Terrorism's Impact On the Credit Industry - The Federal Soldiers and Sailors Civil Relief Act

Terrorism’s Impact On the Credit Industry - The Federal Soldiers and
Sailors Civil Relief Act
By Thomas B. Hudson and Paul S. Ayres*

In the wake of the recent terrorist attacks on the United States, it is estimated that between
35,000 and 50,000 military reservists will be called to active duty over the next several months.
This action once again requires lenders to familiarize themselves and their staffs with the
provisions of the Soldiers' and Sailors' Civil Relief of 1940, 50 U.S.C. App. §§ 501 et seq.
("SSCRA") and to develop internal compliance procedures to manage requests by military
personnel seeking the benefits and protections of this 60-year-old law. Most lenders have not
given serious attention to this statute since Operations Desert Shield and Desert Storm more than
10 years ago. As a result, a brush up on this important law is in order.

Coverage

Enacted in 1940 and amended a handful of times since, the purpose of the SSCRA is to provide
protection for individuals entering or called to active duty in the military service and their
dependents. The statute is intended to postpone or suspend certain civil obligations to enable
service members to devote their full attention to duty. 50 U.S.C. App. § 510. Many questions are
not directly addressed by the statute. However, courts have been very liberal in applying the
protections of the SSCRA to those in service. As noted by the Supreme Court in Maistre v.
Leffers, 333 U.S. 1 (1948), the SSCRA should be read "with an eye friendly to those who dropped
their affairs to answer their country's call." As a result, any doubt regarding application of the Act
should be resolved in favor of service members.

The scope of the law may be broader than you would expect. Persons entitled to the benefits of
the SSCRA include members of the Army, Navy, Air Force, Marine Corps, and Coast Guard as
well as officers of the Public Health Service detailed by proper authority for duty either with the
Army or Navy, who are on active duty or who are in training under the supervision of the United
States just prior to entering active duty. 50 U.S.C. App. § 511. The SSCRA is a federal statute
that applies to creditors and courts generally without exception. The protections of the Act apply
equally to volunteers as well as draftees on active duty, and whether a declaration of war exists
or not. The SSCRA is not limited to consumer credit. Business or commercial credit is also
subject to its protections where the service member is personally obligated, even if only as a
guarantor.

In addition to service members, the SSCRA also protects third parties in some instances. Such
protection may be derivative under the stay protection of § 513 which allows a court to grant
stays, postponements or suspensions of lawsuits or proceedings to person primarily or
secondarily liable with the service member. Such parties would include sureties, guarantors, and
other accommodation parties. In general, a court will analyze whether the service member is
entitled to relief before granting the same protections to these additional parties.

Additionally, under § 536 dependants may assert in their own right specified protections under the
Act. These protections include protection from eviction, contract termination and repossession,
mortgage foreclosure and early termination of leases. For these protections, the dependent may
assert the protection regardless of whether the service member is a party to the underlying
obligation. However, the protections are not available if the court finds that the military service of
the person on whom the applicants are dependent does not materially affect the ability of the
dependent to comply with the terms of the agreement. "Dependent" is not defined by the SSCRA
but the better view is that the term refers to financial dependency on the service member and is
determined on a case-by-case basis.

However, the SSCRA might also be narrower than you would expect. Members of the National
Guard are covered only if activated or mobilized to federal service. State military service will not
invoke SSCRA protections. 50 U.S.C. App. § 511. But several states have enacted statutes2
similar to the SSCRA to cover individuals entering service. For example, Alaska has a statute that
extends the protection of the SSCRA to national guard and naval militia personnel on active duty.
See Alaska Stat. § 26.05.135. Michigan, offers even greater protections to those in service by
prohibiting any seizure or sale of collateral until 90 days after the debtor has left the service. See
Mich. Comp. Laws Ann. § 32.517. The lesson here is that you have to consult both state and
federal law to determine the complete rights of service members.

6% Interest Rate Cap

Of the many protections afforded by the SSCRA, a few are of particular concern to creditors. The
most well known is the 6% rate cap mandated by § 526. Under this provision, creditors may not
charge interest in excess of 6% on any debt owed by active duty personnel if the debt was
incurred prior to active duty status, the contractual rate of interest exceeds 6% and the military
service materially affects their ability to pay debt at the contract rate. This provision is designed to
protect those called to duty who will experience a reduction in income as a result of their service.
In peacetime, those who enter the military frequently experience an increase in income and § 526
cannot be invoked. However, in times of conflict where reserves are called to duty and
experience a sudden and dramatic reduction in income, requests for rate reductions can become
an issue for creditors.

Obligations incurred while on active duty status are not covered even if the debtor is required to
relocate overseas. This distinction is particularly important with respect to open end credit
facilities such as credit cards or home equity lines of credit. Advances made prior to service get
the benefit of the reduced rate, while post-service advances do not. Servicers of these types of
credit facilities must make systems changes to support this tiered rate structure or apply the lower
rate to all advances and balances.

Despite its notoriety throughout the credit industry, there are a number of misconceptions
regarding the interest rate reduction provision that should be clarified. For example:

    •   "Interest" subject to the 6% cap is defined to include service charges, renewal charges,
        fees, or any other charges (except bona fide insurance) in respect of the obligation. The
        charging of additional finance charges as a condition of lowering the rate is likely
        prohibited. Charging of additional fees on top of the 6% - including late charges - would
        also appear to be prohibited.
    •   The rate cap applies to business or commercial loans where the service member is
        personally obligated on the extension of credit;
    •   According to the Department of Education, 20 U.S.C. § 1078(d) expressly exempts
        federal student loans from coverage under § 526. However, other protections under the
        SSCRA would be available, and the military person would be able to avail themselves of
        certain forbearance and deferment options available under the federal student loan
        program.
    •   There is no requirement in the SSCRA that the member prove that their military service
        materially affects their ability to repay in order to qualify. In fact, it is the creditor who has
        the burden of establishing in a court proceeding that the service member's service does
        not materially affect their ability to repay should the creditor seek to avoid reducing the
        rate to the 6% cap;

•   The SSCRA arguably does not require the service person to notify the creditor in any
        particular fashion or provide orders or proof of service in order to obtain the 6% interest
        rate. The benefit appears to be automatically triggered upon transfer to active duty status.
        However, the military will typically assist service members in contacting their creditors
        and providing proof of activation along with a request for the 6% rate cap;
    •   Interest above the 6% cap should be forgiven and reflected in a lower payment amount.
    •   Reduction in the interest rate and waiver of fees are not a form of debt forgiveness and
        will not be reportable under IRS rules for debt forgiveness. 26 C.F.R. 1.6050P-1(d).
    •   The service member is not required to execute a modification agreement or similar
        documentation. Many lenders are under the mistaken impression that the federal Truth in
        Lending Act requires re-disclosure in the event of a SSCRA rate reduction request.
        However, with respect to closed end credit, the rate reduction and the subsequent rate
        increase after the military person leaves active duty do not constitute a "refinance" that
        requires redisclosure. See 12 C.F.R. 226.20(a). With respect to open end credit, no
        redisclosure is required because the creditor has not changed any term of the obligation.
        Federal law simply restricts the full application of the credit terms for a defined period.
        See 12 C.F.R. 226.9(c). Open end creditors should note, however, that their periodic
        statements should show the actual annual percentage rate applies to the account during
        the billing cycles that are affected by the rate reduction.

One gray area under the SSCRA is whether the 6% cap applies to motor vehicle leases. There
does not appear to be definitive caselaw on this issue. However, there are two opposing
arguments that can be raised. The first, is that a lease is not subject to the rate reduction since a
lease does not have an interest rate. A lease is simply a stream of payments for the use of the
lessor's property over time. In essence, it is no different than an apartment lease for which no rate
reduction would likely be contemplated.

The countervailing argument is that given the broad definition of "interest" under the SSCRA, a
motor vehicle lease does have an interest component, specifically rent charges which are
required to be disclosed under Regulation M for most consumer leases. Furthermore, Regulation
M now requires lease contracts to describe the method for calculating the early termination
liability which likely will involve a description of the method for rebating unearned lease charges
upon early termination. Many leases use methods such as the "actuarial method" or "declining
balances method" in which an implicit lease rate is calculated and used to rebate the unearned
lease charges to present value. The argument continues that this is evidence that leases not only
have an interest rate, but that lessors have lease systems which are able to quickly calculate
such a rate and adjust the corresponding payment schedule. The argument is further buttressed
by the argument that given the policy considerations of the SSCRA, the 6% rate cap should be
broadly construed to capture motor vehicle lease contracts as well.

The paucity of litigation involving this gray area of the law is not surprising. In practical terms, a
rate reduction request under § 526 for a motor vehicle lease is almost always a matter of
negotiation between the lessor and the service member or their representative. This is true in part
because of legal uncertainty as to the extent of the rate cap, in part because of the lessee's ability
to invoke various stays under the SSCRA against lessor actions and in part from a desire by
lessors to reasonably accommodate those who are called to active duty. Typical resolutions
include a surrender of the vehicle and negotiation as to any remaining deficiency balance, a
modified payment plan along with an extension, or financing of a purchase option.

Stay Provisions

The other SSCRA provisions of interest to creditors are the various stay provision which prohibit
certain actions during the service member's active duty. Section 531 of the Act prohibits creditors
from repossessing property or rescinding contracts without first obtaining a court order. This
limitation applies to installment contracts for the purchase of real or personal property and leases
with a view to a purchase of real or personal property if the following three conditions are met: (1)
the installment contract or lease was originated prior to active duty; (2) the service member paid a
deposit or installment payment prior to active duty; and (3) the service member's ability to make
payments is materially affected by the member's active duty status.

A similar stay provision exists with respect to obligations secured by real or personal property
which were originated prior to the period of military service and in which the property is still owned
by the service member. For these obligations, § 532 of the SSCRA provides for a stay of any
judicial proceeding commenced during the period of military service to enforce the obligation for
nonpayment or breach occurring prior to or during the period of such service. The court may stay
the proceedings unless the ability to comply with the obligation is not materially affected by the
military service. Furthermore, no sale, foreclosure, or seizure of the property for nonpayment or
any other breach will be valid if made during the period of military service or within three months
thereafter without court approval. While this provision is similar to § 531, there is a key distinction.
Section 532 requires the obligation to be secured by collateral owned by the service member,
while § 531 does not. In cases where the value of the collateral is rapidly diminishing, the court
may order an appraisal of the property and payment to the service member of their equity as a
condition to foreclosure, termination of the contract or repossession. See 50 U.S.C. App. § 533.

Under § 521, a court on its own motion or upon the motion of a service member during active
duty or within 60 days after service, may grant a stay in any civil proceeding unless the military
service does not materially affect the ability to defend the action. This particular stay is broader
than those contained in §§ 531 and 532 described above in two important respects. First, this
stay is not limited to pre-service obligations, it applies to any obligation. Second, there is no
required determination as to the nature of the obligation. Instead, the analysis is simply whether
the ability of the service member to participate in the action is materially affected by their service.
Where a judgment has already been entered, § 523 authorizes a court to stay execution of a
judgment or order already entered against a service member or to vacate or stay any attachment
or garnishment action. These stay provisions can be particularly powerful remedies for the
service member.

A unique stay provision is found at 50 U.S.C. App. § 590 of the SSCRA. This provision is also
similar to §§ 531 and 532 in that it authorizes a stay of enforcement of obligations or liabilities
arising prior to active duty provided the court is satisfied that the service member's ability to repay
is materially affected by his or her service. However, this provision is unique in that: (1) the
service member may institute the stay action, even if there is no default in the obligation; (2) the
service member may request relief up to six months following service; and (3) the stay is much
longer. For real estate obligations and mortgages, the court may suspend payment during service
with repayment over the remaining term plus a period of time equal to their time in service. For
other debts, the court may suspend payments during service with repayment over a term not
exceeding their time in service. This provision is frequently cited by service members in
connection with negotiations regarding motor vehicle lease agreements entered into prior to
service.

Except for the unique extended stay provision under § 590, stays may be granted during military
service and for three months following service. 50 U.S.C. App. § 524. Additionally, except for
periods of limitations imposed by federal revenue laws, statutes of limitations are automatically
tolled during the period of military service even where the service does not materially affect the
ability to participate in the action. 50 U.S.C. App. §§ 525 and 527.

Addition Protections

Some additional provisions of the SSCRA merit careful creditor attention as well. Section 522
provides that when compliance with any contract is stayed under the Act, no fine or penalty may
be assessed during the stay. Even when a stay is not in effect, a court may relieve enforcement
where the ability to pay or perform was materially impaired due to military service. Section 522
would be applicable to late charges or early termination provisions on a motor vehicle lease that
includes a purchase option.

When a service member receives protections under the Act, a lender may not consider such
request for relief by itself as a basis for considering the service member to be in default, denying
or revoking credit, changing the terms of an existing credit arrangement, refusing to grant credit to
such person in substantially the amount or on substantially the terms requested, or creating an
adverse credit report to a consumer reporting agency. See 50 U.S.C. App. § 518.

Conclusion

The SSCRA ensures that military personnel are not harmed financially by virtue of their service to
their country. While, some provisions of the law may create complications for lenders, most
lenders are likely to conclude that these complications pale in comparison to the sacrifices being
made by those called upon to be in harms way.

* Thomas B. Hudson, Esq. is a partner in the law firm of Hudson Cook LLP, and the President of the CounselorLibrary.com, LLC.
Paul S. Ayres, Esq. is a partner in the Linthicum, Maryland office of Hudson Cook, LLP.

Copyright Consumer Credit Compliance Company, LLC, October 2001. All rights reserved.