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Lanier v. Associates Finance





Appeal from the Appellate Court for the First District; heard in that court on appeal from the Circuit Court of Cook County, the Hon. Albert Green, Judge, presiding.


After paying the balance of an installment loan in September 1983, eight years prior to its due date in 1991, plaintiff Alma Lanier instituted a class action against defendants, Associates Finance, Inc., and its alleged parent corporation, Associates Corporation of North America. Plaintiff's class was comprised of persons who had prepaid, or were currently parties to, credit obligations entered into with the defendant Associates Finance, in which the credit agreements computed interest payments according to the Rule of 78's. The plaintiff contended that use of the Rule of 78's to compute interest in loans made to unsophisticated borrowers, absent explanation to the borrower about the effects of the rule upon early repayment, was fraudulent and violated unspecified provisions of the Consumer Fraud and Deceptive Business Practices Act (Ill. Rev. Stat. 1981, ch. 121 1/2, pars. 261 through 271).

The circuit court of Cook County granted defendants' motion to dismiss plaintiff's lawsuit, pursuant to section 2-615 of the Civil Practice Law (Ill. Rev. Stat. 1983, ch. 110, par. 2-615). Finding that the loan-disclosure provisions violated neither the Federal Truth in Lending Act (15 U.S.C. § 1601 through 1665 (1982)) nor State law, the appellate court affirmed the dismissal (134 Ill. App.3d 183). We allowed plaintiff's petition for leave to appeal under Rule 315(a) (103 Ill.2d R. 315(a)) and now affirm the dismissal.

On August 24, 1981, plaintiff obtained a loan in the amount of $24,961.68 from defendant Associates Finance, Inc., at a stated annual percentage rate of 21.59%. In addition, plaintiff was required to pay a service fee of $748.85. The loan was secured by a first mortgage on plaintiff's home and was to be repaid in monthly installments over a 10-year period. The loan agreement provided for prepayment of the outstanding balance of the loan, with a refund of the unearned finance charge computed according to the Rule of 78's, in the following language:

"This Loan Agreement may at the option of the Borrower(s) be paid in whole or in part prior to the last payment date. If Borrower(s) prepays the loan in full, the Lender will allow a refund credit of the interest charge for the months prepaid using the `Rule of 78's' method. No portion of the service fee will be refunded. No refund less than $1.00 will be made."

After making 23 monthly installment payments totaling $11,854.57, plaintiff inquired of Associates Finance as to the amount required to pay off her loan at that time. Associates informed plaintiff that the payoff figure was $27,706. Plaintiff paid that amount and initiated the present lawsuit.

Plaintiff states that, because defendants used the Rule of 78's to compute the interest on her loan, the amount required for plaintiff to pay off the balance of her loan was $4,654.42 more than it would have been had the defendant Associates Finance computed the interest on the loan according to the actuarial method. Plaintiff claims that, because of the Rule of 78's, plaintiff was charged an effective annual interest rate of 31.31% for the 23-month period ending when she paid off her loan, rather than the 21.59% APR stated in the agreement. Plaintiff argues that, since the effect of the rule on interest refunds following early repayment is understood by few borrowers, the defendants had an obligation to explain the Rule of 78's at the time of the loan.

Under the Rule of 78's, which is also known as the sum-of-the-digits method, a higher percentage of the total finance charge for a loan is attributable to the first months of the loan than is attributable to the last months. In a 12-month loan, for example, the borrower will pay 12/78 of the total finance charge during the first month of the loan, and will pay 11/78 of the total charge during the second month. In each succeeding month of a 12-month loan, the amount of the total finance charge paid is reduced by 1/78 of the total charge, until only 1/78 of the total finance charge remains to be paid during the final month. Since the creditor earns most of the finance charge during the early months of the loan term, the amount of unearned finance charge which the debtor will be entitled to in the event of prepayment rapidly declines. Thus, if the debtor prepays after the first month of a 12-month loan using the Rule of 78's, the creditor will have earned 12/78 of the finance charge, and the debtor would be entitled to 66/78 of the total finance charge as a credit against the total amount owed. After two months, prepayment will save the debtor from 55/78 of the total finance charge. After six months, or halfway through the stated term of the loan, prepayment will save the debtor only 21/78 of the total finance charge. See generally Hunt, The Rule of 78: Hidden Penalty for Prepayment in Consumer Credit Transactions, 55 B.U.L. Rev. 331 (1975) (hereafter Hunt); Comment, Consumer Protection: Truth-in-Lending Disclosure of the Rule of 78ths, 59 Iowa L. Rev. 164 (1973).

Use of the actuarial method, as opposed to the Rule of 78's, to compute interest on loans measures true interest yield; the amount of interest attributed to each month or payment period bears a direct relationship to the amount of money held by the borrower and the time for which that amount is held. Drennan v. Security Pacific National Bank (1981), 28 Cal.3d 764, 769, 621 P.2d 1318, 1320, 170 Cal.Rptr. 904, 906, cert. denied (1981), 454 U.S. 833, 70 L.Ed.2d 112, 102 S.Ct. 132.

Unlike the actuarial method of computing finance charges, the Rule of 78's does not provide an accurate approximation of unearned finance charges. (See Ballew v. Associates Financial Services Co. of Nebraska, Inc. (N.D. Neb. 1976), 450 F. Supp. 253. ) Rather, the Rule of 78's allocates too much of the finance charge to the creditor during the early months of the credit transaction. (Hunt, 55 B.U.L. Rev. 331, 338 (1975).) As a result, refunds of unearned finance charges on prepayment of a credit obligation by a debtor are always lower when using the Rule of 78's than when using the actuarial method. (See Drennan v. Security Pacific National Bank (1981), 28 Cal.3d 764, 621 P.2d 1318, 170 Cal.Rptr. 904.) The Supreme Court of California, although upholding the use of the rule in consumer credit transactions, described the rule as a hidden charge on the consumer, unjustified by the economic needs of the lender. 28 Cal.3d 764, 621 P.2d 1318, 170 Cal. Rptr. 904.

The parties agree that the loan-agreement form provided by defendant Associates Finance and signed by plaintiff did not explain how the Rule of 78's operates; the agreement also did not inform borrowers that the Rule of 78's would yield a lower finance-charge rebate upon prepayment than would the actuarial method of computing these rebates.

In count I of the complaint, the plaintiff alleges that, although the annual percentage-rate figure stated in her loan agreement is clear, the "Rule of 78's" method of computing interest is "complicated and obtuse." Plaintiff contends that there was no meeting of the minds when she signed her loan contract. Plaintiff requests that she and others who have prepaid loans obtained from the defendants be allowed to recover the difference between the amount which they tendered to pay off their loans under the Rule of 78's, and the lesser amount which would have been required for prepayment had the interest been computed according to the actuarial method. The plaintiff also seeks to reform the loan agreements of those persons currently obligated to the defendants, to provide for use of the actuarial method, rather than the Rule of 78's presently required by the loan contracts, in computing interest rates upon prepayment.

The plaintiff does not allege in count I that the term "Rule of 78's" is ambiguous, nor does she allege that the term was mistakenly included in the written agreement. Rather, because the plaintiff apparently did not understand the operation of the Rule of 78's at the time she entered into the contract, she now seeks to substitute in the loan contract a provision more advantageous to her and to the members of her class. The court cannot, however, make a new contract for the parties. (See Slezak v. Fleming (1946), 392 Ill. 387, 390; Walgreen Co. v. American National Bank & Trust Co. (1972), 4 Ill. App.3d 549, 554; see also Freeland v. Edwards (1957), 11 Ill.2d 395, 401 (court cannot, by construction, establish a contract different from that expressed in the written agreement).) To permit a contracting party to escape contractual obligations by claiming not to have ...

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