Summary of Attorney General Guidance on Skip-Payment Charges

Summary of Attorney General Guidance on Skip-Payment Charges

On November 18, 2016, Iowa Attorney General Thomas J. Miller’s office published guidance concerning the permissibility, disclosure and treatment of deferral fees under the Iowa Consumer Credit Code (“ICCC”) in connection with so called “skip-a-payment” programs like those offered by many Iowa credit unions. The Iowa Credit Union League’s understanding is that the guidance was issued in response to a complaint filed by the Iowa Bankers Association. Special Assistant Attorney General Jessica Whitney, who is also the Director of the AG’s Consumer Protection Division and Administrator of the ICCC, authored the guidance which is described as “a preliminary review based on information provided,” and “not a formal opinion or legal advice.”

The good news for Iowa credit unions is the guidance generally affirms the permissibility of deferral fees in connection with skip-a-payment programs.

The not-so-good news, however, is the guidance warns that skip-a-payment programs may be construed asdisguised refinancingsunder the ICCC and the federal Truth-in-Lending Act, thereby triggering all new TILA disclosures and rate computation for usury purposes. The practical effect may be that skip-a-payment programs become so cumbersome for lenders and inconvenient for consumers that they will no longer feasible for Iowa lenders.

Break Down of the Analysis Applied in the Guidance

Under the guidance, any skip-payment program involving closed-end, simple interest loans[1]that imposes any additional cost to the borrower is subject to re-characterization as a disguised refinancing and therefore requires a new loan agreement and new TILA disclosures prior to the deferral. The guidance bases this determination on an inferential interpretation of TILA’s “[d]isclosure requirements regarding post-consummation events” applicable to closed-end loans as implemented in Section 1026.20 of Regulation Z.

Section 1026.20 is intended to prevent evasion of TILA disclosure requirements which could otherwise result when significant new or different terms are applied to an existing closed-end loan. Section 1026.20 accomplishes this by construing the terms change as a refinancing[2] whenever the changes are so substantial that they effectively constitute a replacement of the existing loan with an new loan under different terms.

Section 1026.20 doesn’t provide much specificity as to what constitutes a constructive refinancing. It does, however, provide a non-exclusive list of five things that should not be considered a refinancing transaction, including:

“A change in the payment schedule or a change in collateral requirements as a result of the consumer’s default or delinquency, unless the rate is increased . . . .” 12 C.F.R. Part 1026(a)(4).

The Official Interpretation to this elaborates: “A workout agreement is not a refinancing unless the annual percentage rate is increased or additional credit is advanced beyond amounts already accrued plus insurance premiums.” Official Interpretation to 12 C.F.R. Part 1026(a)(4).

The guidance relies on this example to infer that a change in the payment schedule accompanied by an increase in finance charges is a transaction that constitutes a constructive refinancing under Section 1026.20. Under this interpretation, any skip-pay program that imposes an additional cost would be a refinancing and therefore requires a new loan contract and new TILA and ICCC disclosures at the time of deferral.

The guidance recognizes that deferral fees are finance charges for purposes of the ICCC based on the Iowa Supreme Court’s holding in Luttenegger v. Conseco Financial Servicing Corp., 671 N.W.2d 425 (2003). Under the Luttennegger decision, the court determined that the ICCC allows charges that are not explicitly enumerated other charges set forth in Iowa Code § 537.2501, “but treats them as part of the finance charge.” 671 N.W.2d at 433. Since skip-pay or deferral fees are not specifically enumerated in § 537.2501, they are finance charges and they therefore increase the loan’s overall effective APR.

The guidance also recognizes that skip-pay programs could also constitute refinancings if interest is compounded on the deferred balance. If the additional interest accrued during the deferral period is subject to compounding, the total amount of interest charged over the term of the loan would be increased, thereby resulting in a corresponding increase in the effective APR.

In either case - collection of a fee or compounding interest accrued during the deferral period - the overall effective APR would be increased as a result of the skip-pay program, and the guidance warns that the result could mean the program would be regarded as a refinancing under § 1026.20(a) of Regulation Z, thereby requiring a new contract and a new set of TILA disclosures.

Contrary Holdings

The guidance analysis does not distinguish contrary federal case law. Most notably, in Begala v. PNC Bank, Ohio, Nat. Ass’n, 163 F.3d 948 (6th Cir. 1998), the United States Court of Appeals for the Sixth Circuit concluded that acceptance of a deferral (or “payment holiday”) offer in exchange for payment of deferral fees does not constitute a refinancing under § 1026.20. The Sixth Circuit recognized in Begala:

• “Begala attempts to construe the deferrals as refinancings, but the Official Staff Commentary specifically precludes this . . . Begala cannot argue that each deferral authorization resulted in the cancellation of his old obligation and the substitution of a new obligation because it is the very operation of the old obligation-causing interest to accrue on the postponed payments at the rate of his loan to which he objects.” 163 F.3d at 951.
• Begala also cites 9th Circuit precedent from 1974: “Otherwise, subsequent events such as late payment charges, Christmas deferrals or prepayment of the obligation would each require a recomputation of the annual percentage rate. This result would be entirely unwieldy and impractical.” Bone v. Hibernia Bank, 493 F.2d 135, 140-41 (9th Cir. 1974).
• In summary: “No specific duty to make post-consummation disclosures arises under [TILA] or [Reg. Z], and each payment deferral cannot be construed as a new credit transaction, triggering TILA’s disclosure requirements.” 163 F.3d at 952.

The 6th Circuit reviewed a petition for rehearing en banc and took the opportunity to further clarify that Reg. Z says that courts must interpret “the deferral of individual installments as changes in the terms of an existing obligation, as opposed to a new credit transaction requiring new disclosures.” 163 F.3d at 952 (internal quotations omitted).

In Jackson v. Am. Loan Co., 1999 WL 417440 (N.D. Ill. June 1, 1999), the federal district court for the Northern District of Illinois came to the same conclusion. In Jackson, the plaintiffs argued that acceptance of a deferral offer canceled their old debt and created a new obligation upon renewal. The court disagreed and cited Begala and the Official Commentary to 12 C.F.R. Part 2026.20 to conclude that the plaintiffs did not refinance by cancelling and substituting obligations. The court determined:

• acceptance of the deferral offer and payment of the deferral charge merely extended the payment date.
• “The language of the Official Comment expressly excludes such a deferral from falling under the definition of ‘refinancing’ absent the extinguishment of the prior obligation and substitution of a new obligation.” 1999 WL 417440, at *2.

Select Questions and Answers Concerning the AG Guidance

• Given the new guidance can a credit union continue its skip-pay program on closed-end, simple interest loans? And can it offer the program without treating it as a refinanced loan?

A credit union can continue its skip-pay programs, but doing so in compliance with the new guidance makes it a lot more difficult and a lot less profitable. Although the guidance does not conclusively determine that a skip-pay program must be treated as a refinancing, it acknowledges uncertainty and does advise that creditors “should . . . make an additional set of refinancing disclosures via a separate written agreement regarding the terms due to the deferral of a closed-end, simple interest loan.”

The only way to implement a skip-pay program for closed-end, simple interest loans without treating it as a refinancing - i.e., requiring a new loan agreement/note and providing all new upfront disclosures - under the guidance would be to have a program that does not involve additional costs to the consumer. No fee could be charged for the deferral and interest charged during the deferral period could not be subject to compounding.

• How can a credit union mitigate its risk when offering a skip-pay program?

The best way to mitigate legal and compliance risk involving skip-pay programs offered in connection with closed-end, simple interest loans is to follow the new guidance. That is, either do not impose additional costs in connection with the program or treat the skip-pay program as a refinancing and require a new loan agreement and TILA disclosures for each customer that chooses to participate. Include all skip-pay fees as finance charges in your new (refinancing) TILA disclosures and in your computation of any maximum allowable rate.

• What if my credit union’s program has already started, what is the risk with continuing the program?

The guidance is an informal interpretation of existing law rather than the enactment of a new law. In other words, the guidance tells us what the law means and has always meant so it applies retrospectively. Unless your skip-pay program is already set up as a refinancing, you are potentially at risk of litigation and regulatory enforcement for violations of TILA and the ICCC. If you have already communicated skip-pay offers to your members, you could potentially avoid liability by waiving all associated fees and applicable compounded interest. You should seek qualified legal advice to evaluate your program and potential solutions.

• Do you recommend I get a legal opinion letter from an attorney to continue the program?

I strongly recommend that you seek legal advice from an attorney qualified to advise you on matters involving the ICCC if your credit union offers a skip-pay program in Iowa. Neither this outline or program nor the guidance evaluates specific factors that may be relevant to your program. This outline and program describe the guidance and related issues in a very general way and do not apply facts concerning any actual skip-pay program. This outline and program are not intended as legal advice.

• How do you calculate the APR? Is it added to the total finance charge listed on the original loan document or is it based on the remaining term of the loan?

If your skip-pay program involves additional costs to the borrower that are finance charges under the ICCC, the guidance recommends treating the program as a refinancing and therefore requiring a new loan agreement and TILA disclosures. As such, you would calculate the new APR in the same manner as any other loan - by including the sum of all finance charges during the loan term in the APR computation. The term of the refinancing would be the remaining loan term, so the effect of the guidance is that the APR (and rate for usury purposes) would be based on the remaining term of the original loan. Finance charges collected prior to the deferral would not be included in the computation because they would not be part of the constructive refinancing.

• What is an informal advisory opinion by the AG? Is it now the law?

The last paragraph of this guidance specifically states that it “is an informal opinion of the Administrator,” and that “it is neither an official opinion of the Attorney General nor a formal ruling of the Administrator.” Technically, therefore, it is not the law and potentially it will have no bearing whatsoever on how any court or agency might apply the ICCC to skip-pay programs.

Even if the guidance were a formal attorney general opinion, its force and effect would still be somewhat vague. For instance:

• The Iowa Supreme Court has held, “Opinions of the Attorney General are not binding upon the Supreme Court, and it is the duty of the Supreme Court to make independent inquiry as to interpretation to be given statutes interpreted by the Attorney General.” Des Moines Ind. Community School Dist. v. Armstrong, 95 N.W.2d 515 (Iowa 1959).
• However, the court has also said, “Opinions of Attorney General are entitled to careful consideration by courts and are generally regarded as highly persuasive but are not binding on judiciary which has duty to enter upon independent inquiry as to interpretation to be placed on statutes involved in proceeding before the court.” City of Nevada v. Siemmons, 59 N.W.2d 763 (Iowa 1953) (emphasis added).
• In practical terms, it might depend on who you ask. An official Attorney General Opinion has said, “Opinions of Attorney General constitute a body of legal precedents having authority the same in kind, if not the same in degree, with decisions of the courts, and administrative officers should regard them as law until they are withdrawn or overruled by the courts.” Op. Atty Gen. 1911-1912; 1912 WL 48709.

The bottom line is this: Whether formal or informal, any interpretation of the ICCC that comes out of the Attorney General’s office, particularly an interpretation authored by the Assistant Attorney General who is responsible for the ICCC, will be persuasive to courts and agencies and must be taken very seriously.

• Was there a change in the law that brought about this new position?

The impetus for the guidance is not apparent in the guidance itself, although it is clear that the guidance responds to an inquiry posed to the AG’s office. There was no change in the ICCC that caused a need for clarification.

• Could this advisory impact other lending programs such as loan workout arrangements for troubled borrowers?

Possibly. If you charge a fee in connection with the workout arrangement then the same principles would apply.

The guidance relies on one of the specified exclusions from what should be considered a refinancing under Section 1026.20 as the basis for its determination. Specifically, as cited above, the guidance relies on Section 1026.20(a)(4) and its Official Interpretation, which provides:

“A workout agreement is not a refinancing unless the annual percentage rate is increased or additional credit is advanced beyond amounts already accrued plus insurance premiums.”

By inference, therefore, a workout agreement that does increase the annual percentage rate arguably is a constructive refinancing for purposes of Section 1026.20. The guidance relies on this inference to construe deferral programs as constructive refinancings, so the same rule would arguably apply to workouts.

RONALD K. VASKE is a partner in Lindquist & Vennum’s Financial Institutions practice group and co-chair of the firm’s Payment Systems and Consumer Financial Services practice. His experience in consumer financial services dates back more than 25 years, first as a manager for a financial institution’s national credit card business and, for the past 18 years, as an industry specialist in private law practice. Ron advises banks and other financial services firms in compliance, regulatory supervision, third party relationships, business transactions, litigation management and strategic planning matters. He works with clients in preparing for and responding to both compliance and safety and soundness examinations, including supervisory enforcement and appeals, as well as day-to-day compliance and business strategy. Ron regularly speaks at national conferences regarding issues concerning consumer financial services and payment systems.

[Disclaimer: Nothing herein should be considered legal advice. You should seek qualified Iowa counsel for specific advice.]

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[1] The guidance only affects skip-payment programs for closed-end, simple interest loans. Although it provides a brief summary of ICCC provisions concerning deferral charges for closed-end, precomputed loans - which are specifically provided for statutorily and allowed under the ICCC - the guidance solely analyzes and provides direction for treatment under the ICCC of deferral charges associated with closed-end, simple interest loans. Similarly, the guidance refers to the ICCC’s change in terms provisions that would control disclosure of deferral programs for open-end loans.

[2] These re-characterized terms changes are referred to as “constructive refinancings” because the changes are construed as refinancings under Section 1026.20.