This article is reprinted here with permission. Originally published in the PA Banker (Quater 3, Volume 21.3), the official magazine of the PA Bankers Association.
On May 23, the FTC launched an investigation into unfair or deceptive practices in the small business financing industry. Press reports of this investigation emphasized the investigation’s relevance for online lenders and providers of merchant cash advances, as the “bad” practices that spurred the investigation, including alleged misuses of confessions of judgment, were attributed to such actors. However, banks, as well as nonbanks, are subject to the prohibitions against unfair or deceptive acts or practices contained in section 5 of the FTC Act, which underpin the investigation. Thus, it is important for banks to understand the basis for this investigation and pay close attention to its findings.
The FTC’s investigation was announced closely on the heels of the agency’s May 8 workshop, titled “Strictly Business – An FTC Small Business Forum on Small Business Financing.” At the conclusion of that workshop, FTC Bureau of Consumer Protection Director Andrew Smith addressed the agency’s ability to apply the section 5 prohibitions to transactions involving small businesses as follows: “Unlike other federal regulators, we’re not constrained by personal, family or household purposes. [We believe] that our statute, our organic statute, the FTC Act, allows us to address unfair and deceptive practices even with respect to businesses.”
The UDAP prohibitions came into being in 1938, when Congress amended the FTC Act to add them to existing proscriptions against “unfair methods of competition.” On its face, the Act appears to preclude citing UDAPs in connection with a commercial transaction, as section (n) of section 5 specifies that: “The Commission shall have no authority under this section or section 57a of this title to declare unlawful an act or practice on the grounds that such act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers . . .” UDAPs are cited in commercial transactions, however, as the FTC interprets the term “consumer” broadly to include small businesses themselves-not just the natural person owners and employees of such businesses-as a form of protected consumer.
The position that a small business is a “consumer” for purposes of section 5 was directly challenged in FTC v. IFC Credit Corp., a motion to dismiss action brought in the District Court for the Northern District of Illinois, Eastern Division. In upholding the FTC’s interpretation, the court in FTC v. IFC Credit Corp. noted that: “It would not have been a difficult feat of draftsmanship for Congress in subsection (n) to have restricted the operation of the [FTC Act] to those unfair practices that affect individuals purchasing household goods for personal use.” Finding the language of section 5 unclear with respect to small businesses, the court proceeded to review the applicable legislative history, noting that during the long history of section 5, the FTC has interpreted the term consumer both broadly and narrowly. The court then considered the ramifications of excluding small businesses, noting that this outcome would “exclude from regulation literally millions of transactions that occur on a daily basis, regardless of how deceptive or unfair the acts or practices that prompted those transactions might be.” The court also reviewed dictionary definitions of the term consumer, concluding that no single, accepted definition existed. Based on the foregoing analysis, the court held that the FTC’s interpretation was reasonable and entitled to deference under Chevron U.S.A., Inc., 467 U.S. at 863 (1984).
In the case of banks, section 5 is enforced by the federal banking agencies. To this end, in 2009 the FDIC issued a cease and desist order against Advanta Bank citing multiple violations of section 5 in connection with that institution’s business credit card activities. This reliance on section 5 was necessary because with few exceptions, the federal Truth-In-Lending Act (the TILA) and Regulation Z do not apply to business-purpose credit. Hence, the FDIC could not cite the alleged wrongful acts as violations of the TILA. Although this action ended in a settlement, it has been cited as precedent by other federal banking agencies.
The Commonwealth of Pennsylvania maintains its own UDAP prohibitions in the form of the Unfair Trade Practices and Consumer Protection Law. (the UTPCPL). In the 1990 case In re Fricker, the U.S. Bankruptcy Court for the Eastern District of Pennsylvania considered whether a business-purpose loan made by a nonbank lender was subject to the UTPCPL. The In re Fricker plaintiffs were appealing from a sheriff’s sale of their home, which had resulted from the lender’s enforcement of a confession of judgment. After nullifying this sale on the basis that Pennsylvania law bars using a confessed judgment to compel the sale of a residence, the court turned its attention to whether the UTPCPL could be used to challenge the validity of the underlying loan.
In considering the plaintiffs’ UTPCPL claim, the In re Fricker the court noted that both the TILA and the “several Pennsylvania laws regulating maximum interest rates and finance charges specifically exempt businesspurpose credit.” After concluding that the loan clearly was made for a business purpose, the court posited whether it might be subject only to “’the law of the jungle’. . and hence. . beyond the grasp of the law to remedy.” Ultimately, however, the court found that the loan’s validity could be challenged under the UTPCPL. In explaining the reasons for its decision, the court stated: "Even in a business transaction, . . UDAP is susceptible to as broad an interpretation as necessary to serve its purpose of preventing any form of fraud or overreaching. It is a weapon which has been crafted especially for the purpose of curbing the creditorpredator-like behavior which we find pervades the conduct of [the lender]in the instant transaction."
In sum, UDAP is best described as a “wild card” that runs counter to the general presumption of armslength, equal bargaining power in commercial dealings and, in some cases, counter to express statutory or regulatory exclusions. In this regard, inserting contract language specifying that a loan is being made for a business purpose, and not for personal or household purposes, will not prevent a bank agency or court from finding UDAPs—whether in the guise of section 5 of the FTC Act or the UTPCPL.
When dealing with small businesses, banks should assume that the subject transaction may be scrutinized for potential UDAPs by any or all of plaintiff lawyers, bank agencies, attorneys general or a court. This does not mean the technical requirements of statutes that do not apply by their terms should be complied with. Rather, the transaction should be considered in light of both commonly accepted notions of fairness and the copious guidance interpreting section 5 that has been issued by the FTC and the federal banking agencies. Lastly, if doubt exists regarding UDAP risks, qualified legal counsel should be consulted.
