No Fix, No Pay

It is a drearily familiar story: a consumer buys an auto, refrigerator, sofa or whatever, and signs a time-payment contract. The product quickly breaks down or proves otherwise defective, and the dealer refuses to repair or replace it. Understandably, the consumer then tries to withhold payment--only to find that his contract has been sold by the dealer at a discount to a bank, finance company or other lender. The lender proclaims, quite correctly, that as the purchaser of a presumably valid contract--in legal parlance, as a "holder in due course"--he has no responsibility for the merchandise but has a legal right to collect the payments. The consumer is stuck: he must continue paying for a no-good product that nobody will fix.

Now, after months of hearings, the Federal Trade Commission has moved to end this nightmare. In a ruling earlier this month, the agency decreed that a holder in due course is responsible for the merchandise, that a consumer can stop payment on a faulty product--and that all that has to be spelled out in bold type on the installment contract.* Consumers may still be sued by holders in due course for payment, but they now have a legal basis for defending themselves. The move will not prevent shoddy merchandise from reaching the marketplace. But since no bank or finance company wants to hire auto mechanics or TV repairmen, the FTC's action should make lenders more wary about buying contracts from merchants who will not stand behind the goods they sell.

Lots of Loans. The FTC'S ruling does not apply to contracts already in effect. Nor does it cover credit-card purchases (consumers are already protected under the Fair Credit Billing Act) or loans that the buyer himself arranges from a third party (an auto loan, say, from a bank). Rather, the regulation is aimed at credit deals set up by the seller --even if the seller only steers the consumer to a certain finance company. That adds up to a lot of business, says the FTC--$122 billion last year alone.

While the rule should inspire consumers to buy with more confidence, it does not please most lenders. Some object to the sweeping language. In reply, the FTC notes that though 40 states have passed laws defining in detail the liability of the holder in due course, few of them were really effective because merchants and lenders found loopholes. Another complaint is that the rule will force small lending institutions to do costly additional work in screening contracts. That, in turn, could lead to higher interest rates and thus harm low-income people who most need installment credit. Perhaps. But the last thing needed by any American, rich or poor, is credit to buy products so shoddy that no one will stand behind them.

* The wording: "Any holder of this consumer credit contract is subject to all claims and defenses which the debtor could assert against the seller of goods obtained hereto or with the proceeds hereof."

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