Court of Appeal Rules This Hot Potato Leaves Everybody Burned

Before Grayot v. Bank of Stockton, no published California case answered the question of whether a lender can assign-back a consumer credit contract to a seller to avoid liability under the Federal Trade Commission’s Holder Rule. In Grayot, the Third Appellate District held that the holder of a contract may not avoid liability for claims that arose while it held the contract by later reassigning the contract.

What happened?

With a $15,000 down payment, Chad Grayot purchased a used vehicle from a car dealership. The Holder Rule requires consumer credit contracts to include specific language indicating to the consumer that they can assert against third party creditors all claims and defenses that could be asserted against the seller of a good or service, such as Grayot’s used car. The contract Grayot entered with the car dealership contained the notice required by the Holder Rule. The contract was later assigned to the Bank of Stockton who became the new “holder” of the contract. Grayot made a few payments before making the Bank an offer to surrender the vehicle in exchange for a refund of his down payment and the few payments he had made. In response, the Bank re-assigned the contract to the dealership, cancelled Grayot’s loan, and reimbursed the dealership for the monthly payments Grayot made to the Bank. Twenty days after Grayot’s offer, the Bank informed Grayot that it was no longer the holder of the contract. Based on the holder provision in the contract, Grayot sued to have the Bank refund his payments.

The trial court granted summary judgment for the Bank on the basis that, at the time of litigation, the Bank was not a holder of the contract subject to the Holder Rule.

What did the Court of Appeal do?

Before the Holder Rule’s adoption in 1975, a third party who purchased a consumer’s promissory note did so free from any claim the consumer may have had against the original seller. The third party purchaser was free to go after the consumer for nonpayment, while remaining immune to the consumer’s claims of fraud, misrepresentation, breach of contract, or breach of warranty against the seller. In adopting the Holder Rule, the FTC recognized such a scheme created an imbalance of power between a consumer and a financer, and determined that financers were better suited than consumers to assume the risk of a seller’s reliability. The FTC reasoned financers engage in far more transactions than a typical consumer, and have easier access to the courts.

The Court noted that the purpose of the Holder Rule is to notify all future holders that by accepting assignment of the contract, they are stepping into the seller’s shoes. Thus, when the Bank accepted assignment of the contract, it became liable for any claim Grayot had against the car dealership. If the Bank was liable to Grayot while it held the contract, that liability necessarily attached before it reassigned the contract back to the dealership. Subsequent reassignment did not absolve the Bank, or any similarly situated seller or financer, from that liability. In other words, “any effort by an intermediary assignee to play ‘hot potato’ with a consumer credit contract will not be effective.”