The California Court of Appeal, Third District, recently ruled that the FTC's "holder rule" allows consumers to assert causes of action against the owner of their consumer installment sale contract for alleged violations of California's Consumer Legal Remedies Act, as well as for negligence stemming from improper repair of the vehicle, even though these allegations would not render the transaction "practically worthless."
The Court also concluded, however, that the purchasers' state-law cause of action for negligent credit defamation was preempted by the federal Fair Credit Reporting Act, and that they lacked standing as third-party beneficiaries under a dealer agreement which provided protective warranties benefiting only the holder of the debt and not the consumers.
A copy of the opinion is available at: http://www.courts.ca.gov/opinions/documents/C067812.PDF.
Plaintiffs-consumers ("Consumers") purchased a motor home from defendant dealer ("Dealer") that they financed with an installment agreement. Consumers also paid Dealer for an extended service contract. Shortly after selling the motor home to Consumers, Dealer assigned the installment contract to defendant bank ("Bank") pursuant to an agreement whereby Dealer promised to defend Bank against any legal action arising out of the sale of the motor home. The agreement further indicated that Bank's failure to exercise any rights or to require Dealer's performance of any duties under the agreement would not operate as a waiver of rights under the agreement.
Due to alleged ongoing electrical problems with the motor home that were never repaired despite Consumers' efforts, Consumers wrote to the manufacturer of the motor home explaining their plight, as well as to Bank stating that they would stop payments on the loan until repairs were made. Further, their attorney later notified Dealer, Bank, and the manufacturer, among others, that Consumers had relinquished their ownership interest in the vehicle, indicating that Consumers would be seeking compensation for their troubles.
After Consumers stopped making the payments on the motor home and disclaimed their ownership in the vehicle, Bank re-possessed the motor home. However, while taking no action to collect on the loan, Bank also reported to various consumer credit reporting agencies that Consumers had defaulted on the installment agreement.
On the theory that both California law and the Federal Trade Commission's ("FTC's") so-called "Holder Rule" allowed them to assert against Bank the same claims they had against Dealer or the manufacturer, Consumers then sued Dealer, Bank, and others, asserting various causes of action, including breach of warranty, breach of contract, breach of the covenant of good faith and fair dealing, violation of California's Consumer Legal Remedies Act ("CLRA"), negligence for improper repair of the motor home, and negligent defamation of credit for Bank's supposedly improper reporting of incorrect credit information to credit bureaus.
Further, asserting that they were third-party beneficiaries of the dealer agreement between Bank and Dealer, Consumers also sought declaratory and injunctive relief as to Bank's liability under that agreement and on whether the return of the motor home nullified any potential claim of Bank to a security interest in the motor home.
Bank demurred as to the causes of action relating to the CLRA, negligence, negligent credit defamation, and declaratory and injunctive relief. Bank also moved for summary adjudication on the remaining causes of action.
The lower court sustained the demurer without leave to amend and entered summary judgment in favor of Bank, reasoning in part that the Holder Rule did not permit Consumers to assert claims against Bank that related only to Dealer's duties under the installment contract. The lower court further ruled that Consumers' cause of action for disparagement of credit was preempted by the federal Fair Credit Reporting Act, 15 U.S.C. § 1681, et seq. Noting that Consumers' affirmative relief was "limited to no more than what they have already paid on the contract, the lower court also awarded attorney's fees to Bank. Consumers appealed.
The Appellate Court reversed, concluding among other things that the Holder Rule applied to allow Consumers to assert against Bank the claims they otherwise had against Dealer, but limited Consumers' recovery to no more than what they already paid under the installment contract. The court also reversed the award of attorney's fees.
As you may recall, the "Holder Rule" requires that the following language, set in all capital letters of at least 10-point typeface, prominently appear in every consumer installment contract that is assigned to a subsequent creditor: "Notice: Any holder of this consumer credit contract is subject to all claims and defenses which services obtained pursuant to or hereto or with the proceeds hereof. Recovery hereunder by the debtor shall not exceed amounts paid by the debtor hereunder." 16 C.F.R. § 433.2.
In addition, California's CLRA makes unlawful various "unfair methods of competition and unfair or deceptive acts or practices" in sales transactions and requires that a plaintiff who intends to assert a damages claim under the CLRA provide at least 30 days' notice to prospective defendants of the alleged violations and "[d]emand that such person correct, repair, replace or otherwise rectify the goods or services alleged to be in violation" of the CLRA. See Cal. Civ. Code §§ 1770, subd. (a), 1780, 1782, subd.(a)(2).
Finally, the federal Fair Credit Reporting Act ("FCRA") concerns issues related to credit reporting and completely preempts all state common law tort claims against furnishers of credit information arising from conduct regulated by the FCRA. See 15 U.S.C. § 1681t(b)(1)(F). See also, e.g., Riegel v. Medtronic, Inc., 552 U.S. 312, 324 (2008)(holding '[a]bsent other indication, reference to a State's "requirements" includes its common-law duties"); Sanai v. Saltz, 170 Cal. App. 4th 746, 773 (2009).
Noting a split of authority interpreting the Holder Rule, but analyzing the Holder Rule according to what the Court saw as the plain meaning of its language, the Court of Appeal ruled that the Holder Rule allows a consumer to assert against the holder of a consumer credit contract "all claims and defenses" that the consumer could assert against the seller, including claims based on negligence and the CLRA. See Music Acceptance Corp. v. Lofing, 32 Cal. App.4th 610, 627-28 (1995)(noting in part that in abrogating the holder in due course doctrine in consumer credit transactions, the FTC shifted the burden of seller misconduct to the creditor); Oxford Fin. Companies, Inc. v. Velez, 807 S.W.2d 460, 463 (Tex. App. 1991). In so ruling, the Court rejected Bank's assertion that the Holder Rule was ambiguous and limited to those situations where a seller's breach of contract rendered the transaction "practically worthless." See, e.g., Ford Motor Credit Co. v. Morgan, 536 N.E.2d 587 (1989)(avoiding "plain meaning" interpretation of Holder Rule).
With respect to damages, the Court also ruled that, as expressly stated in the Holder Rule, Consumers' recovery against Dealer and Bank was limited to the amount they already paid under the installment contract.
Turning to the lower court's dismissal of the causes of action based on alleged CLRA violations, and negligence, the appellate court concluded that Consumers were not barred from asserting those causes of action. Among other things in so doing, the court determined that, contrary to Bank's assertion, Consumers had satisfied the CLRA's notice requirements by their various letters to Bank, Dealer and the manufacturer. Second, clarifying the distinction between the causes of action for negligence and negligent credit defamation, the court ruled that to the extent the negligence claim was based on the alleged failure to repair the motor home and not on derogatory remarks on Consumers' credit reports, the negligence cause of action against Bank remained viable. However, with respect to Consumers' claim that Bank negligently reported inaccurate credit information to credit agencies, the court ruled that, pursuant to the express preemption provision in the FCRA, their state-law cause of action for negligent credit defamation was preempted.
Finally, ruling that Consumers were not third-party beneficiaries of the dealer agreement between Bank and Dealer because Dealer made warranties under that agreement specifically to benefit Bank and not Consumers, the Court concluded that Consumers lacked standing to seek declaratory and injunctive relief under the dealer agreement. The Court also ruled that Consumers had forfeited their remaining causes of action for failure to present sufficient legal arguments.
Accordingly, the Court reversed the judgment in Bank's favor on the CLRA and negligence causes of action and also reversed the lower court's order awarding attorney's fees and costs to Bank.
Ralph T. Wutscher
McGinnis Wutscher LLP
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