Our U.S. Senators are working hard to protect consumers, but we’re not sure they have thought through this one. Senate Bill 257, introduced in January as the “Consumer Credit Fairness Act,” resuscitates an effort that started last July. The two-page bill creates a class of “high cost” credit transactions that would be exempt from claims by the creditor for distribution in bankruptcy.
Under the bill, a “high cost consumer credit transaction” means an extension of credit by a creditor that results in a consumer debt with an Annual Percentage Rate, plus “costs and fees incurred in connection with the extension of such credit,” that at any time while the credit is outstanding exceeds the lesser of:
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The sum of 15% and the yield on United States Treasury Securities having a 30-year period of maturity; or
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36%.
In other words, the rate calculation becomes a moving target, increasing incrementally each time the creditor assesses a late charge or returned check fee, or when the creditor seeks repossession fees, attorney fees, or collection costs. More on that later.
The bill disallows creditors from making a claim for distribution from the bankruptcy estate if the claim arises out of a high cost consumer credit transaction. Simply put, creditors who knowingly or unknowingly find themselves holding a “high cost consumer credit transaction” need not file a proof of claim or otherwise try to participate in the administration of the bankruptcy estate. SB 257 will deprive those creditors of any distribution if the bankruptcy estate has any assets.
But wait, there’s more. If the debtor has “any debts arising from a high cost consumer credit transaction,” the bill absolves the debtor from having to satisfy the “means” test that would require the court to dismiss a presumptively abusive Chapter 7 filing or convert it to a Chapter 13. Without the presumption of abuse that results from the Bankruptcy Code’s rough calculation of the debtor’s ability to repay the debts identified in the Chapter 7 petition, apparent abuse of the Code will have to be overcome using the more amorphous “bad faith” filing claims, the “totality of the circumstances” test and others available under the Bankruptcy Code.
The bill does not identify the “costs and fees” the creditor has to add to the APR to test whether it made a high cost consumer credit transaction. Presumably, Congress intends a broad interpretation of the phrase, such that it would include late charges, returned check fees and other life-of-loan fees, like repossession and collection costs. To the extent those fees become part of the calculation of the rate trigger, even a conservatively underwritten and low-rate credit agreement can become a “high cost” transaction pretty quickly. Adding further to the confusion, the bill fails to identify the point in time when the creditor should look to the US Treasuries yield to test the rate against the triggers for a “high cost consumer credit transaction.” Again, assuming that Congress intended to leave this question unanswered, the creditor will have to measure rates against another moving target because if an extension of credit is ever a “high cost consumer credit transaction,” the restrictions of SB 257 apply. Finally, we do not know whether the bill will apply prospectively after its effective date or to existing credit transactions.
Right now, the rate trigger under this bill for an extension of credit to be a “high cost consumer credit transaction” would be a little higher than 19%. That is pretty high for a mortgage loan in the current interest rate environment, but rates on credit card accounts, payday loans, and subprime credit of just about any kind will exceed that threshold. Bills like this, should they become law, will have disastrous results on the availability of consumer credit, because creditors will not bear the credit risk associated with making even nominally non-prime loans. And when that credit dries up, the consumers who relied on it for basic necessities will have no other options available to them. The Obama Administration has made it a priority to try and restore the free flow of credit, but this bill and others like it go too far and will likely have the opposite effect.
A Senate committee intended to mark-up SB 257 in late May. Most recently, Senator Sheldon Whitehouse (D. R.I.) appended the substance of the bill to the Dodd-Shelby Credit Card bill, HR 627, in apparent hopes of getting it through Congress with an initiative that already has support from the Obama Administration. We’ll keep you posted on the developments.
Chuck Dodge is a partner in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Chuck at 410.865.5427 or by email at cdodge@hudco.com.