The Holder Rule – A Way to Eliminate Private Student Loans and Service Contract Loans

It has been frustrating watching debtors stuck with loans from private student loans to finance contracts for services that were sold in a deceptive or fraudulent manner. Consumers get left on the hook for unfair and deceptive practices while the underlying companies who profited laugh and the lenders say they have no responsibility.

But that may not be true.

The Federal Trade Commission has a Holder in Due Course Rule that may just be the basis for consumers to raise a defense against deceptive services and allows people to be repaid and have the remainder of the loans forgiven.

The rule is officially known as the Trade Regulation Rule Concerning Preservation of Consumers’ Claims and Defenses. The text of the rule can be found here and below.

Why the Holder Rule is Important

One situation that comes to mind is the ongoing struggles faced by consumers who allegedly owe Asset Acceptance for student loan assistance services when the company has closed or vanished yet Asset Acceptance claims they are still the holders of a loan contract for services.

Another situation would be when a for-profit school closes or is found to have engaged in deceptive practices.

How Debt is Cancelled

The consumer would either have to use the Holder Rule as a negotiating tool or state it as a claim against the entity in a legal proceeding. When it comes to these technical issues I always feel the average consumer benefits greately from the advice and assistance of representation by a lawyer who is licensed in the state the debtor lives in.

How You Get Your Money Back

Under the Holder Rule, if found entitled for recovery, the consumer would receive back all the money they paid under the contract and the remainder of the debt would be forgiven. The forgiven debt may be taxable but that is between the consumer and the IRS if the creditor issued a 1099-C for the forgiven debt.

It’s Never That Easy

Like everything else when it comes to consumers getting their money back, it’s never easy. The current holder of the money will generally fight back and make it difficult for the consumer to get what might be legally owed them. But difficult does not mean impossible.

What is often impossible is for the consumer to afford competent legal representation when they can’t afford to pay a lawyer for professional. The entity holding the cash from the debtor tends to have deeper pockets and can afford to fight.

Additionally, the Holder Rule may not apply to all lenders.

Tips and Advice From Others Regarding the Holder Rule

According to a public filing by 26 consumer organizations, “The Holder Rule is one of the most important actions the Commission has ever taken in preventing and remedying unfair and deceptive practices in the marketplace. When a seller of a good or service originates or helps arrange credit, the Rule allows consumers to raise the seller’s misconduct as a basis for bringing claims or defenses against the entity holding the debt. Specifically, the Rule requires a notice in the credit documents that assignees in credit sales and direct lenders related to sellers are subject to claims and defenses that the consumer has against the seller of the goods or services. Thus for virtually all consumer transactions, from car loans to certain types of student loans to home improvement contracts, consumers have a viable consumer remedy for seller misconduct even when their obligation is owed to a creditor and not to the seller.”

The groups also said, “When a consumer is being sued by a creditor, it is rarely practical for the consumer to sue the seller in a separate action, particularly when the seller is insolvent or distant. It is far more practical and fair to be able to raise seller-related claims and defenses against the party collecting on the debt. The creditor is also in a far better position than is the consumer to recover from the seller (e.g. through recourse agreements) and to police the seller’s conduct.”

The advice offered in public comments seems to directly apply to most situations when the debtor has financed services from an entity that has gone out of business. The groups state, “without the Holder Rule, creditors could in effect run a laundry for fly-by-night retailers. [State ex rel. McGraw v. Scott Runyan Pontiac-Buick, Inc., 461 S.E.2d 516, 526 (W. Va. 1995).] Without the Rule, consumers would owe on the credit obligation even though they cannot recover from the fraudulent seller. The Rule helps stop this practice in its tracks.” – Source

The collection of consumer advocacy groups went on to give three more reasons the Holder Rule is important for consumers.

  1. even if the seller is solvent, it is usually impractical to expect a consumer to defend a collection action and simultaneously bring an affirmative suit against the seller. The Commission has stated this itself: “Consumers are not in a position to police the market, exert leverage over sellers, or vindicate their legal rights in cases of clear abuse. . . . Redress via the legal system is seldom a viable alternative for consumers when problems occur.” The collection suit may be resolved years before the affirmative suit, and it is often not feasible for a consumer to bring an affirmative action for the small amount of money at stake. Many contracts today force consumers to raise claims in arbitration, and not in court, and studies have shown that the impediments for bringing an action in arbitration are normally insurmountable. By far the most practical action for the consumer is to defend the collection action by raising against the collecting creditor the consumer’s claims and defenses against the seller. Perhaps of even greater importance is that the consumer can apprise a collector that defenses exist if the collector were to attempt a collection lawsuit.
  2. making related lenders liable for the acts of the original seller serves the additional goal of establishing a market-based incentive for creditors to inquire into the merchants for whom they finance sales and to refuse to deal with those merchants whose conduct would subject the creditor to potential claims and defenses. It is far more practical for the market to police itself than to ask enforcement officials to police every consumer transaction. There are literally billions of consumer transactions each year, and it would be unreasonable—and impossible—to ask federal, state and local agencies to be responsible for monitoring all such transactions. Clearly, self-policing mechanisms are to be preferred so that enforcement agency responsibilities are manageable.
  3. the related creditor is in a much better position than the consumer to recover money from the seller. The Commission has recognized this itself: “As a practical matter, the creditor is always in a better position than the buyer to return seller misconduct costs to sellers, the guilty party.” The creditor is in an excellent position to recover money from the seller: the holder “has recourse to contractual devices which render the routine return of seller misconduct costs to sellers relatively cheap and automatic . . . The creditor may also look to a ‘reserve’ or ‘recourse’ arrangement or account with the seller for reimbursement.”
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Longstanding But Little Used

The use of the Holder Rule as a defense in collection activity for private student loans or debt relief service contracts is an approach I just have not heard about that much.

It’s worth going back to the original guidance offered by the Federal Trade Commission in 1976 to look at the intent of this consumer protection.

The FTC in 1976 said, “A consumer relying in good faith on what the seller has represented to be a product’s characteristics, service warranty, etc., makes a purchase on credit terms. The consumer then finds the product unsatisfactory; it fails to measure up to the claims made on its behalf by the seller, or the seller refuses to provide promised maintenance. The consumer, therefore, seeks relief from his debt obligations only to find that no relief is possible. His debt obligation, he is told, is not to the seller but to a third party whose claim to payment is legally unrelated to any promises made about the product.

The seller may, prior to the sale, have arranged to have the debt instrument held by someone other than himself; he may have sold the debt instrument at a discount after the purchase.

From the consumer’s point of view, the timing and means by which the transfer was effected are irrelevant. He has been left without ready recourse. He must pay the full amount of his obligation. He has a product that yields less than its promised value. And he has been robbed of the only realistic leverage he possessed that might have forced the seller to provide satisfaction – his power to withhold payment.” – Source

Maybe You Should Talk to an Attorney

If you are faced with a situation where a third-party lender is attempting to collect for services supposed to be provided by another, you may want to talk to a local attorney about how the Holder Rule may allow you to deal with the situation.

The Actual Holder Rule Text


§433.1   Definitions.
§433.2   Preservation of consumers’ claims and defenses, unfair or deceptive acts or practices.
§433.3   Exemption of sellers taking or receiving open end consumer credit contracts before November 1, 1977 from requirements of §433.2(a).

Authority: 38 Stat. 717, as amended; (15 U.S.C. 41, et seq.)

§433.1   Definitions.

(a) Person. An individual, corporation, or any other business organization.

(b) Consumer. A natural person who seeks or acquires goods or services for personal, family, or household use.

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(c) Creditor. A person who, in the ordinary course of business, lends purchase money or finances the sale of goods or services to consumers on a deferred payment basis; Provided, such person is not acting, for the purposes of a particular transaction, in the capacity of a credit card issuer.

(d) Purchase money loan. A cash advance which is received by a consumer in return for a “Finance Charge” within the meaning of the Truth in Lending Act and Regulation Z, which is applied, in whole or substantial part, to a purchase of goods or services from a seller who (1) refers consumers to the creditor or (2) is affiliated with the creditor by common control, contract, or business arrangement.

(e) Financing a sale. Extending credit to a consumer in connection with a “Credit Sale” within the meaning of the Truth in Lending Act and Regulation Z.

(f) Contract. Any oral or written agreement, formal or informal, between a creditor and a seller, which contemplates or provides for cooperative or concerted activity in connection with the sale of goods or services to consumers or the financing thereof.

(g) Business arrangement. Any understanding, procedure, course of dealing, or arrangement, formal or informal, between a creditor and a seller, in connection with the sale of goods or services to consumers or the financing thereof.

(h) Credit card issuer. A person who extends to cardholders the right to use a credit card in connection with purchases of goods or services.

(i) Consumer credit contract. Any instrument which evidences or embodies a debt arising from a “Purchase Money Loan” transaction or a “financed sale” as defined in paragraphs (d) and (e) of this section.

(j) Seller. A person who, in the ordinary course of business, sells or leases goods or services to consumers.

[40 FR 53506, Nov. 18, 1975]

§433.2   Preservation of consumers’ claims and defenses, unfair or deceptive acts or practices.

In connection with any sale or lease of goods or services to consumers, in or affecting commerce as “commerce” is defined in the Federal Trade Commission Act, it is an unfair or deceptive act or practice within the meaning of section 5 of that Act for a seller, directly or indirectly, to:

(a) Take or receive a consumer credit contract which fails to contain the following provision in at least ten point, bold face, type:




(b) Accept, as full or partial payment for such sale or lease, the proceeds of any purchase money loan (as purchase money loan is defined herein), unless any consumer credit contract made in connection with such purchase money loan contains the following provision in at least ten point, bold face, type:



[40 FR 53506, Nov. 18, 1975; 40 FR 58131, Dec. 15, 1975]

§433.3   Exemption of sellers taking or receiving open end consumer credit contracts before November 1, 1977 from requirements of §433.2(a).

(a) Any seller who has taken or received an open end consumer credit contract before November 1, 1977, shall be exempt from the requirements of 16 CFR part 433 with respect to such contract provided the contract does not cut off consumers’ claims and defenses.

(b) Definitions. The following definitions apply to this exemption:

(1) All pertinent definitions contained in 16 CFR 433.1.

(2) Open end consumer credit contract: a consumer credit contract pursuant to which “open end credit” is extended.

(3) “Open end credit”: consumer credit extended on an account pursuant to a plan under which a creditor may permit an applicant to make purchases or make loans, from time to time, directly from the creditor or indirectly by use of a credit card, check, or other device, as the plan may provide. The term does not include negotiated advances under an open-end real estate mortgage or a letter of credit.

(4) Contract which does not cut off consumers’ claims and defenses: A consumer credit contract which does not constitute or contain a negotiable instrument, or contain any waiver, limitation, term, or condition which has the effect of limiting a consumer’s right to assert against any holder of the contract all legally sufficient claims and defenses which the consumer could assert against the seller of goods or services purchased pursuant to the contract.

[42 FR 19490, Apr. 14, 1977, as amended at 42 FR 46510, Sept. 16, 1977]

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