Many of our daily business transactions are governed by special sets of rules. For example, sales, credit, and banking are heavily regulated by stringent standards. Business transactions may involve several major law specialties, particularly contract and property law.
Ohio and a number of other states have adopted the Uniform Commercial Code (UCC). It governs a wide range of commercial practices, including (1) sales of goods and merchandise, and other consumer transactions; (2) commercial paper, such as checks, promissory notes, and the like; and (3) secured transactions, which are sales of goods on credit, or loans secured by an agreement roughly similar to a mortgage but on personal property, not real estate.
Most commercial transactions, specifically consumer transactions, are not included in the UCC, but are covered by separate statutes. Some of these are (1) retail installment sales; (2) charge accounts; (3) home solicitation sales; and (4) small loans.
Checks and promissory notes are the most common forms of commercial paper. Others include drafts, bills of exchange, and certificates of deposit. To simplify matters, think of a regular check when the term "commercial paper" is used. Similarly, think of depositing a check, paying a bill by check, or cashing a check when the terms "negotiable" or "negotiability" are mentioned.
When a check is negotiated, the cash represented by the check is transferred. For example, when a person writes a check to pay their utility bill, the value of the cash represented by the check is removed from the account of the person who wrote the check and added to the account of the utility. Another way of understanding negotiability is to substitute the word with "transferability." When commercial paper meets certain requirements, it is negotiable and moves freely in commerce. In a sense, commercial paper or negotiable paper is a substitute for cash and is used in commerce because it can be more convenient and secure than cash.
Commercial paper is negotiable if it meets four criteria: (1) it is signed by the person making it (the maker) or by the person on whose account it is drawn from (the drawer); (2) it contains an unconditional promise or order to pay a specified sum of money; (3) it is payable either on demand or at a definite time; and (4) it is payable either to the order of a particular person or to the bearer, which is the person in actual possession of the commercial paper, even if his or her identity was not revealed when the commercial paper was first issued. An ordinary check, when it is properly executed, is a negotiable instrument. Other common negotiable instruments are drafts, bills of exchange, certificates of deposit, and promissory notes.
Commercial paper is transferred or negotiated by endorsement. An endorsement may be unconditional or it may place some limit on how the instrument can be negotiated in the future. For example, a check is unconditionally endorsed by signing it on the back. When endorsed in this way, the check becomes payable to the bearer, that is, it is payable to the person or entity possessing the check when it is re-negotiated (presented for payment). If the check is endorsed as, "For deposit to the account of ...," it can only be negotiated by depositing it in the named account. If it is endorsed as, "Pay to the order of ...," only that person named can negotiate it further.
For commercial paper to move freely in the business and banking industry, persons who were not parties to the original transaction must have reasonable assurance that the negotiable instrument is good and will be honored (paid). This assurance is provided through the doctrine of "holder in due course."
In general, a holder in due course takes a negotiable instrument free of all claims by any person and free of the defenses of any party to the instrument with whom the holder has not dealt. To become a holder in due course, a person to whom a negotiable instrument is transferred must: (1) give something of value in return for having the instrument transferred to him or her; (2) complete the transaction in good faith; and (3) complete the transaction without notice of any claim or defense against the instrument.
Suppose a buyer purchases supplies on credit and gives the supplier a promissory note due in six months and the supplier takes the note to the bank to have it "discounted." This means that the supplier sells the note to the bank for something less than its face value in order to get cash immediately instead of waiting six months for the payment. The bank then takes the note to another financial institution and have it re-discounted in order to increase the bank's supply of money or credit. In each case, the note is transferred by endorsement.
The maker of the note (buyer) is primarily liable. The holder in due course does not have to look to the maker alone, or even at all, for payment. The maker, the supplier who had the note discounted, and the bank which had the note re-discounted are jointly and severally liable for the note. The maker of the note has agreed to pay the note at the time it is due and to make such payment to the person or entity having possession at that time. The endorsement by the supplier and the bank are individual agreements that each will be liable for payment if the maker "dishonors" (does not pay) the note. If the supplier to whom the note was originally given furnished improper, unsatisfactory, or insufficient supplies, the maker of the note has a valid excuse for nonpayment, but it is only valid against the supplier. The maker cannot assert this as a defense against the holder in due course.
A cognovit note is a promissory note in which the maker grants a warrant of attorney to the holder of the note to confess judgment against the maker of the note. This means that in case of default, the holder of the note is authorized to go to court and have a judgment entered against the maker without the formalities of notice and trial.
Many states prohibit use of cognovit notes. In Ohio, these are unacceptable in consumer transactions and their use in other transactions are limited. Any note given in a consumer loan or transaction and executed on or after January 1, 1974 can only be enforced by a regular lawsuit. This means that the cognovit provision of such a note (the waiver of notice and the right to trial) is invalid in consumer transactions. If the remainder of the note is valid, it may be enforced after notice and trial.
In Ohio, cognovit provisions are valid in commercial transactions. However, the note must contain a conspicuous warning to the maker that they are giving up the right to notice and trial. Further, the actual confession of judgment may be filed only in the jurisdiction where the maker lives or the note was executed.
Consumer transactions are covered by both state and federal law and are often dependent upon the use of credit. Currently, Ohio law allows an interest rate of up to 25 percent, including annual percentage. This is their alternative to other statutory methods that compute the annual percentage rate for retail installment sales and revolving charge accounts (credit cards). It must also be noted that some allowable methods of computing interest may result in annual percentage rates of more than 25 percent and that such rates are enforceable under the law. Furthermore, it must be stressed that a 25 percent annual percentage rate (or any other interest rate) is not a required rate. Interest rates are subject to market pressure and negotiation. Buyers should shop for low-interest rates and low finance charges in the same way they shop for affordable prices. One of the basic goals of the Federal Truth in Lending Law is to provide consumers with sufficient information so they can shop for credit, as well as know and compare the cost of credit.
Buyers are entitled to have, and to read, all parts of applications, contracts, and disclosure statements. Before signing anything, buyers should (1) read all parts of an application or contract, as well as all disclosure statements; (2) ask questions about all aspects of such documents that are unclear; and (3) obtain satisfactory answers to all questions. If a buyer does not understand any document, they should ask for, and obtain, an opportunity to study the document, or have an attorney study the document. Denial of information or assistance, or difficulty in obtaining information or assistance, should alert the buyer that there may be problems.
As stated above, most consumer transactions are covered by both state and federal laws. For example, both state and federal laws concern the rescission (cancellation) of many kinds of consumer transactions within a certain period after receiving the goods or services. The time for exercising the right of rescission is normally very short; for example, within three days of receiving the goods or services. Similarly, in most consumer transactions the traditional concept of holder in due course has been modified. Under the consumer laws, a buyer has the right to assert all defenses against any person or entity to whom the seller has transferred the buyer's contract or note.
In most consumer transactions, the buyer will receive a disclosure form which includes the disclosures required by the Federal Truth in Lending Law. Sellers and lenders may, with certain limitations, modify the disclosure forms which may be separate from the contract or part of the contract. Even when disclosure forms are part of a contract, the information shown must also clearly appear in the contract. In a case in which a consumer transaction is based upon a revolving charge account (credit card) transaction, the buyer must be given a disclosure statement before the account is established and during every periodic statement or bill issued.
For example, a disclosure statement for the purchase of an automobile from Big Wheel Auto was released on May 1, 1981 with the following contractual conditions: (1) the price of the car was $7,607.50; (2) the buyer paid Big Wheel a down payment of $1,500 and financed the remaining $6,107.50 for 36 months at an annual percentage rate of 14.84 percent; and (3) the monthly payments are $211.23, with the first payment due June 1, 1981.
A disclosure form will generally contain only that information required by the Truth in Lending Law. It is not the entire contract so it typically does not identify the make, model, color, or serial number of the car.
Buyers should obtain and study the disclosure form and contract before making a final commitment. For the transaction described above, the disclosure form would (before purchase) show that the Annual Percentage Rate (APR) is 14.84 percent and the Finance Charge is $1,496.80, thereby it costs $1,496.80 to finance $6,107.50 under this contract for three years at an APR of 14.84 percent. Under this contract, the buyer must pay back $7,604.30 or $1,496.80 more than the $6,107.50 which will be financed or borrowed.
The disclosure form would show (1) the total amount, including down payment, that the buyer will pay; (2) the number, amount, and date when payments are due; (3) that credit life insurance will be purchased and it will cost $120.00; (4) the seller will retain a security interest in the car (the car may be repossessed and sold by the seller if the buyer fails to make payments); (5) certain filing fees will be paid; (6) late charges will be assessed; and (7) if the buyer completes all payments before three years, he or she will not have to pay a penalty and may be entitled to a refund.
If the buyer had indicated on the disclosure form that they wanted an itemization, they would have received a written itemization similar to the following:
Itemization of the Amount Financed of $6,107.50
$ -0- Amount given to you directly
$ 5975.00 Amount paid to your account
_______ (Big Wheel Auto)
Amount paid on your behalf
$ 12.50 to Motor Vehicle Bureau
$ 120.00 to Credit Life Ins. Co.
$ -0- Prepaid finance charge
Before addressing the disclosure requirements for credit card transactions, a few general comments on credit card law are required. First, credit cards cannot be issued indiscriminately. They can be issued only in response to a written or oral request, or as a renewal or replacement of a card that a cardholder had previously accepted. Second, a cardholder's liability for the unauthorized use of a credit card is limited to $50. Thus, if a credit card is lost or stolen, the cardholder's maximum liability for any items improperly charged to cardholder's account is $50. (The maximum liability can be reduced by contract or through negotiation. Further, the cardholder can reduce the maximum liability by reporting the loss as soon as possible after such loss is discovered.) Third, a cardholder may, within certain limits, assert good faith claims and defenses against the card issuer and withhold payments. The card issuer may not attempt to collect the amount in dispute or issue adverse credit reports until the dispute is settled.
In general, a financial institution must submit a written notification to the consumer at least 21 days before the effective date of any term or condition changes, particularly if the change would result in greater cost or liability, or decreased access to the cardholder's account.
As noted above, there are special disclosure requirements for credit card accounts. Before a credit card account is used, the card issuer must provide the cardholder with a written initial disclosure. The initial disclosure must show (1) the periodic (monthly) rate used to compute finance charges and the annual percentage rate of the finance charges; (2) when finance charges begin to accrue and any free-ride period (a period where no interest or finance charges are made); (3) the method used to determine the balance on which the finance charge is computed; and (4) if a security interest is retained, a description of the property or item purchased by the cardholder. Finally, the initial disclosure must contain a statement of the cardholder's billing rights under the federal Fair Credit Billing Act.
In addition to the initial disclosure, the card issuer must provide the cardholder with periodic statements (bills) for each billing period in which there is an outstanding balance. The periodic statements must use the same terminology as the initial disclosure and must show (1) the previous balance of the account; (2) the transactions within the billing period; (3) credits; (4) periodic rates; (5) the balance on which the finance charge is being computed; (5) the finance charge; (6) the annual percentage rate; (7) any other charges; (8) the closing date of the billing cycle; and (9) the address for notices of billing errors.
In addition to the initial and periodic disclosures, the card issuer must provide the following disclosures: (1) an annual statement of billing rights, if billing rights are not stated on each periodic statement (bill); (2) a written notice that previously disclosed terms of the account or contract are to be changed (such notices must be made at least 15 days before the effective date of the change); and (3) the existence and amount of any surcharge.
As noted above, the card issuer must notify the cardholder of the cardholder's right to challenge billing errors. In summary, the procedure for challenging billing errors is as follows:
A retail installment sale is a transaction in which a consumer pays the purchase price over time by making periodic payments. The transaction always involves an installment note executed by the buyer to the seller and a security interest (like a mortgage) in the items purchased, which permits the seller to repossess the items if the debt is not paid. Usually, the contract, security agreement, and note are included on the same form. The sale of the automobile mentioned in the “Buyer Disclosure” section is an example of a retail installment sale.
A balloon note is a promissory note under which the buyer agrees to pay a series of small installments and a final large installment for the remaining balance. Balloon notes are permitted in consumer transactions only if the note contains a provision that specifically allows the buyer to refinance the balance due on the final installment at the same, or better, terms as the small installments.
For example, suppose a person buys a used car for $1,000, giving a down payment of $100 cash and financing the balance for two years. With the finance charges added to the unpaid balance, the buyer would normally pay monthly installments of more than $50. In order to reduce these payments, the buyer could execute a balloon note requiring 23 installments of $35 each and a final installment of $397. The law requires that the buyer be permitted to refinance the final installment amount on the same or better terms. That is, the note must state that the interest rate, payment amounts, and repayment period for the refinanced final payment must be the same or lower than those of the original contract. Thus, the buyer would be able to pay the refinanced final payment over 24 installments.
If the buyer is more than 30 days late on a payment in a consumer transaction, the seller may accelerate the payments. This means that the seller can declare all payments immediately due on account of the default.
A buyer who pays off the balance completely before the final payment is due is entitled to a proportionate refund on the interest or finance charges.
Ohio law controls home solicitation sales. The law is directed at abuses which became common in sales made at consumers' homes. These abuses included, for example, (1) deception and high-pressure sales tactics; (2) sales of goods and services which the consumer did not really want or need; (3) sales of goods and services of inferior quality at grossly inflated prices; and (4) business practices of some transient salespersons and their employers.
These business practices included selling the consumers' promissory notes at a discount and leaving the area. Specifically, certain door-to-door salespersons would sell the consumers' notes (consumers' written promise to pay) to finance companies or banks for less than the face amount of the note and then leave the area. In effect, they left the consumer with a debt to pay the finance company or bank, but without anyone or any entity to contact about problems with the sale or with the goods and services. Nevertheless, it should also be noted that the good faith sale of promissory notes at a discount is a common and legitimate business practice.
A home solicitation sale is defined as a sale concluded at the buyer's home in a personal solicitation by the seller. Such sales do not include (1) sales under $25; (2) sales of real estate, insurance, stocks, bonds, or cars or automotive services (when such sales are by licensed brokers or dealers in such items); or (3) sales at auctions.
In order to be valid, a contract for a home solicitation sale must be in writing and must contain the same language used in the sales pitch. This means that the salesperson cannot say one thing and put another in the contract. If the sale is an installment sale, the laws on retail installment sales must be met. The contract must contain a notice of cancellation (a clear description of the buyer's right to cancel) and clear instructions on how the buyer can cancel the contract.
A buyer in a home solicitation sale may cancel the contract at any time within three days after it has been signed by sending or delivering a cancellation notice to the seller in any of various forms. If the sale is canceled, the seller must return money paid, plus any trade-in or deposit.
Also, the seller cannot discount the note until five days after the sale. The seller cannot negotiate (transfer) the note if the sale is cancelled but must return the note to the buyer. If the note is negotiated, the laws on Retail Installment Sales apply and the transferee (person or entity who received the note from the seller) must notify the buyer of the transfer and give the buyer 15 days to state defenses or claims. A buyer who cancels a home solicitation sale must return any goods in the same condition as when they were received.
The Ohio "Lemon Law," effective November 1987, applies to the purchase of new automobiles. Purchasers of new motor vehicles which do not conform to applicable express warranty within one year of delivery, or the first 18,000 miles of operation, have legal remedies against the seller. The rights include compelling the seller to repair the defects, and in the event that repair attempts are unsuccessful, replacement of the motor vehicle or refund of the purchase price.
Formerly, retail installment sales contracts were the most important method of extending consumer credit. Although installment sales are still important, credit cards are the most common method used today. Another means of extending consumer credit is the small loan.
The credit card is perhaps the most widespread method for extending consumer credit. Generally, a credit card serves as evidence that the holder has a contract with the issuer of the card to maintain a revolving charge account in the cardholder's name. Historically, revolving charge accounts have been among the most expensive forms of consumer credit.
A revolving charge account contract permits the cardholder to purchase goods and services any time they present the card. The card issuer must then send the cardholder monthly statements. Under some plans, the cardholder may pay the total monthly balance without charge (just as if the cardholder had an open account with the issuer). In most cases though, the cardholder may make a minimum payment and carry the balance of the statement into the following month or months by paying a monthly finance charge. The minimum monthly payment may vary depending on the amount balance and is not necessarily uniform among issuers.
The issuer typically has no security interest in the goods sold. Late payment charges cannot be assessed on a revolving charge account, but finance charges for amounts not paid in time can be added to the unpaid balance.
Some credit card accounts are not revolving charge accounts. Rather, they are open accounts in which the cardholder has promised to pay the card issuer all of the balance due within a certain time. Under the agreement, a balance cannot be carried forward to the next billing period. These credit cards are usually "travel and entertainment" cards.
The Electronic Fund Transfer Act establishes the basic rights, liabilities, and responsibilities of consumers who use electronic money transfer machines (automatic teller machines). The terms and conditions involving a consumer's account must be disclosed in simple terms when he or she signs up for the electronic fund transfer service. In addition to certain other specific requirements, the disclosure must include (1) the consumer's liability for unauthorized transfers; (2) the person or office to contact with questions; (3) a statement of charges involved in the service; (4) the circumstances under which the financial institution will disclose information concerning the customer's account to third persons; (5) the consumer's right to stop payment of a preauthorized electronic fund transfer, along with steps to initiate a stop payment order; and (6) the statement of consumer's right to receive documentation of electronic fund transfers.
Loan companies must be licensed by the state. They are permitted to make small loans of up to $5,000 at special interest rates and can charge up to 21 percent per year. Further, interest rates are negotiable. Buyers should not blindly accept the first interest rate which is offered and should shop for the best possible interest rate and terms. Further, they should negotiate. Just because an interest rate figure, or any other item, is in writing or is printed does not mean that it cannot be changed. Sellers of money, as well as sellers of merchandise, can change the terms of their documents.
Consumers end up in difficult situations, particularly with credit transactions, primarily because of unwise decisions. Most of these situations can be avoided by following five simple rules: (1) use credit sparingly; (2) stay within your budget; (3) make sure you know what is involved before obligating yourself; (4) live up to your obligations, but if you get into trouble, let the other party know your situation; and (5) keep accurate records.
Consumer credit is expensive and should only be used when absolutely necessary. In the long run, it is much wiser to pay cash because the money saved on interest can be used to buy more goods and services. We usually buy something because we think we need it now, but most of these purchases could be delayed. Most of the time, it is smarter to save and pay cash than to buy now and pay more later. Further, regular savings through a bank, credit union, or investments could make your savings grow.
Do not sign up for payment transactions which you think you will have trouble meeting. Keep in mind your other obligations, including rent or mortgage payments, food and clothing for your family, medical bills, insurance premiums, home maintenance, and having a little left over for emergencies and leisure. Do not rely on your overtime pay to meet long-term payments. The fact that your employer currently is working at full capacity and you are getting substantial overtime pay is no guarantee that the overtime will continue.
Do not sign up for any business transaction without understanding the contract, your rights, and obligations.
Once you have obligated yourself, keep your promise. A good credit rating can be very valuable. Whereas a bad credit rating can hold you back financially by preventing you from getting credit in the future, or by making future credit more expensive.
However, there may be times when it is impossible for you to meet your obligations promptly. If this does happen, contact the creditor and discuss your situation. Creditors are generally willing to adjust or temporarily delay payments. People in the business of extending consumer credit know that if they pressure debtors in financial trouble too much or too quickly, they may destroy the debtor's ability to eventually make complete payment. If you do not contact the creditor when you run into financial difficulties, the creditor may conclude that you are untrustworthy, and downgrade your credit rating.
It is important to keep (1) copies of all the papers you sign; (2) copies of all correspondence to and from you concerning purchases and payments; and (3) a record of all payments. If there is a disagreement or error, you will have your own records so it would be much easier to argue your position, negotiate, or prove your claim or defense in court. Finally, your mortgage and home equity loan records can provide proof of the interest you paid on these loans, which may be deductible for federal income tax purposes.
Disclaimer: Articles appearing on this website are intended to provide broad, general information about the law. Before applying this information to a specific legal problem, readers are urged to seek advice from an attorney.
Reprinted and distributed by Fanger & Davidson LLC with permission from the Ohio State Bar Foundation as a service to our clients and friends. Excerpted from The Law And You, A Handbook of General and Everyday Law Affecting Ohio Citizens. Prepared for the Ohio State Bar Association by the Ohio State Bar Foundation. Copyright © 1997-1999 Ohio State Bar Association. All rights reserved.