply in such recourse agreement Ql3(b)-3: Language o f contract situations where the bank is purchasing provision limiting applicability of dealer paper. waiver. If a bank’s consumer credit * * * * * contracts contain a clause that states “I waive my state property exemption 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 secures this loan,” for example, would be a permissible waiver of exemption provision under the rule. 13(c) Assignment of Wages * * * * * Q13(c)-5: Offer o f a commission as security. Is the rule’s prohibition against a bank's taking an assignment of a consumer’s future wages 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 assignment; the fact that it has not yet been received by the consumer does not affect its treatment under the rule. * * * * * 13(d) Security Interest in Household Goods * * * * * Ql3(d)-5: Refinancings—releasing a portion o f security interest. When a bank has entered into a purchase money loan transaction secured by household goods and then advances additional funds to the consumer in subsequent refinancings of that transaction, is the bank required to release a proportionate amount of the security interest in the household goods, as die original loan amount decreases? A: The rule does not require a proportionate reduction of the security interest as the original loan amount decreases; such may be required, however, under state law. * * * * * Ql3(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 consumer for household goods in which the bank originally had a permissible purchase money security interest? A: A security interest in substituted household goods would violate the rule’s prohibition on taking a nonpurchase money security interest in household goods unless the goods were substituted pursuant to a warranty; as such, the Federal Register / Vol. 51, No. 210 / Thursday, October 30, 1986 / Rules and Regulations goods would be considered part of the original money transaction for purposes of the rule. * * * * * 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. * * * * * Section 227.15 Unfair Late Charges. * * * * * Q15-2: Skipped and partial payments. What 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 passes in which the consumer fails to make the missed or “skipped” payment or to pay the outstanding balance of the partial payment? A: Yes, the rule does not prohibit the bank from assessing a delinquency charge for each month that the skipped or partial payment remains outstanding. 14(b) Disclosure Requirement * * * * * Ql4(b)-13: Continuing guaranties. When must a bank give the cosigner * * * * * notice to a guarantor who has executed a guaranty for not only the original loan, Ql5-5a: Allocation o f excessive but also for future loans of the primary payment. Assume that beginning in debtor? Must a cosigner notice be given January a consumer’s payment on an to the guarantor with each subsequent installment loan is $40 a month. The loan to the primary debtor? consumer pays only $35 of a $40 January A: The cosigner notice should be payment and a late charge of $5 is provided before the guarantor becomes imposed on the account. If the following obligated on the guaranty—that is, at month’s payment is for $45, may the the time the guaranty is executed. The creditor use the extra $5 to pay off the cosigner notice need not be given to the late charge and impose another late guarantor with each subsequent loan charge since the previous month’s made to the primary debtor, since the payment is still deficient $5? cosigner is already obligated under the A: If a consumer’s payment could original contract to guarantee future bring the account current except for an indebtedness. However, since the outstanding late charge, no additional guarantor is being asked to guarantee late charge may be imposed. not only the original debt, but also the * * * * * future debts of the primary obligor, the Board of Governors of the Federal Reserve cosigner notice should be modified to System, October 24,1986. accurately reflect the extent of the William W. Wiles, guaranty obligation. For example, the Secretary of the Board. first sentence of the cosigner notice [FR Doc. 86-24517 Filed 10-27-86; 3:16 pm] could read “You are being asked to BILUNG CODE 6210-01-M guarantee this debt, as well as all future debts of the borrower entered into with this bank through December 31,1987.” Ql4(b)-13a: Continuing guaranties— open-end plan. If a cosigner executes a guaranty on an open-end credit plan (that is, one guaranteeing all advances made under the plan), does the bank have to modify the cosigner notice 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. Ql4(b)-14: Renewal or refinancing of credit obligation. What happens when a credit obligation involving a cosigner is renewed or refinanced? Must a bank give the cosigner another notice at the time of the renewal or refinancing? A: If under the terms of the original credit agreement the cosigner is obligated for renewals 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. 39649
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