The Dodd-Frank Act prohibits “abusive” acts and practices in the offering or provision of consumer financial products and services. That prohibition was new in federal law in 2010, and it engendered significant uncertainty about what would mark an act or practice as abusive. The Act identified four different types of potentially abusive conduct, each with elements set forth in the statute. But for each type, the statutory elements used some open-ended terms, like “unreasonable,” which the Consumer Financial Protection Bureau was left to elaborate. In particular, three of the four descriptions of abusive conduct in the Dodd-Frank Act involve “tak[ing] unreasonable advantage of” some characteristic that exposes consumers to potential harm (such as a lack of understanding of material risks). What qualifies as taking unreasonable advantage?
Bureau enforcement actions have shed at best a dim light on how the Bureau understands and applies these concepts, in part because there has been little occasion for actual briefing on abusiveness claims in the Bureau’s enforcement complaints. In the proposed rule on payday lending, the Bureau explained an abusiveness theory in a rulemaking for the first time. Nobody should realistically expect the Bureau to lay out a definition or a bright-line rule, and indeed this proposed rule did not. But how much leeway courts give the Bureau to determine what is “unreasonable advantage” will probably depend on the clarity and rigor of its reasoning when it makes those determinations.
As background, the payday proposal addresses two types of loans that the rule would define: covered short-term loans and covered longer-term loans. Subject to certain exceptions, a loan on which repayment is due within 45 days would be a covered short-term loan. A loan of longer than 45 days would be a covered longer-term loan if it has an interest rate over 36% and the lender either takes a vehicle title as collateral or “obtains a leveraged payment mechanism,” such as a right to make automated withdrawals from a bank account. For either type of covered loan, the proposed rule would determine that it is an unfair and an abusive practice to make a loan without reasonably determining that the borrower will have the ability to repay the loan. The rule would specify various ways a lender should make an ability-to-repay determination, and it would provide a number of exceptions. The exceptions are important and complicated, and the proposed rule would have a number of other features. But as indicated above, this post focuses on the proposed determination that lending without reasonable underwriting is an abusive practice. IIn addition, I’ll discuss only short-term loans, for the sake of brevity and because that will be enough to illustrate the point.
The Bureau would find that lending without underwriting “takes unreasonable advantage” of borrowers’ lack of understanding of material risks. The Bureau says payday borrowers don’t understand the risk that a first short-term loan will grow into a multi-loan sequence with much higher borrowing costs (and risks of default). Second, the Bureau would find that making covered loans without underwriting takes unreasonable advantage of borrowers’ inability to protect their interests. The proposal suggests that payday borrowers are unable to protect themselves from the risks just mentioned, because they borrow at times when they need cash immediately and don’t have the time, resources, or opportunity to find other sources.
The Bureau acknowledges that a lender can take some amount of advantage of a borrower. As the statute says, conduct is abusive only if it takes “unreasonable” advantage. In principle, a business could take advantage of consumers’ misunderstanding of risks, or inability to protect their interests, without being abusive, so long as the advantage doesn’t cross the line to being unreasonable. What leads the Bureau to think the accused practice is unreasonable here is a combination of “[s]everal interrelated considerations.” The Bureau observes that lending without regard to the borrower’s ability to repay is different from how lenders operate traditionally and in (says the Bureau) “virtually every other credit market.” Meanwhile, the proposal states, short-term lenders’ business model depends on consumers’ being unable to repay their loans, because customer acquisition costs are high enough that single short-term loans, paid in full, would not be profitable. “Also relevant” is the fact that payday borrowers generally have “moderate incomes, little or no savings,” and poor access to other credit. Finally, the proposal says that lenders do things that “further exacerbate the risks and costs” for consumers, such as using marketing techniques to push consumers to treat the loans as short-term credit, facilitating rollover into new loans, and not encouraging borrowers to pay down principal gradually as they reborrow.
The proposal doesn’t explain why these four considerations make the accused practice abusive. However, only the fourth seems potentially robust as a contribution to a decision that the practice takes unreasonable advantage. Strikingly, that is the one most tenuously related to the definition that the Bureau has actually proposed for an abusive practice.
The first two observations, about lenders’ business model, must stand or fall together. Failure to assess a borrower’s ability to repay, on its own, might be different from many other credit markets. (But perhaps not all. Microfinance famously relies on alternative models of loan decisionmaking.) Novelty and difference might be suspicious, but it would seem like a dangerous use of the law to make them indicators of unreasonableness. Moreover, in general it is hard to see how not assessing borrowers’ ability to repay would enable a lender to take any advantage of borrowers’ vulnerability to the risk of not repaying. As the proposal notes, a borrower’s failure to repay is, in most credit markets, bad for the lender. The critical difference here is that, according to the proposal, lenders don’t assess ability to repay because they would actually rather borrowers don’t repay immediately, but rather reborrow and support the business model.
This situation is to be assessed against the statutory criterion: that the practices “takes unreasonable advantage of” consumers’ inability to protect themselves. Consider the latter. There is evidently a population of consumers who need credit in urgent circumstances and who, for various reasons, have little choice about where to get it. Providing that credit will involve some cost. Charging the borrowers that cost, plus profit, might well amount to taking advantage of their inability to protect themselves. Still, as the Bureau acknowledges, only taking unreasonable advantage is abusive. Perhaps charging too much would be unreasonable. But the proposal does not go that way. Rather, it argues that the structure itself—imposing a hefty finance charge over a series of short-term loans and therefore not wanting the borrower to pay the first loan back in full—is an unreasonable way to collect the money. Why that should be so is not obvious, and the proposal does not say.
The Bureau’s third consideration is that payday borrowers tend to be particularly vulnerable. That vulnerability is certainly relevant to the question whether they are unable to protect their interests. And therefore it might be something a lender would try to take advantage of. But unless the Bureau means to suggest that for some vulnerabilities, any advantage a business might take would be unreasonable, the fact that many payday borrowers have an inability to protect their interests does not weigh in either direction on whether a particular business model is unreasonable.
That leaves us with the fourth consideration, the observation that payday lenders do marketing to push consumers to focus on the short-term—and thus underestimate the full costs and risks of the loans. That consideration does sound more like unreasonableness, and it is consistent with claims of abusiveness the Bureau has made in a few enforcement actions. Roughly speaking, the idea would be that payday lenders have partly caused or contributed to consumers’ vulnerability—the lack of understanding of the risks, and the inability to protect themselves—by using marketing techniques that obscure the risks and encourage consumers to underestimate them. Perhaps it might be acceptable to take advantage of preexisting consumer misapprehensions; but, in this line of thought, a practice becomes abusive when it profits from consumer misunderstanding that the lender has enhanced in service of its business.
To my eyes, that looks like a potentially quite viable theory of an abusive practice. However, it would not be the practice that the Bureau’s proposal identifies! Under the proposed rule, every covered short-term loan made without reasonably assessing the borrower’s ability to repay the loan would be abusive—regardless whether the lender had done anything to foster consumer misunderstanding. Conversely, a lender might obfuscate the costs of its loans by every means possible, which is the sort of conduct that led to the Bureau’s fourth consideration. Such a lender might achieve great success in inducing borrowers to take high-cost loans. But as long as it had assessed their ability to repay, it would not be liable for the abusive practice this proposal discusses.
All this might seem theoretical, because if the Bureau issues a rule that looks like the proposal, it will still have the unfairness determination, and the rule might look almost exactly the same even if a court struck the abusiveness finding. It is actually quite important. As a practical matter, a defendant facing potential liability will care a great deal whether lending without underwriting is only unfair, or is unfair and abusive. In the second situation, the same course of conduct might lead to multiple sets of civil penalties.
More significantly, though, the proposal’s discussion of “unreasonable advantage” is important for what it reveals about the Bureau’s approach to abusiveness. I suggest that the agency is still so awed by its new abusiveness authority that it is reluctant to use it as a real policymaking tool. Since the enactment of the Dodd-Frank Act, the power to find conduct abusive—even if it was not unfair or deceptive—has been a sword of possibly broad sweep that the Bureau could wield in its regulatory mission. As the discussion above indicates, the payday proposal contains material that might have supported a specific, precise finding about a relatively narrowly defined abusive practice. But adopting that finding, especially alongside the sweeping unfairness determination, might have brought “abusive” down to earth. Instead, the Bureau proposed to make an equally sweeping abusiveness determination, at the cost of providing a fairly vague and thinly explained rationale for the finding.
Courts may accept this, or they may develop a narrower understanding of “unreasonable advantage” on their own. The Bureau has taken a gamble on the scope of the prohibition on abusive practices.