168 F.3d 932 (7th Cir. 1999), 98-1190, Adams v. Plaza Finance Co., Inc.
|Citation:||168 F.3d 932|
|Party Name:||Christine ADAMS, on behalf of herself and all others similarly situated, Plaintiff-Appellant, v. PLAZA FINANCE COMPANY, INC., Defendant-Appellee.|
|Case Date:||January 27, 1999|
|Court:||United States Courts of Appeals, Court of Appeals for the Seventh Circuit|
Argued Oct. 30, 1998.
Rehearing and Suggestion for Rehearing
En Banc Denied March 18, 1999.
Daniel A. Edelman (argued), Cathleen M. Combs, James O. Latturner, Louise T. Walsh, Edelman & Combs, Chicago, IL, for Plaintiff-Appellant.
Brian W. Bell, Swanson, Martin & Bell, Chicago, IL, Ted L. Perryman (argued), John L. Walker, Roberts, Perryman, Bomkamp & Meives, St. Loius, MO, for Defendant-Appellee.
Before POSNER, Chief Judge, and EASTERBROOK and RIPPLE, Circuit Judges.
POSNER, Chief Judge.
This class suit against Plaza Finance Company seeks statutory (not compensatory) damages for violation of the Truth in Lending Act, 15 U.S.C. §§ 1601 et seq.; § 1640(a). The district court granted summary judgment for the defendant largely on the basis of a district court decision, since reversed by the Fifth Circuit in Edwards v. Your Credit, Inc., 148 F.3d 427 (5th Cir.1998), in a case virtually identical to this one. A number of similar cases are pending elsewhere. Alvin C. Harrell, "Consumer Credit," 52 Consumer Finance L.Q. Rep. 104, 106 (1998).
In view of the procedural posture of our case, we construe the facts as favorably to the plaintiff as the record will permit. The defendant specializes in making small, short-term loans to individuals who have bad credit (the default rate on its loans is 25 percent). It lent the named plaintiff $307 for ten months, of which $7 went to pay for a premium for "nonfiling insurance," that is, insurance against losses to the finance company resulting from its failure to file (record) its security interest. The Truth in Lending disclosure form that the plaintiff was given listed, besides $307 as the "amount financed" (see Federal Reserve Board Regulation Z, 12 C.F.R. § 226.18(b)), a "finance charge" (basically the amount of interest charged for the loan, but including certain service charges as well, see 15 U.S.C. § 1605(a)) of $128 and an annual interest rate of 83 percent. In computing the interest rate for Truth in Lending purposes, the finance company uses the finance charge as the interest and the amount financed as the principal. Hence, other things being equal, the disclosed interest rate is higher the higher the finance charge and lower the higher the amount financed. This creates an incentive for lenders, who want the interest rate to look as low as possible, to shift items from the finance charge (interest) to the amount financed (principal).
The loan to the plaintiff was secured by a wage assignment plus a security interest in various items of the borrower's personal property, such as a television set. Unless such an interest is recorded in the local UCC registry of security interests in personal property, the holder of the interest will not be able to enforce it against a subsequent secured creditor who records his own security interest. UCC § 9-312(5)(a), 810 ILCS 5/9-312(5)(a); Midwest Decks, Inc. v. Butler & Baretz Acquisitions, Inc., 272 Ill.App.3d 370, 208 Ill.Dec. 455, 649 N.E.2d 511, 516 (Ill.App.1995). (Filing generally is unnecessary to perfect a purchase-money security interest, UCC §§ 9-302(1)(d), 307(2), 810 ILCS 5/9-302(1)(d), 307(2), but that type of security interest is not involved in this case.) Because the rules in Article 9 of the Uniform Commercial Code regulating filing are complex and demanding, see, e.g., UCC §§ 9-103, 9-401, 9-403(2), it is easy for a lender to make a mistake, such as filing in the wrong place or failing to renew the filing statement after its expiration; and lenders sometimes insure themselves against the consequences of such a mistake by buying nonfiling insurance.
The Truth in Lending Act permits a lender to include as a service fee a premium for such insurance. 15 U.S.C. § 1605(d)(2). The $7 that Plaza charged the plaintiff was the per-loan premium it pays to Voyager Property and Casualty Insurance Company. This is the same insurance company that was involved in the Fifth Circuit's Edwards decision. Although Voyager is licensed to sell nonfiling insurance in Illinois, where the loan to the plaintiff was made, there is no suggestion that Illinois has determined that Voyager's contract with Plaza and its performance of that contract are consistent with the terms of the license or the insurance law of Illinois. Indeed, we can find nothing in the record or in the law of Illinois to indicate what Illinois understands by "nonfiling insurance."
The plaintiff argues that the "insurance" which Voyager has sold Plaza either is not insurance at all, or is not nonfiling insurance but instead default insurance--and a premium for default insurance, unlike a premium for nonfiling insurance, must be included in the finance charge. 12 C.F.R. § 226.4(b)(5). Interest is compensation not only for the time value of money but also for the risk of default, and so a charge to the borrower that is intended to compensate the lender for that risk is functionally part of the borrower's interest expense. A premium for default insurance is such a charge, and so it belongs in the "finance charge" (interest) column of the disclosure form.
The usual purpose of insurance is to shift risk from an individual or other entity that is risk averse, and so would prefer to substitute a cost certain (a fixed insurance premium) for the risk of incurring a larger cost, to an entity that by pooling independent risks can minimize the overall risk to itself. Union Labor Life Ins. Co. v. Pireno, 458 U.S. 119, 127-31, 102 S.Ct. 3002, 73 L.Ed.2d 647 (1982); Group Life & Health Ins. Co. v. Royal Drug Co., 440 U.S. 205, 211, 99 S.Ct. 1067, 59 L.Ed.2d 261 (1979); Clark Equipment Co. v. Dial Corp., 25 F.3d 1384, 1388 (7th Cir.1994); Sears, Roebuck & Co. v. Commissioner, 972 F.2d 858, 863 (7th Cir.1992). The simplest example is life insurance. A person who does not want to bear the financial risk of dying young can buy life insurance, for which he pays a fixed premium. The financial risk of his early death is shifted to the insurance company, which by pooling that risk with the risk of its policy holders who die old can eliminate the risk of incurring an unexpectedly steep loss from a premature death. By pooling, the insurance company shields itself from that risk; by joining the pool, the insured eliminates the risk to himself.
No risk-shifting purpose is discernible in the arrangement between Plaza and Voyager. Their original contract expressly capped Voyager's potential liability to Plaza at 90 percent of the premiums paid by Plaza. This meant that no risk was shifted to Voyager. If Plaza paid Voyager premiums of $50,000, and had insured losses of $100,000, for a total loss-related cost of $150,000, it would receive $45,000 in insurance proceeds from Voyager, leaving it with a net cost of $105,000 ($150,000 - $45,000)--a net cost greater than the premiums, greater even than the incurred loss, that is, the loss against which Plaza nominally insured. Plaza was in effect a self-insurer, and the cost of self-insurance is not within the dispensation to exclude premiums for nonfiling insurance from the finance charge. 12 C.F.R. Part 226, Supp. I, § 226.4(e)(4) (Official Staff Commentary on Regulation Z).
Of course insurance policies always have limits; but when the limit is at or below the premium, the insured is not shifting risk by buying the policy. This cannot be the end of the analysis, however. Insurance has other functions besides risk-shifting, including smoothing costs over time, providing assistance in defending against claims (liability insurers typically provide a defense if their insured is sued for conduct covered or even just arguably covered by the policy), and exploiting various tax opportunities. Wisconsin Power & Light Co. v. Century Indemnity Co., 130 F.3d 787, 791 (7th Cir.1997); Sears, Roebuck & Co., supra. But at argument Plaza's lawyer was able to identify only one possible function of Voyager's insurance, and that is to avoid having to include $7 in the finance charge. By its lawyer's own acknowledgment, Plaza is getting nothing in the way of a service from its so-called insurer,
whether for bearing risk or for anything else, in exchange for the $7 that it pays Voyager--or rather for the 70cents it pays Voyager, for it gets the rest of the $7 back. If the only function of the insurance policy is to monkey with the disclosed interest rate, it is not a bona fide policy; it is a fraud.
And that is, so far as the record indicates, the only function of the "nonfiling insurance" that Plaza bought from Voyager: to enable the lender (Plaza) to shift $7 of what otherwise would be an interest charge from the finance-charge column on the Truth in Lending disclosure form to the amount-financed column. See 12 C.F.R. § 226.18(b)(2). The expense to the borrower is the same, but the disclosed annual interest rate is lower. Remember that items added to the finance charge count as interest in computing the disclosed annual interest rate, and so increase that rate, while items added to the amount financed increase the denominator in the interest-rate calculation and so reduce the disclosed rate. In this case, the disclosed interest rate would have risen to 89 percent if $7 had been subtracted from the amount financed and added to the finance charge. The smaller the loan, the bigger the difference that the shift of $7 makes. Consider a very simple example: a one-year loan (amount financed) of $50 (and Plaza makes loans that small), and a finance charge of $40 payable at the end of the year, and hence an annual interest rate of...
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