You are interested in buying a new car and Bob lets you borrow one of the new cars on his lot for a week to test drive. You decided you like the car and when you visit Bob to drop off the car, he...

You are interested in buying a new car and Bob lets you borrow one of the new cars on his lot for a week to test drive. You decided you like the car and when you visit Bob to drop off the car, he hands you the following document and a pen: 

I promise to pay to the order of Bob's Auto Emporium $20,000 with interest at the rate of 70% per annulment. What type of instrument is this, does this instrument meet the requirements for negotiability under the UCC?

Asked on by berty63

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Stephen Holliday | College Teacher | (Level 1) Distinguished Educator

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In your example, the debt instrument is called a promissory note, that is, a simple promise to pay $20,000 dollars at an interest rate of 70%.  Such an instrument, however, would not be enforceable, at least in the United States, for several reasons.  Also, the UCC, or Uniform Commercial Code, would not govern a consumer debt instrument because, as its title states, it governs commercial transactions.  Instead, a number of other regulations, loosely referred to as Truth-in Lending ("TILA"), Regulation Z, and, in several states, the Uniform Consumer Credit Code (the "UCCC"), governs transactions involving private consumers (that is, not businesses).

As this promissory note is written, the debtor would be paying 70% per year in perpetuity.  Because a car loan is considered a closed-end debt, as opposed to an open-end or revolving debt, the debt must be limited to specific time periods, in most cases, 36 to 60 months.  In addition, because many states have enacted some form of the UCCC, and many, if not all,  other states have restrictions on interest rates for consumer transactions, an interest rate of 70% would violate usury laws.  For example, in a typical UCCC state, closed-end loans can carry an interest rate of no more than 12% per year, and open-end or revolving loans carry higher rates but on a sliding scale--36% on the first $1,000 of debt; 24% on amounts from $1,000 to $5,000, and so on.

Perhaps more important than these issues, however, is that, under the circumstances you have described, this instrument violates the primary consumer protection law in the United States known as the Truth-in-Lending Act (15 United States Code 1601 and following).  This act, for example, requires that all disclosures regarding the nature of the debt be fully described and provided to the consumer in advance of the consummation of the transaction.  In the scenario above, the borrower seems to have been presented with terms he or she has not seen or discussed with the creditor.  Even without TILA protections, this promissory note violates common-law contract requirements because the "agreement' has been made without the consent of the prospective debtor--in other words, an enforceable contract must be an agreement between two or more parties, not an agreement of one.  As your question implies, there has been no input, no negotiation, from the most important party in a debt transaction, the debtor.

Even if the debtor signed such an agreement, under TILA, he or she has at least three days to rescind (cancel) the contract and is not required to provide a reason for the cancellation to the prospective creditor.  In some cases, if the creditor and debtor agreed that the creditor will be paid a certain amount if the debtor rescinds the contract, then the debtor may owe that amount upon rescission.

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