KANSAS COMMENT, 2010

1. This section does away with the holder in due course doctrine under which the assignee of consumer paper could enforce the obligation irrespective of legitimate claims or defenses which the consumer may have had against the dealer. The doctrine is codified in the UCC (K.S.A. 84-3-305 and 84-9-403) so that the U3C will supersede the UCC rule, at least with respect to consumer credit transactions (see K.S.A. 84-9-201). The third party financier will be subject to claims and defenses whether the holder in due course of a negotiable instrument issued in violation of K.S.A. 16a-3-307, or an assignee claiming under a "cut-off clause" or "waiver of defenses clause" which in the past had been used as a contractual substitute for negotiability. The policy justifications for this section are to protect the consumer from the harshness of the holder in due course doctrine as well as to encourage financial institutions taking assignments of consumer paper to use discretion in dealing with sellers and lessors whose transactions give rise to an unusual percentage of consumer complaints. See also the Kansas comment to K.S.A. 16a-3-307.

2. Except for the consumer's right to rescind a contract held by a third party subject to a defense, the rights of the consumer under this section are basically defensive. That is, the consumer-buyer is prohibited from suing the third party financier for return of any down payment of installments already paid before the assignee receives notice of the defense. The consumer-buyer may assert a claim or defense only as a defense to or set-off against claims by the third party financier. In addition, the consumer can assert a claim or defense against the assignee only to the extent of the amount still owing to the assignee at the time the assignee gets written notice of the claim or defense. For example, if a consumer purchases a used car from a dealer and signs a $700 installment contract which is then assigned to a bank or finance company, and if the consumer has already made four monthly installments of $30 each before discovering that the car is a lemon, the consumer can defend against a claim for the balance due by the bank or finance company but the consumer can neither obtain a refund from the financier of $120 nor subject the financier to any open ended claim for personal injury arising from defects in the car. (See, however, the Eachen case discussed in note 4, infra.) The third party financier is subject only to claims and defenses against the seller arising out of the sale, e.g., a claim for breach of warranty. For example, in Perry v. Goff Motors, Inc., 12 Kan. App. 2d 139, 736 P.2d 949 (1987), the court held that the assignee was subject to the buyer's claim that the sale of a car was fraudulent and void because it violated the Kansas motor vehicle laws. In addition, the buyer must make a good faith effort to obtain reasonable satisfaction from the seller before asserting the claim or defense against the assignee. The terms "good faith effort" and "reasonable satisfaction" are deliberately not defined; their meaning will depend upon the facts of a given case.

In Rosemond v. Campbell, 343 S.E.2d 641 (S.C. App. 1986), the court held that the U3C permitted the consumer to assert any claim available against the seller, including a fraud claim, offensively in a suit against the assignee. The South Carolina legislature, however, had amended the U3C to remove the language "as a matter of defense to or setoff against" found in subsection (2)(d) of this section. In Kansas, the consumer would have to wait until the assignee sued and then raise the claim as a defense.

3. Subsection (3) provides FIFO ground rules for determining what amount is owing to the assignee at the time notice of the defense is given. Subsection (5) provides for mandatory recourse by the financier against the dealer after assertion of a defense by the consumer, although non-recourse paper is still effective if the consumer has no excuse for the default. The theory of this subsection is that the ultimate risk should be shifted to the merchant in cases where the merchant's misconduct (breach of warranty, fraud, etc.) gave rise to the consumer defense. Third party practice — intervention, joinder or impleader — is also expressly authorized by this subsection wherever appropriate. Subsection (4) sets forth a short one-year statute of limitation for suits brought under this section.

4. This section should be read together with the F.T.C. Holder in Due Course Regulations, 16 C.F.R. Part 433, which require that all consumer paper contain a legend in ten point, bold face type expressly stating that the holder of the paper is subject to all claims and defenses which the consumer debtor could assert against the seller or lessor of the goods or services in the underlying transaction. The F.T.C. Regulations do not create any substantive rights in the consumer; they merely preserve against the assignee all state law rights the consumer already had against the seller or lessor. The purpose of the F.T.C. Regulations, like the purpose of this section, is to abolish the holder in due course doctrine in consumer transactions. Under the F.T.C. Regulations, the debtor's recovery is limited to a refund of amounts already paid, although the F.T.C. Regulations do not prohibit a greater recovery if state law allows it. In Eachen v. Scott Housing Systems, Inc., 630 F.Supp. 162 (M.D. Ala. 1986), the court ruled that the F.T.C. Regulations permitted the consumer to sue the assignee for breach of warranty, notwithstanding that state law limited liability to cases of defense or setoff. Liability was limited to a refund of amounts paid.

5. This section deals only with the assignee's derivative liability for claims and defenses arising out of the underlying contract. Neither this section nor the F.T.C. Regulations limit rights the consumer may have directly against the third party financier for the financier's own actions, either under the KCPA or similar statute or under developing concepts of lender liability.

Law Review and Bar Journal References:

Consumer's right to assert personal defenses against lending institution under UCCC discussed in "The New Kansas Consumer Legislation," Barkley Clark, 42 J.B.A.K. 147, 195 (1973).

The uniform commercial code, the statute of frauds, and the farmer, 25 K.L.R. 318, 323 (1977).

"Lemon Aid for Kansas Consumers," Barkley Clark, 46 J.B.A.K. 143, 153, 155 (1977).

Warranty violations in Tripartite finance lease agreements, Winton A. Winter, Jr., 25 K.L.R. 573, 582 (1977).

"Survey of Kansas Law: Consumer Law," John C. Maloney, 27 K.L.R. 197 (1979).

"Farmers and the Law: Exemptions and Exceptions," J. W. Looney, 50 J.B.A.K. 7, 16 (1981).

"The FTC Holder Rule: A Sword and a Shield for Defrauded Consumers," Robert E. Hiatt, J.K.T.L.A. Vol. XXI, No. 5, 13 (1998).

"History & Overview of the Uniform Consumer Credit Code," Ryan E. Hodge, J.K.T.L.A. Vol. XXVI, No. 3, 8 (2003).

CASE ANNOTATIONS

1. No notice of claim or defense given; section K.S.A. 60-511 controlled time limitation. Jackson County State Bank v. Williams, 1 Kan. App. 2d 649, 650, 573 P.2d 1092 (1977).

2. District court erred in granting judgment to seller's assignee in foreclosure counterclaim where sale fraudulent and void. Perry v. Goff Motors, Inc., 12 Kan. App. 2d 139, 146, 736 P.2d 949 (1987).

3. Assignee of second mortgages could enforce challenged note allegedly in violation of KUCCC (K.S.A. 16a-5-102 et seq.). Pilcher v. Direct Equity Lending, 189 F. Supp. 2d 1198, 1199 (2002).