*This material is excerpted with permission from Pratt's State Law and Regulation of Closed-End Credit by D.S. Berenson. The publisher may be contacted at http://www.aspratt.com.

Often we see the terms "consumer credit sale" "retail installment transaction," and "conditional sale." The term consumer credit sale ostensibly refers both to open, or revolving, credit sales and to closed-end credit sales.

Open-end credit sales of consumer goods and services generally take the form of the seller's use of a credit card, often bearing the name of the seller or retailer from whom the consumer is making the purchase. The credit is open-ended because it allows the consumer to make additional purchases, and to carry the balance or debt incurred for an open period of time, so long as the minimum payments are made as agreed between the parties. In technical terms, this means that finance charge can be computed from time to time on the outstanding unpaid balance.

Alternatively, closed-end credit generally utilizes a fixed finance charge, and the customer is required to pay the debt off in regular payments, over a set amount of time. The closed-end transaction may take the form of a retail installment contract or simply a sales slip and an agreement to take back the purchase price in installment payments.

Typical examples of closed-end consumer credit sales include the financed home modernization purchase, whereby a contractor sells a home improvement to a consumer and offers to finance the purchase through installment payments. Many major appliances, such as consumer electronics, refrigerators, and furniture, are often sold on credit by the department store. Although many retailers now use a store credit card, the use of a retail installment contract is still quite common. The use of credit to fund service purchases has also seen new developments in recent years, as many medical procedures can now be purchased on credit. The use of "eye-paper" to finance laser eye surgery and "plastic paper" to sell plastic surgery procedures is now commonplace. Many business people do not realize that simple agreements to accept debt in installment payments, as often utilized by hospitals, doctors, utility companies and others, can trigger federal and state compliance requirements for credit sales, regardless of whether any interest charge is imposed on the debtor.

Thus, consumer credit sales of goods and services are, by their very nature, the most common form of credit used in our society. Yet this type of transaction is generally considered to be the lost child of the consumer finance industry. This is due to the fact that credit sales of consumer goods and services are generally of a smaller dollar amount, usually less than $10,000 and very often no more than $1,000 to $5,000. As such, they lack the financial sex appeal of an $80,000 mortgage or a $30,000 automobile financing. In addition, because the credit originates primarily from retail merchants, as opposed to large mortgage lending institutions or automobile dealerships, the industry is expansive but fragmented.

Another significant reason why this particular area of finance has been disregarded for so long is that consumer credit sales present special problems for state legislatures and regulators. The historical nexus of this problem is the distinction between a loan and a credit sale. Some legislators and attorneys have argued that the distinction between the two is more fiction than fact, that the taking of a loan of money to purchase goods as opposed to the purchase of the goods on credit are two sides of the same coin. They often point to the fact that the credit sale of goods under many state laws is exempted from the usury limitation imposed on more traditional lenders making loans of money, and that this is an unfair distinction without merit. However, the legal difference between a credit sale and a loan is distinct and true, and can be disarmingly summed up as follows: one is the sale of goods and services on credit, and the other is not.

Many state legislatures have yet to address the concept of the consumer credit sale, assuming that such practices are adequately covered by a small loan law or similar lending statute. In other cases, the issue has simply never been brought before the legislature for consideration. This causes difficulty for both the buyer and the seller in the transaction, as what often results is a regulatory black hole, upon which even the state's administrators sometimes prefer not to comment. Sellers and their counsel are left trying to discern the Byzantine interplay of state lending and security statutes, which will often conflict with one another or with the legal formalities of a credit sale as opposed to a loan of money.

A TYPICAL CONSUMER CREDIT SALE

A typical consumer credit sale can be illustrated by a brief look at the home remodeling and modernization industry. We use this example because very often the credit sale of a home improvement good or service is the most complex to follow and understand. Home improvement credit sales are also perhaps the most common like-product form of credit sale in the United States, and subject to increasing amounts of legislation and litigation.

The transaction generally begins when a home improvement contractor visits a potential consumer at the consumer's residence. A home improvement purchase is agreed to between the contractor and the consumer, perhaps for a new deck, a roof, windows, or an outdoor pool, and a home improvement contract is executed. At this point, we may consider the sale completed as a transaction, depending on the terms of the home improvement contract and its reference, or lack thereof, to any credit or financing agreement between the parties.

The contractor then offers, or the customer requests, payment options for the purchase price. Very often the ability to provide financing options to a consumer is a significant factor in consummating the sale. The contractor might have a number of different financing options at its disposal. One typical option is the use of a direct loan by a third-party lender. These direct lenders are usually banks, finance companies, mortgage companies, and the like. The contractor will usually complete a credit application for the consumer and forward it to the direct lender on the consumer's behalf. On occasion, the contractor may present the consumer with the lender's direct loan paperwork for completion and submission to the lender with the credit application. The lender then reviews the credit application and determines if it wishes to make a loan of money to the consumer. Very often the transaction takes the form of a consolidation loan, where the consumer has requested (or has been sold) not just money to pay off the home improvement purchase, but money to pay off an automobile loan, pay off credit cards, refinance a first or second mortgage, or obtain extra cash. The contractor is simply one of the creditors being paid off when the direct lender closes the transaction with the consumer. In essence, this is akin to consumers going out to seek their own financing to pay for the home improvement, but the process is assisted by relationships the contractor may already have with a direct lender.

A more common alternative is the use of the credit sale. Here, the contractor takes a credit application from the consumer and may complete financing paperwork at the same time, usually in the form of a retail installment contract. In other instances, the contractor may return to the consumer's residence at a later date to complete the finance paperwork. In these cases, however, it is the contractor that is listed as the creditor on the finance documents. In theory, it is the contractor, as creditor, who then must make a determination as to the merits of financing the sale of the home improvement. On occasion, and depending heavily upon state laws, the home improvement contractor may be able to provide the consumer with credit insurance, covering damage to property, loss of income, health insurance, and so on, or with the consolidation of other debts, paying off a mortgage, credit cards, and the like, no different from the direct lender. On occasion, the contractor may even be able to offer the consumer cash out of the transaction. All of these extras are included on the retail installment contract as part of the credit sale.

It is important to note that most, if not all, states view the assignment of the retail installment transaction between the contractor as the originating creditor and the investor as a secondary market transaction. That is, it is the contractor who is listed as, and remains liable as, the originating creditor in the transaction. Under the Truth in Lending Act (TILA), for example, it is the creditor who is responsible for providing the myriad disclosures and right of rescission a consumer may be afforded in a closed-end credit transaction. TILA defines "creditor," in part, as a person who extends credit and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when there is no note or contract. TILA 226.2(a)(17)(i). However, this does not necessarily mean that assignees have no cause for creditor liability concern. An assignee may also be liable as the creditor on a retail installment contract, depending on the circumstances of the situation. (See, for example, Ford Motor Credit Co. v. Cenance et al., 452 US 155; 101 S. Ct. 2239 (1981).)

Similarly, under the Real Estate Settlement Procedures Act (RESPA), where a contractor assigns its legal interests in a retail installment contract secured by real estate to a funding assignee, the funding assignee is considered the lender for purposes of RESPA disclosures. However, if the contractor can be defined as a creditor under the Consumer Credit Protection Act (CCPA) and makes more than $1,000,000 in financed deals a year, the contractor is considered the lender under RESPA. (See generally, Appendix B to 24 CFR Part 3500.) There are a number of open questions regarding this issue, which have yet to be addressed by case law or by the Department of Housing and Urban Development, but it will be adequate to note for our purposes that the question of "creditor" liability may remain open in many circumstances for both the credit seller and the assignee.

Of course, many consumer credit sales are much simpler than those seen in home improvement transactions. Often, the use of an assignee as the funding lender is not encountered, and in most non­home improvement credit sales there is never any question about the seller taking a security interest in the buyer's real estate, and as such RESPA does not comes into play. Indeed, many states have enacted separate regulations to address the credit sales of home improvement goods and services separate and apart from their RISA coverages. The unique considerations of home improvement credit sales have yielded a fertile breeding ground for improper conduct by some contractors and investors dealing in home improvement credit sale paper. In some instances, an unscrupulous home improvement salesperson may attempt to stack the credit sale with unneeded credit insurance or inappropriate fees and may fail to provide the necessary state or federal disclosures or rescissions, or accurately represent the financial terms required in such disclosures. Conduct such as this and similar actions have led to a noticeable taint to the home improvement industry itself since the 1960s, although the primary complains in home improvement transactions focused on deceptive sales practices that were technically unrelated to the financing of the sale. Fortunately, such practices have received increased scrutiny from consumer advocacy watchdogs, and many courts have now become used to seeing contractors and finance companies brought into court for alleged violations of state and federal disclosure laws and consumer protection statutes. Unfortunately, we have also seen a tremendous increase in litigation brought not so much for the sake of a wronged consumer, but to gin a technical error or a marginal claim into suits seeking statutory penalties and attorney fee awards under TILA, RESPA, and broadly worded state consumer protection statutes. Often, defendants find themselves pressured into costly settlements to avoid a forum hostile to the home improvement or lending industry, as well as costly litigation, runaway juries, and adverse publicity.