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Today's Trends in Credit Regulation

Model Contract Clauses
By Elizabeth C. Yen

Elizabeth Warren, charged with organizing the new Consumer Financial Protection Bureau, wants the financial services industry to use short and simple credit card and mortgage agreements that are easy for consumers to understand. She has said that “[t]he new consumer bureau is based on a pretty simple idea: people ought to be able to read their credit card and mortgage contracts and know the deal.”[1] Specifically about credit card agreements: “What should we drive toward? Short agreements that can be read in very little time with very high levels of understanding.”[2]

On the credit card side, the Federal Reserve Board may be trying to move the industry one small step closer to shorter agreements. For example, certain unsecured credit card account servicing fees may now be disclosed verbally to cardholders, which may help to shorten agreements slightly. Perhaps more significantly, the Board is prohibiting certain information from being included in a credit card agreement’s disclosure table, and requiring use of certain specified phrases to describe fairly complex concepts. For example, if a credit card issuer uses the average daily balance method to calculate and accrue finance charges, the account-opening disclosure table must use a certain specified phrase to describe that method. The Board has also recently proposed prohibiting credit card issuers from including certain supplemental information within the account-opening disclosure table about how the finance charge grace period works for new purchases. The Board’s focus seems to be on mandating the use of specific succinct phrases within the disclosure table, as short-hand for complex concepts that may be subject to minor implementation variations from card issuer to card issuer, on the theory that more elaborate disclosures are not well understood by consumers.

The revised federal model privacy policy disclosure format uses a similar approach to disclosing fairly complicated information sharing practices: short model phrases should be used to convey a financial services company’s information sharing practices, with only minimal variations permitted (if a financial services company wants to rely on the safe harbor provided by the new model disclosure format), while the actual permissible parameters of a company’s information-sharing practices are described in far greater detail in federal and state privacy laws and regulations.

However, one reason credit card and other consumer credit contracts have become so long is that, when consumers challenge a specific account servicing practice as being contrary to (or different from) what had been disclosed or expressly agreed upon, contracts are revised to add more specificity about the challenged servicing practice. Since open-end (revolving) consumer credit contracts also typically include certain required Truth in Lending disclosures, even if the disclosure aspects of the contracts fulfill all applicable disclosure requirements, consumers remain free to challenge a servicing practice as an unauthorized departure from the terms of the consumer credit contract.

To keep consumer credit contracts reasonably short and succinct, we will need to carry over the same principles of contract interpretation that are being used with model disclosure phrases: If a model, consumer-tested or governmentally-approved disclosure phrase is considered acceptable short-hand for a much more complex underlying concept, that same disclosure phrase also should be considered acceptable short-hand for contract interpretation purposes. Similarly, if Regulation Z allows disclosures to disregard certain minor irregularities (such as the fact that not all months have 30 days, or that some years have leap days), consumer credit contract terms and conditions should similarly be allowed to omit discussion of such minor account servicing irregularities without creating adverse consequences for account servicers (who may not all handle such irregularities in exactly the same way).

New consumer-tested “short-hand” contract phrases will also need to be developed and approved by applicable federal regulators for use in consumer credit contracts. For example, Regulation Z only requires a very short disclosure of the fact that a creditor is taking a security interest in certain types of property. However, as a matter of contract, the security agreement that creates and governs the security interest is of necessity quite long. If a credit card account is secured by a mortgage on the consumer’s home, consider the fact that the Fannie Mae/Freddie Mac uniform first mortgage deed is over 14 pages long (not counting riders).[3] If a credit card account is secured by the pledge of a new deposit account established and maintained with the card issuer, the card issuer may need to provide deposit account disclosures, terms and conditions, in addition to a pledge agreement. If electronic fund transfers are permitted to or from the pledged deposit account, additional disclosures, terms and conditions may be needed.

Without “safe harbor” short-hand phrases that will be conclusively allowed to stand in for more complex contract terms, consumers may continue to litigate whether their accounts are being serviced in a manner consistent with their consumer credit contract terms and conditions, and creditors may need to continue including more specificity, not less, in consumer credit contracts and security agreements.

Elizabeth C. Yen is a partner in the Connecticut office of Hudson Cook, LLP, headquartered in Maryland. She is admitted to practice in Connecticut only. The views expressed herein are personal and not necessarily those of any employer, client, constituent or affiliate of the author. Elizabeth can be reached at 203-776-1911 or by email at eyen@hudco.com.

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[1]See www.whitehouse.gov/blog/2010/09/17/fighting-protect-consumers.

[2]September 29, 2010 remarks at The Financial Services Roundtable leadership dinner.

[3]The Maine “plain English” version of the Fannie Mae/Freddie Mac first mortgage document is 2 pages longer than the “non-plain English” version used in other states. This provides a useful example of the tension between drafting an agreement that includes certain legal concepts not necessarily widely understood, in a manner that can be read with a relatively high level of understanding, and drafting that same agreement in a shorter, more succinct manner.

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