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N. C. Freed Co. v. Board of Governors of Federal Reserve System


decided: February 1, 1973.


Moore, Hays and Mulligan, Circuit Judges.

Author: Moore

MOORE, Circuit Judge:

The Board of Governors of the Federal Reserve System (the Board) and the Federal Trade Commission (FTC) appeal from a judgment and order of the United States District Court for the Western District of New York declaring invalid a regulation promulgated by the Board pursuant to the Truth-in-Lending Act, which comprises Title I of the Consumer Credit Protection Act*fn1 (the Act). The action for declaratory judgment and injunction was brought below by appellees N. C. Freed Company, Inc., and International Roofing Corp., two corporations in the home improvement industry organized under the laws of the State of New York, pursuant to the Declaratory Judgment Act (28 U.S.C. § 2201) and the Administrative Procedure Act (5 U.S.C. §§ 701-706).*fn2 Appellees sought, and the district court granted, a two-part order (1) declaring invalid 12 CFR § 226.9(a),*fn3 which was designed to implement Section 125(a) of the Act,*fn4 on the ground that the Board exceeded its Congressionally conferred authority in overextending the reach of said Section; and (2) enjoining the FTC and all other federal agencies from enforcing the regulation.


The relevant facts are not disputed by the parties. The business of the appellees is derived almost entirely from credit transactions with homeowners wishing to have improvements made on their homes. The usual business procedure followed by the appellees involves salesmen who call upon the homeowner in an effort to secure contracts for the performance of home repair work. The contracts ordinarily provide that the appellees will perform the work on the homeowner's premises for an agreed price, on credit terms. At the time the contract is executed the homeowner-obligor is not required to execute a (second) mortgage, deed of trust, or other indenture on his residence as a condition for the extension of credit. He is, however, required to sign an unsecured promissory note to the contractor's (appellees') order, for the contract price of the work. Typically, the promissory note is then negotiated or assigned by appellees to a bank or other financial institution. By operation of law in many states such a promissory note spawns various statutory liens, such as mechanic's, materialmen's, artisan's, and similar type liens, on the consumer's home at the time the work is commenced.*fn5

Section 125(a) of the Act requires that a creditor (e.g., appellees or a financial institution) furnish the consumer with a notice of the right to rescind the home improvement contract within three days from the date of its execution in any credit transaction*fn6 wherein a security interest is retained or acquired in the consumer's residence. Pursuant to Section 105 of the Act,*fn7 which directs the Federal Reserve Board to "prescribe regulations to carry out the purposes of [Section 125]", the Board promulgated the challenged regulation, which provides that a consumer shall have the right to rescind a credit transaction within three days from the date of its execution where a security interest is or will be retained or acquired by a creditor in the consumer's home.*fn8 The present controversy centers upon the verb tense difference between the language of Section 125(a), "is retained or acquired", and that of the regulation, "is or will be retained or acquired." The appellees argued successfully below that the Board has improperly extended the reach of Section 125(a) to cover non-consensual or statutory liens arising in futuro, and that Congress had intended that the right of rescission prescribed by the Section would pertain only to second mortgages or other consensual liens given by the homeowner at the time the contract is executed. On cross-motions for summary judgment the district court entered judgment for appellees, concluding that the regulation exceeded the Board's authority and was thus unlawful:

That much of the regulation pertaining to security interests that will be retained or acquired is beyond the Board's power and is an invilad implementation of Section 125(a).

The plain fact is that Congress in enacting Section 125(a) made rescindable only those contracts which acquired a security interest through a mortgage, deed of trust, or other consensual type lien, and did not include liens which might arise in the future by operation of law.*fn9 (emphasis added)

The Federal Reserve Board and the FTC on appeal argue that the challenged regulation is both necessary and proper to effectuate the purposes of the Truth-in-Lending Act, and that, in seeking to protect unwitting consumer-homeowners from home improvement frauds, Congress did not intend to restrict protection provided by the Act solely to consensual liens, such as second mortgages, but intended to include all liens resulting from a consumer credit transaction. The narrow issue we must here decide is whether the Federal Reserve Board exceeded its authority by including statutory liens within the rescission provision of the Truth-in-Lending Act. Our close reading of the legislative history leads us to agree with the position taken by appellants Federal Reserve Board and Federal Trade Commission and, accordingly, we reverse the judgment below.*fn10


The avowed purpose of the Consumer Credit Protection Act, enacted in 1968 after eight years of Congressional consideration, was to "assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit."*fn11 The Act is remedial in nature, designed to remedy what Congressional hearings revealed to be unscrupulous and predatory creditor practices throughout the nation.*fn12 Since the statute is remedial in nature, its terms must be construed in liberal fashion if the underlying Congressional purpose is to be effectuated. See Peyton v. Rowe, 391 U.S. 54, 64-65, 88 S. Ct. 1549, 20 L. Ed. 2d 426 (1968); Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S. Ct. 548, 19 L. Ed. 2d 564 (1967).

In Tcherepnin the Supreme Court held that the term "securities", for purposes of the Securities Exchange Act, should be construed broadly because of the remedial nature of that statute, legislation designed to protect investors through the requirement of full disclosure by issuers of securities. The Court stated that in defining "security" under the Exchange Act (as we must determine the proper scope of "security interest" under the Truth-in-Lending Act), "form should be disregarded for substance and the emphasis should be on economic reality." (Id.) See also Johnson v. Southern Pac. Co., 196 U.S. 1, 14-18, 25 S. Ct. 158, 49 L. Ed. 363 (1904); FTC v. Mandel Bros., Inc., 359 U.S. 385, 388-389, 79 S. Ct. 818, 822, 3 L. Ed. 2d 893 (1959) ("We deal with remedial legislation of a regulatory nature where our task is to fit, if possible, all parts into an harmonious whole."

One "economic reality" of the home improvement industry is that, in work such as that performed by the appellees, second mortgages and statutory liens are used extensively to secure payment of home improvement contracts that are ordinarily "insecure" business ventures.*fn13 Our reading of the legislative history demonstrates that although Congress was concerned in Section 125(a) primarily with abuses flowing from creditor use of second mortgages as a security device, it was equally concerned with abuses stemming from use of other types of liens:

Another provision of the bill is also vitally important. That is the Cahill amendment, or rather a series of amendments in the House, to strike at home improvement racketeers who trick home owners, particularly the poor, into signing contracts at exorbitant rates, which turn out to be liens on the family residences. Any credit transaction which involves a security interest in property must be clearly explained to the consumer as involving a mortgage or lien ; any such transaction involving the consumer's residence -- other than in a purchase-money first mortgage for the acquisition of the home -- carries a 3-day cancellation right.*fn14 (emphasis added.)

The typical home improvement contract is procured, usually under pressure conditions, by a prime contractor (such as the appellees) who frequently possesses little or no capital of its own; the actual work is often done by various subcontractors.*fn15 When the promissory note signed by the homeowner is assigned or negotiated to a financial institution, which can then assert holder-in-due-course status against him,*fn16 his premises become vulnerable not only to the statutory liens available to the prime contractor, but also to the various mechanic's and materialmen's liens of the subcontractors, as well as to the secured position of the holder-in-due-course financial institution. Thus, if the homeowner should default in payment to the prime contractor, the latter could levy on the home to obtain payment, that is, unless the contractor has waived its statutory liens. But even though the prime contractor may waive its liens in the contract, it usually cannot waive statutory liens arising in favor of subcontractors,*fn17 so that if the prime contractor fails to pay its subcontractors the latter can also levy on the home to collect payment.*fn18 Conceivably, then, in many states even if the homeowner has already paid the prime contractor, in order to protect his home from subcontractor statutory liens, he may also have to pay the subcontractors, thus paying twice for the same work.

The appellees recognize the existence of this problem but they argue, and the district court agreed, that, because Section 125(a) speaks of a mortgage or lien that is retained or acquired, liens arising in the future by operation of state law were meant to be excluded since they are not "retained or acquired" at the time the contract is executed by the parties. This argument, however, flies in the face of established authority that a contract will be deemed to include in its terms all rights conferred upon the parties by the laws of the state in which the contract is executed. See Von Hoffman v. City of Quincy, 71 U.S. 535, 4 Wall. (71 U.S.) 535, 550, 18 L. Ed. 403 (1866), where the Supreme Court early held that "the laws which subsist at the time and place of the making of a contract, and where it is to be performed, enter into and form a part of it, as if they were expressly referred to or incorporated in its terms." Hence statutory liens do not, as the district court ruled, arise only in the future; they may be retained or acquired at the time the credit transaction is executed. In some states mechanic's liens relate back to, and attach, as of the time of the original contract.*fn19 In numerous states mechanic's liens relate back to, and attach, as of the time work on the home is commenced or materials are furnished.*fn20 It is clear to us that in Section 125(a) Congress intended to establish a national policy of protecting consumers whose residences are jeopardized by operation of all types of security interests acquired by creditors in the home improvement industry, and that the goal was to provide uniform protection throughout the nation, irrespective of the vagaries among the states' lien laws.*fn21 Because of the various differences among the states in the treatment of statutory liens, and the opportunities for evasion of Section 125(a) which these differences make possible, consumers can be effectively protected only if all statutory liens are included within the regulatory ambit of that Section. With an awareness of the multifarious pitfalls created by statutory liens, through which a homeowner may unwittingly lose one of his most precious possessions, his home, it would be most incongruous for us to construe Section 125(a) in the manner urged by the appellees: that is, that Congress intended the statute to require disclosure and three-day right of rescission as to some, but not all, of the various security interests created by a home improvement contract. We think that the only way in which the Act's objective of "meaningful disclosure" of credit terms may be achieved is if the various statutory liens are included and treated uniformly under the Truth-in-Lending Act; this Congress intended through the operation of Section 125(a), and this the Federal Reserve Board recognized in 12 CFR § 226.9(a). Carving statutory liens out of the protection provided by Section 125(a) would not only render impossible such uniformity among the states, it would defeat the goal of providing "meaningful" disclosure to the consumer. We refuse to perform such a surgical procedure.

Ruling on this precise issue in Gardner and North Roofing and Siding Corp. v. Board of Governors of Federal Reserve System, 150 U.S. App. D.C. 329, 464 F.2d 838 (D.C.Cir. 1972), the District of Columbia Circuit has, we think, correctly determined the question:

We think it a reasonable construction of the statute that Congress intended to require disclosure of all the consequences flowing from the signing of a home improvement contract, including not only the consequences spelled out in the contract, but also those necessarily inherent therein. Any other construction would expose the homeowner to hidden and perhaps fatal traps; it would lead to precisely the kind of imposition that Congress intended to prevent. Viewed in this light we think the challenged regulation is entirely consistent with the legislative purpose and is a reasonable and proper device for carrying it out. 464 F.2d at 842.


We conclude that, in ruling that the right of rescission provided by Section 125(a) applies only to cases in which the creditor retains or acquires a consensual lien, or second mortgage, the district court relied on a too technical and narrow construction which eviscerates the statute, and which renders consumers susceptible to the very abuses Congress sought to prevent. We hold that the Federal Reserve Board did not exceed its authority in defining "security interest" to include statutory liens, and in interpreting the right of rescission provided in Section 125(a) as extending to such statutory liens. The challenged regulation constitutes a clarification, and not an improper extension, of the statute and it therefore does not exceed the bounds of the mandate given the Board by Congress.*fn22 Since the regulation is clearly consistent with the legislative purpose,*fn23 it may not be overturned. Phelps Dodge Corp. v. NLRB, 313 U.S. 177, 194, 61 S. Ct. 845, 85 L. Ed. 1271 (1941). And since the regulation constitutes a contemporaneous construction of a statute by the agency charged by Congress with the administration of the Act, the Board's construction is entitled to deference. Udall v. Tallman, 380 U.S. 1, 16, 85 S. Ct. 792, 13 L. Ed. 2d 616 (1965); Gardner and North Roofing and Siding Corp., supra, 464 F.2d at 842. Appellees' position on appeal, relying as it does on a hypertechnical construction of the language in Section 125(a), would enable disreputable firms to act in an underhanded manner. We fail to see how the three-day right of rescission provided in Section 125(a), as implemented in 12 CFR § 226.9(a), can cause harm to reputable business firms.

Accordingly, we reverse the judgment below.

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