Requiring cash as collateral for loans violates TILA interest rates disclosure requirements

Law Reporter, Jun 2000

Williams v. Chartwell Fin. Servs., Ltd., - EM -,Nos. 99-2258, 99-2287,2000 WL 137128 (7th Cir. Feb. 8, 2000).

The Seventh Circuit Court of Appeals held that a lender's practice of requiring cash as collateral for loans reduced the amount of the loans for purposes of calculating interest rates under the Truth in Lending Act (TILA), 15 U.S.C. 1601 et seq.

Here, two people entered into loan agreements with Chartwell. Chartwell required each to deposit a cash security, which Chartwell placed in its operating account for business expenses. Upon paying their loan obligations, each borrower was to receive the deposit with nine percent interest. The annual percentage rates (APRs) were calculated according to the amount borrowed as stated in the loan agreements. The borrowers sued Chartwell, alleging, among other claims, that defendant's practice of requiring borrowers to provide cash collateral reduced the actual amount of the loans, resulting in inaccurate APRs in violation of TILA. The trial court granted defendant summary judgment, finding that the cash collateral was like any other type of security. Further, the trial court found no violation of TILA because, even if the cash was considered a deposit, the regulations exempt deposits earning interest at an annual rate greater than five percent from APR disclosures.

Reversing, the Seventh Circuit found that the trial court failed to focus on the economic substance of the transaction in determining whether TILA had been violated. A security, the court noted, gives a creditor interest in property that may be sold or taken to satisfy an obligation. In this case, the cash collateral was not to make the loans more secure, but rather to reduce the amounts of the loans. Defendant, the court reasoned, used the cash as a means to reduce the amount of money it initially put at risk. Thus, defendant was obligated under TILA to calculate the interest according to the amount of the loan after reduction by the cash collateral.

The court rejected the idea that the required cash securities were deposits exempt from TILA disclosure requirements because they earned greater than five percent annual interest. The type of deposit contemplated by TILA, the court explained, is the "traditional" deposit account or interest-bearing account. These accounts are usually held with federally regulated institutions, the court found. Here, defendant does not have a license to accept deposit accounts and the cash it accepts as collateral is not federally insured or regulated. Thus, the court concluded, defendant does not qualify for the deposit exemption under TILA. The court also disagreed that putting the cash security into defendant's operating account meets the definition of a deposit exempted under TILA. Defendant's operating account did not segregate the funds from borrowers, nor did it earn interest on behalf of its customers, the court observed.

Plaintiffs' Counsel Tara Goodwin, Chicago, Ill.