Overview
In response to customer demand, retailers are offering new payment options for their products beyond simple cash and card transactions. One of these options surging in popularity is an arrangement that allows customers to split their purchases into several smaller – often four –payments. These programs appeal to retailers because they can offer their customers more flexible payment options while receiving full payment upfront. Customers also appreciate the flexibility to take home their purchases before making payment in full. While these arrangements may appear new, they are a variant of what is often referred to as a retail installment sales contract (RISC).
The Different Types of RISC-y Businesses
Today's RISCs come in different forms and are backed by well-funded technology companies. For example, two RISC providers, AfterPay and Quadpay, allow eligible customers to pay for purchases in four, two-week installments through a linked debit or credit card.[1] While these companies do not charge interest, customers who fail to make timely payments will incur late fees.
Other companies, such as Affirm and Klarna, offer more traditional credit arrangements through partnerships with regulated entities, such as banks.[2] These programs also offer more variable payment schedules and terms, with payment schedules from as short as a few months to several years, and with interest rate terms ranging from 0% to 30%. The fees for late payments are governed by the terms of the loan.
These programs also vary in how the retailer relationship with the customer is structured. With AfterPay, the retailer enters into a RISC with the customer which the retailer then assigns to AfterPay.[3] In other arrangements, the RISC is entered into between a customer and a financial institution[4] or directly between a customer and a RISC provider.[5] But even these models differ in their specifics. For example, one provider allows for the creation of a "virtual card" that can be used at any retailer that accepts Visa.[6] Another requires a link to an existing credit card and makes a reservation for the purchase amount on the customer's line of credit before collecting a monthly, interest-free installment.[7]
Legal Landscape
Generally, today's RISCs are designed to avoid application of certain federal and state laws. For example, the federal Truth in Lending Act's Regulation Z applies only to consumer credit "that is subject to a finance charge or is payable by a written agreement in more than four installments."[8] Many state laws also exclude contracts that do not charge interest or finance charges, or require four or fewer payments. California's Retail Installment Sales Act (referred to as the "Unruh Act"), for example, governs certain RISCs that provide for payment in more than four installments, contain a finance charge, or where the goods or services are available at a lesser price if paid for by either cash or credit card.[9] Both federal and state RISC laws regulate disclosure and substantive requirements.
Even if a RISC falls outside the scope of federal or state-specific RISC laws, these types of payment programs still must comply with anti-discrimination lending laws, such as those implemented by Regulation B,[10] and other consumer protection regulations that prohibit unfair, deceptive, and abusive acts and practices (UDAAP).[11]
Part of the appeal to retailers of RISCs is that customers can make larger purchases seemingly at no or little additional cost. And the data show that customers who pay using RISCs tend to spend more than they would using other forms of payment.[12] Despite the potential for increased sales, retailers should understand that even though customers may be offered interest free terms, they can incur fees and charges and harm their credit scores if they miss or are late on payments. Under one popular model, a customer is assessed late fees that can eventually reach up to 25% of the purchase price.[13] Another model claims never to impose late fees or interest payments, but will report charge offs to credit bureaus and can make referrals to collection agencies.[14]
Things to Consider Before Taking on RISCs
Retailers should consider the extent to which payment installment options are beneficial to their long-term business model. Even though a retailer does not assess the fees associated with RISCs, it may nonetheless face reputational harm, as customers may not distinguish between the retailer and the RISC provider, as well as diminished purchasing power from such customers if their access to credit becomes impaired. This latter result, in particular, has the potential to attract the attention of regulators and consumer groups. Additionally, the ability to link to a merchant's website from a RISC provider (and vice versa) may contribute to customer confusion regarding the relationship between a merchant and a RISC provider.
The federal Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC) both have authority to investigate complaints and bring actions against persons engaged in unfair or deceptive sales practices.[15] States with strong consumer protection laws also may consider enforcement in this space, and may even revisit their own RISC laws, many of which have not been updated in decades. While RISC providers operating today have largely avoided scrutiny, they should be prepared for regulatory questioning of their services and practices.
Retailers also should understand the nature of their relationship with their customers. As explained above, at least one RISC arrangement has the retailer entering into a RISC directly with the customer and then assigning it to a third party. In this case, the retailer should assure itself of its legal authority to enter into such a contract with a customer, as well as its continued compliance with any applicable regulatory requirements (such as Regulation B) in each jurisdiction in which it offers the payment service. Retailers also should assess the legal and regulatory requirements of assigning the contract to third parties.
In other scenarios, the RISC is entered into between a customer and a financial institution or directly between a customer and a RISC provider. Due to the varied structures and methods used by RISC providers, these arrangements and the regulatory hurdles they may entail also warrant close attention.
Generally, RISC providers will be the ones bearing the risk when it comes to ensuring customer payment and regulatory compliance. The majority of RISC-providing entities advertise their assumption of risk as a major aspect of their services, allowing retailers to expand their customer base without fear of fraud or default.[16] Still, retailers may find themselves party to potential lawsuits stemming from collection or late fee disputes. Retailers should review their RISC providers' terms of service and consider whether they are properly indemnified in the event of a customer dispute or class action. Additionally, retailers should consider adding an arbitration clause and class action waiver to their online terms of use to help protect against consumer class action litigation.
Finally, companies offering RISCs typically insist on being an exclusive extended payments provider and may enter into a joint marketing program with the retailer. Accordingly, retailers should evaluate their legal and reputational liabilities from any joint marketing efforts, as well as the customary profiling of retailers on the RISC provider's website. Retailers should consider the appropriate level of diligence needed to assure themselves that any co-branded marketing materials comply with applicable federal and state laws.
Conclusion
Retailers exploring adding RISCs to their list of possible payment methods should carefully consider the legal and reputational risks of engaging in what is still a nascent and less regulated part of the financial services industry.
[1] AfterPay Purchase Payment Agreement, Afterpay (last updated Aug. 30, 2018); Quadpay Customer Agreement, Quadpay (last updated March 11, 2019).
[2] Affirm Terms, Affirm (last updated May 30, 2019); WebBank Klarna Credit Account Agreement, Klarna (last updated Oct. 11, 2018).
[3] AfterPay Purchase Payment Agreement, supra note 1.
[4] Affirm Terms, supra note 2.
[5] Sezzle User Agreement, Sezzle (last updated Mar. 1, 2019).
[6] Quadpay Customer Agreement, supra note 1. See also Valerie Safronova, It's Layaway, But for a Post-Recession Economy, New York Times (May 3, 2019).
[7] Splitit Terms & Conditions, Splitit (last updated April 2019).
[8] Regulation Z, 12 C.F.R. § 1026.1(c)(1). Similarly, a "creditor" under Regulation Z is limited to "[a] person who regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments (not including a down payment), and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when there is no note or contract." 12 C.F.R. § 1026.2(17)(i).
[9] CA Civil Code § 1802.6.
[10] 12 C.F.R. Part 1002. The Official Interpretation of the Authority and Scope of Regulation B states that "[t]he Equal Credit Opportunity Act and Regulation B apply to all credit - commercial as well as personal - without regard to the nature or type of the credit or the creditor . . . . If a transaction provides for the deferral of the payment of a debt, it is credit covered by Regulation B even though it may not be a credit transaction covered by Regulation Z (Truth in Lending) (12 CFR part 1026). Further, the definition of creditor is not restricted to the party or person to whom the obligation is initially payable, as is the case under Regulation Z. Moreover, the [Equal Credit Opportunity] Act and regulation apply to all methods of credit evaluation, whether performed judgmentally or by use of a credit scoring system." 12 C.F.R. Appendix Supplement I to Part 1002.
The Official Interpretation continues, "Regulation B covers a wider range of credit transactions than Regulation Z (Truth in Lending). Under Regulation B, a transaction is credit if there is a right to defer payment of a debt - regardless of whether the credit is for personal or commercial purposes, the number of installments required for repayment, or whether the transaction is subject to a finance charge." Id.
However, providers of "incidental credit," defined as extensions of consumer credit "(i) that are not made pursuant to the terms of a credit card account; (ii) that are not subject to a finance charge (as defined in Regulation Z, 12 CFR 1026.4); and (iii) that are not payable by agreement in more than four installments," are excepted from certain procedural requirements of Regulation B. See 12 C.F.R. § 1002.3(c) (Incidental Credit).
[11] Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), Pub. L. No. 111-203 at Title X, Subtitle C, Sec. 1036 (2010). See Unfair, Deceptive or Abusive Acts or Practices, Consumer Financial Protection Bureau (CFPB) Consumer Laws and Regulations (Oct. 2012). See also Prohibition of Unfair, Deceptive, or Abusive Acts or Practices in the Collection of Consumer Debts, CFPB Bulletin 2013-07 (July 10, 2013).
The principles of "unfair" and "deceptive" practices in the Dodd-Frank Act are similar to those under Section 5 of the Federal Trade Commission Act. 15 U.S.C. § 45.
[12] Annie D' Innocenzio, New Ways to Pay: Installment Payments with a Twist, AP (Aug. 8, 2018).
[13] Afterpay Purchase Payment Agreement, supra note 1.
[14] Sezzle User Agreement, supra note 5.
[15] The authority to take enforcement, supervision, and rulemaking actions concerning abusive acts resides with the CFPB, though it has not issued any rules under this authority. The meaning of "abusiveness" is less developed than "unfair" or "deceptive," and the CFPB recently held a symposium to gather input on how to clarify the standard. See Evan Weinberger, CFPB Signals Greater Clarity Coming for Abusive Standard, Bloomberg Law (June 25, 2019).
[16] This includes AfterPay, Affirm, Klarna, and Sezzle, among others.
