James v. National Financial, LLC

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

GLORIA JAMES, )
)
Plaintiff, )
)
v. ) C.A. No. 8931-VCL
)
NATIONAL FINANCIAL, LLC, )
)
Defendant. )

OPINION

Date Submitted: December 15, 2015
Date Decided: March 14, 2016

Richard H. Cross, Jr., Christopher P. Simon, CROSS & SIMON, LLC, Wilmington,
Delaware; Alexander J. Pires, Jr, Diane E. Cooley, PIRES COOLEY, Washington, DC;
Attorneys for Plaintiff Gloria James.

Edward T. Ciconte, Daniel C. Kerric, CICONTE, SCERBA & KERRICK, LLC,
Wilmington, Delaware; Kenneth M. Dubrow, THE CHARTWELL LAW OFFICES,
Philadelphia, Pennsylvania; Attorneys for Defendant National Financial, LLC.

LASTER, Vice Chancellor.
 Defendant National Financial, LLC (―National‖) is a consumer finance company

that operates under the trade name Loan Till Payday. In May 2013, National loaned $200

to plaintiff Gloria James (the ―Disputed Loan‖). National described the loan product as a

―Flex Pay Loan.‖ In substance, it was a one-year, non-amortizing, unsecured cash

advance.

The terms of the Disputed Loan called for James to make twenty-six, bi-weekly,

interest-only payments of $60, followed by a twenty-seventh payment comprising both

interest of $60 and the original principal of $200. The total repayments added up to

$1,820, representing a cost of credit of $1,620. According to the loan document that

National provided to James, the annual percentage rate (―APR‖) for the Disputed Loan

was 838.45%.

James defaulted. After National rejected her request for a workout agreement, she

filed this action seeking to rescind the Disputed Loan. She proved at trial that the

Disputed Loan was unconscionable, resulting in an order of rescission. She also proved

that National violated the federal Truth in Lending Act, resulting in an award of statutory

damages plus attorneys fees and costs.

I. FACTUAL BACKGROUND

Trial took place on September 21, 22, and 24, 2015. The parties submitted

seventy-two exhibits, introduced live testimony from six fact witnesses, called two expert

witnesses, and lodged five depositions. The following facts were proven by a

preponderance of the evidence.

1
A. Hardworking But Poor

James is a resident of Wilmington, Delaware. From 2007 through 2014, James

worked in the housekeeping department at the Hotel DuPont. In May 2013, when she

obtained the Disputed Loan, James earned $11.83 per hour. As a part-time employee, her

hours varied. On average, after taxes, James took home approximately $1,100 per month.

James‘ annualized earnings amounted to roughly 115% of the federal poverty line,

placing her among what scholars call the working poor.1 Contrary to pernicious

stereotypes of the poor as lazy, many work extremely hard.2 James exemplified this

attribute. She got her first job at age thirteen and has been employed more or less

continuously ever since. Her jobs have included stints in restaurants, at a gas station, as a

dental assistant, as a store clerk, and at a metal plating company. In 2007, she obtained

her position with the Hotel DuPont. She was laid off on December 31, 2014, when the

1
Oxfam America, Hard Work, Hard Lives: Survey Exposes Harsh Reality Faced
by Low-Wage Workers in the US 2 (2013) (―A common definition of ‗the working poor‘
is people earning less than twice the poverty level . . . .‖); see Annual Update of the HHS
Poverty Guidelines, 78 Fed. Reg. 5,182, 5,183 (Jan. 24, 2013) (establishing poverty line
for a single-person household at $11,490 per year).
2
Oxfam America, supra, at 1 (citing a survey which ―found that America‘s
working poor have a strong work ethic, put in long hours, and believe that hard work can
pay off. . . . The survey found that most low-wage workers barely scrape by month to
month, are plagued by worries about meeting their families‘ basic needs, and often turn to
loans from family or friends, credit card debt, pawn shops and payday loans, and
government programs just to get by.‖); see also U.S. Bureau of Labor Statistics, Dep‘t of
Labor, A Profile of the Working Poor, 2013 5 (2015) (explaining that there is a ―sizable
group of full-time workers who live below the poverty threshold,‖ which can be
explained by ―low earnings‖).

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hotel reduced its part-time staff.

B. James’ Use Of Credit

James is undereducated and financially unsophisticated. She dropped out of school

in the tenth grade because of problems at home. Approximately ten years later, she

obtained her GED.

Around the same time she obtained her position with the Hotel DuPont, James

attempted to improve her skills by enrolling in a nine-month course on medical billing

and coding. For seven months, she worked from 8:00 a.m. to 4:00 p.m. at the hotel, then

attended classes starting at 5:00 p.m. She was also taking care of her school-age daughter.

Two months before the end of the program, the schedule became too much and she

dropped out. James thought she received a grant to attend the program, but after dropping

out she learned she actually had taken out a student loan. She eventually repaid it.

James does not have a savings account or a checking account. She has no savings.

She uses a Nexis card, which is a pre-paid VISA card.

In May 2013, when she took out the Disputed Loan, James had been using high-

interest, unsecured loans for four to five years. She obtained loans from several finance

companies. She used the loans for essential needs, such as groceries or rent. On at least

one occasion, she used a loan from one provider to pay off an outstanding loan from

another provider.

Before the Disputed Loan, James had obtained five prior loans from National.

James believed that she repaid those loans in one or two payments. The payment history

for the loans shows otherwise.

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 For her first loan from National, James borrowed $100 on September 1, 2011. She

repaid a total of $205 by making five payments over the course of two months.

 9/9/11 – Payment of $30.00.

 9/21/11 – Payment of $80.00.

 10/7/11 – Payment of $15.00.

 10/21/11 – Payment of $15.00.

 11/3/11 – Payment of $65.00.

For her second loan, James borrowed $100 on August 22, 2012. She again repaid a

total of $205, this time by making four payments over the course of two months.

 9/7/12 – Payment of $30.00.

 9/21/12 – Payment of $30.00.

 10/5/12 – Payment of $80.00.

 10/19/12 – Payment of $65.00.

For her third loan, James borrowed $150 on October 31, 2012, less than two

weeks after repaying her second loan. She repaid a total of $252 by making three

payments over the course of two months.

 11/16/12 – Payment of $100.00.

 11/30/12 – Payment of $28.50.

 12/14/12 – Payment of $123.50.

4
 For her fourth loan, James borrowed $100 on December 20, 2012, one week after

repaying her third loan. She repaid it the next day by making a single payment of $102.

The prompt repayment suggests that James refinanced her loan through another provider.

For her fifth loan, James borrowed $200 on December 27, 2012, less than one

week after repaying her fourth loan. James failed to make the second payment, failed to

make the fourth payment, and finally repaid the loan two months later. Her repayments

totaled $393.

 1/11/13 – Payment of $60.00.

 1/24/13 – Attempted debit of $60 declined.

 1/29/13 – Attempted debit of $60 declined.

 2/8/13 – Payment of $73.00.

 2/22/13 – Attempted debit of $60 declined.

 2/27/13 – Payment of $260.00.

Despite James‘ difficulty in repaying her fifth loan, National sent her text

messages soliciting her interest in another loan. A text message on March 29, 2013,

stated, ―Loan Til [sic] Payday welcomes you with open arms. If you ever need a loan

again we want to be your source! :)‖ A text message on April 5, 2013, stated, ―Loan Til

[sic] Payday misses you! Call NOW and receive $20 off your first payment.‖

C. The Disputed Loan

On May 7, 2013, James needed money for food and rent. She went to National‘s

―Loan Till Payday‖ storefront operation at 1935 West Fourth Street in Wilmington,

Delaware. At the time, National operated fourteen stores in Delaware.

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 James dealt with Ed Reilly, National‘s general manager. In that capacity, Reilly

oversaw National‘s business operations and supervised its loan approvals. He also filled

in at stores from time to time. He happened to be working in the store at 1935 West

Fourth Street when James came in for a loan.

James told Reilly that she wanted to borrow $200. Reilly looked up James in the

computer program that National uses to track its customers and their loans, which is

known as the ―Payday Loan Manager.‖ It has a main page for each customer that

provides identifying information and the account‘s status. It also has tabs that allow the

user to review information about current or past loans, including the payment history, and

to enter and review notes about the loans.

James was a customer in good standing, meaning that she did not have to fill out a

new loan application. She provided Reilly with her Nexis card, two recent paystubs, and

her driver‘s license.

Using the internet, Reilly pulled up James‘ Nexis card account history for the

preceding sixty days and printed out a copy. It showed that James started the period with

a positive balance on her card of $384.70. During the sixty days, she received direct

deposit credits totaling $2,216.58 and incurred debits totaling $2,594.38, for negative

cash flow of $377.80. Her ending balance was $6.90, and she had a pending authorization

for that amount. Her available cash was zero.

During the sixty day period, James‘ Nexis card was declined fourteen times. Reilly

testified at trial that if someone‘s transaction history showed three or four declines, then

they probably should not receive a loan.

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 After reviewing her transaction history, Reilly offered to loan James $400 rather

than $200. The $400 would have represented almost 40% of James‘ after-tax monthly

income. Reilly offered that amount because National has a policy of loaning borrowers

up to 40% of their after-tax monthly income, regardless of their other expenditures.

National only checks to ―make sure they‘re positive on payday.‖ Tr. 244 (Vazquez); see

Tr. 472 (Reilly) (―[S]he started with a surplus.‖).

James declined the offer of $400. She only wanted $200, and she did not believe

she could repay $400.

James thought she was getting a payday loan with a block rate of ―$30 on $100.‖

As James understood it, this meant she would pay $60 to borrow the $200.

Lenders developed the block rate concept to describe the finance charge for a

traditional payday loan, which was a single-payment loan designed to be repaid on the

borrower‘s next payday. National‘s trade name—Loan Till Payday—embodies this

concept. Because the loan was technically intended to be outstanding only for a single

block of time, payday loan companies described the finance charge by identifying the

dollar amount per $100 borrowed that the customer would owe at the end of the period. A

block rate of ―$30 on $100‖ meant that a customer who borrowed $100 would repay

$130 on her next payday.

In May 2013, when James approached National for a $200 loan, National was no

longer making traditional payday loans. Effective January 1, 2013, the General Assembly

amended Delaware‘s statutory framework for closed-end consumer credit to impose

limits on payday loans. See 78 Del. Laws ch. 278 (2012) (codified at 5 Del. C. §§ 2227,

7
2235A, 2235B, & 2235C) (the ―Payday Loan Law‖).

In response to the Payday Loan Law, National recast its payday loans as non-

amortizing installment loans that were structured to remain outstanding for seven to

twelve months. The Payday Loan Law only applied to loans designed to be outstanding

for sixty days or less, so by making this change, National sidestepped the law.

Throughout this litigation, National insisted that it no longer made payday loans.

Despite shifting to longer-dated installment loans, National continued to frame its

finance charges using a block rate. National adhered to this practice for a simple reason:

It made a high cost loan product sound cheaper than it was. On an annualized basis, a

customer who repays $100 by making an interest-only payment of $30 every two weeks

followed by $130 at the end of a year pays $810 in interest for an annualized rate of

838%. By framing the interest as a block rate, National‘s employees could tell customers

that the interest rate was 30%. Although National‘s customers eventually saw an APR on

the loan agreement, National‘s employees followed a practice of telling customers that

the APR had ―nothing to do with the loan.‖ Tr. 335 (Carter). As National pitched it, the

APR was ―irrelevant‖ unless the customer kept the loan outstanding for an entire year; if

the customer only planned to keep the loan outstanding for a few weeks, National‘s

employees said that the APR ―means nothing.‖3

3
Tr. 337-38 (Carter). It is true that the APR calculation changes depending on
when the customer repays the loan, but the APR for a block rate of ―$30 on $100‖
remains high. James originally planned to repay her loan in two payments of $130. Had
she done so, the APR would have been 630.3272%.

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 When James obtained the Disputed Loan, she focused on the block rate and the

concept of $30 in interest per $100 borrowed, just as National intended. She thought she

would have to pay back $260. She told Reilly that she would repay the loan in two

payments of $130 each. She planned to pay $130 on her next payday of May 17, 2013,

and another $130 on May 31.

James told Reilly that she wanted to make her payments in cash and that she did

not want to have her Nexis card debited. James viewed this as important because she

knew from past experience that she could incur additional charges if a lender debited her

account when there were insufficient funds to make a payment, particularly if the lender

attempted to debit her account multiple times. Reilly entered a note in the Payday Loan

Manager reflecting that James did not want to have electronic debits from her account.

The note stated ―No ACH debits,‖ using the abbreviation for the automated clearinghouse

for electronic payments operated by the Federal Reserve and the National Automated

Clearing House Association. JX 29B at 659. He entered another comment stating,

As National learned the hard way, it is difficult to convert a block rate into an
accurate APR. During 2013, the Delaware State Banking Commissioner questioned the
accuracy of the APRs in National‘s loan agreements. After several audits, National
changed how it calculates interest on its loan products. Effective January 1, 2014,
National no longer uses a block rate. During each payment period, National instead
charges simple interest at a rate of either 1% or 2% daily, depending on whether the
payment period is two weeks or one month. At the end of each payment period, the
amount of interest is totaled and either paid by the borrower or added to the loan balance.
Using the banking conventions of a 30-day month and a 360-day year, the economic
substance of 2% simple interest per day is the same as the block rate: $30 per $100
borrowed. National employees now call its products ―1 percent loans‖ and ―2 percent
loans.‖ Tr. 335, 336 (Carter).

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―Customer wants to walk in cash payments.‖ Id.

Reilly also entered a note in the Payday Loan Manager reflecting James‘ plan to

repay the loan in two payments. But Reilly‘s note contemplated different payments than

what James understood she would be making. Reilly recorded that James would make

one payment of $150 on May 17 and a second payment of $143 on May 31. Reilly‘s note

thus had James repaying $293. James thought she was repaying $260.

Reilly printed out a copy of National‘s standard form loan document and showed

James where to sign. The loan document was titled ―Delaware Consumer Installment

Loan Agreement.‖ JX 19 at 1 (the ―Loan Agreement‖). In a box labeled ―Type of

Contract,‖ it said ―FlexPay.‖ The repayment schedule did not reflect either the two

repayments that James wanted to make or the two repayments that Reilly entered in the

Payday Loan Manager. The Loan Agreement instead contemplated twenty-six interest-

only payments of $60 each, followed by a balloon payment comprising a twenty-seventh

interest payment of $60 plus repayment of the original $200 in principal. The total

amount of interest was $1,620. According to the Loan Agreement, the APR for the loan

was 838.45%. Using Reilly‘s planned repayment schedule, the APR was 1,095%.

James signed the Loan Agreement, and Reilly gave her a check. From the time

James walked into the store, the whole process took about twenty minutes.

D. James Cannot Repay The Loan.

On May 8, 2013, the day after obtaining the Disputed Loan, James broke her hand

while cleaning a toilet at the Hotel DuPont. After missing an entire week of work, she

asked her supervisor to allow her to return because she could not afford to remain out any

10
longer. As James explained at trial: ―I don‘t get paid if I don‘t work.‖ Tr. 34 (James). Her

supervisor agreed that she could work two or three days per week on light duty.

On May 17, 2013, James went to the Loan Till Payday store and made the first

interest payment of $60. She spoke with Brian Vazquez, the store manager. She told him

that she had broken her hand and would not be able to work, and she asked him to

accommodate her with some type of arrangement. Vazquez told her that she would have

to make the scheduled payments and that National would debit her account if she did not

pay in cash. Vazquez then suggested that James increase her payment from $60 to $75.

James was nonplussed and asked him, ―How can I pay $75 if I can‘t pay $60 interest.‖

Tr. 36 (James). Vazquez responded that being able to work fewer hours was not the same

as losing her job.

At trial, Vazquez recalled that when James asked for help, he suggested that she

increase her payment. He tried to portray this as an accommodation that was

advantageous to James, because the additional money would pay down principal.

Leaving aside the obvious problem that his proposal contemplated James paying more

when she could not pay less, it was not an accommodation. James had the right to pre-pay

principal at any time. Vazquez offered James something that she already had.

Vazquez also testified that he wanted James to make payments to ―keep[] her

active, not past due, so she was still in good standing with our company and able to get

loans with us in the future.‖ Tr. 257 (Vazquez). Yet Vazquez testified later that if a

customer missed a payment, then National would stop charging interest and only add a

late fee of 5%. This meant that Vazquez proposed an arrangement that kept interest

11
accruing, whereas if James had defaulted, then interest would have stopped and she only

would have owed a $3 late fee.

At bottom, Vazquez refused to lower James‘ payments or give her any kind of

accommodation. His proposals tried to get National more money and faster.

E. James Defaults.

On May 31, 2013, National attempted on four separate occasions to debit James‘

Nexis account for $60. Each time, the debit was declined. At trial, Vazquez justified the

debits by distinguishing between an electronic debit from a Nexis card and an ACH

withdrawal from a bank account. Vazquez claimed that James only told National not to

make ACH withdrawals.

Despite being a stickler for this distinction, Vazquez was less punctilious when it

came to National‘s authority for taking the debit. For that purpose, Vazquez relied on a

provision found on the last page of the Loan Agreement, which was titled ―Credit Card

Authorization.‖ Vazquez asserted that this provision applied because a credit card

payment and a debit card payment were ―the same thing.‖ Tr. 287 (Vazquez). It is true

that from a consumer‘s perspective, they are functionally the same thing, but so are a

bank account and a Nexis card.4 National tried to have it both ways, taking a legalistic

4
There is significant popular confusion regarding the differences between credit
cards and debit cards. See Ronald J. Mann, Making Sense of Payments Policy in the
Information Age, 93 Geo. L.J. 633, 655-56 (2005) [hereinafter Making Sense of
Payments]. ―While credit cards and debit cards look similar, they are fundamentally
different.‖ Stephen Wilks, The Governance Ecology of Electronic Food Stamp Delivery:
Is It Time for A New Praxis?, 30 Harv. J. Racial & Ethnic Just. 311, 318 n.30 (2014);

12
approach when that advanced its purposes, then taking a functional approach when that

was advantageous.

On June 3, 2013, National tried twice more to debit James‘ Nexis card, each time

for $60. Both debits were declined. On June 7, National tried twice more. At that point,

the attempted debits were for $63, which included a $3 late fee. Both were declined.

On June 8, 2013, an unidentified National employee called James at the Hotel

DuPont and left a message with her employer. National also sent her a ―Collection Text‖

accord Tr. 602-03 (Zywicki). Credit cards offer a line of credit, and credit card payments
are processed over private credit card networks, such as those operated by Visa and
MasterCard. As part of the Consumer Credit Protection Act, consumers have greater
protection and access to remedies compared to other payment methods. See Ronald J.
Mann, Payment Systems and Other Financial Transactions 158-59 (5th ed. 2011)
[hereinafter Payment Systems] (―One of the most distinctive features of the current credit-
card system is that it gives the consumer a right to cancel payment that is much broader
than the consumer‘s rights in any of the competing systems.‖).

Unlike a credit card, a ―debit card necessarily is tied to a particular bank account.‖
Ronald J. Mann, Credit Cards and Debit Cards in the United States and Japan, 55 Vand.
L. Rev. 1055, 1099 (2002). A debit card is thus like a digital checkbook: ―the payment
comes from the cardholder‘s bank account at the time of the transaction or, at most, a few
days later.‖ Making Sense of Payments, supra, at 649. ―[U]nlike a credit card, a debit card
does not reflect an independent source of funds.‖ Payment Systems, supra, at 200.

Debit cards offer two types of transactions: PIN-based and PIN-less. PIN-based
transactions flow through regional and national networks established exclusively for debit
card transactions, and the payment is generally withdrawn immediately. PIN-less
transactions use the credit card networks.

The ACH network is a different animal. “The ACH network is a nationwide
computerized counterpart to the checking system, parallel to (but separate from) the
networks used for transactions on credit cards or on debit cards. The network is used for
electronic transfers between accounts at American financial institutions—most
commonly for automated deposits of salaries and for automated payments for recurring
bills (mortgages, car payments, and the like).‖ Id. at 221.

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stating, ―Gloria, to avoid further occurrences on your account, you must call Tracey, at

Loan Till Payday.‖

On June 13, 2013, an unidentified National employee again called James at the

Hotel DuPont and left a message with her employer. That same day, National

successfully made an ACH withdrawal of $63, comprising $60 in interest plus a $3 late

fee. Recall that James had told National not to make electronic withdrawals, and that

Reilly had entered a note on the account stating ―No ACH debits.‖ Recall also that

National justified debiting her Nexis card on the theory that a debit was different than an

ACH withdrawal. At this point, however, National made an ACH withdrawal.

On June 14, 2013, the notes in the Payday Loan Manager indicate that an

unidentified National representative spoke with James. On June 27, National debited her

Nexis account for $75. National also sent James an automated text: ―Refer a friend and

get $20 credit on your next payment! Call now! Loan Till Payday.‖

F. James Hires Counsel And Files Suit In Federal Court.

After her discussion with Vazquez on May 17, 2013, James decided to contact

counsel. On June 14, James sent a letter to National opting out of the arbitration provision

in the Loan Agreement. On July 1, James filed suit in the United States District Court for

the District of Delaware. James v. Nat’l Fin., d/b/a Loan Till Payday LLC, C.A. No. 13-

CV-1175-RGA (D. Del. filed July 1, 2013).

Tim McFeeters is the sole owner of National. On July 8, 2013, after being served

with the federal action, he entered a note in the Payday Loan Manager: ―DONT WORK

DONT CALL DONT TAKE ANY $$$.‖ JX 29B at 662.

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 As of July 8, 2013, James had repaid National $197. She has not made any

payments on the Disputed Loan since then.

G. This Litigation

On September 20, 2013, after voluntarily dismissing her federal action, James

filed this lawsuit on behalf of herself and other similarly situated borrowers. Count I of

the complaint sought a permanent injunction barring National from collecting on the

loans made to James and other class members. Count II sought a declaration that the

terms of National‘s loan documents were unconscionable. Count III alleged that National

breached the implied covenant of good faith and fair dealing inherent in the loan

agreements. Count IV alleged that National unjustly enriched itself at the expense of the

class members. Count V alleged violations of the Delaware Consumer Fraud Act, 6 Del.

C. §§ 2511-2527. James later dropped Counts IV and V.

On October 10, 2013, National moved to compel arbitration. National also sought

to dismiss the complaint under the creative theory that James could not state a claim for a

class action. I denied the motion to dismiss, noting that James had opted out of arbitration

and that National‘s arguments against class certification were premature.

When National moved to compel arbitration, it knew that James had opted out.

National had made that point affirmatively as a ground for dismissing her federal action.

Because National knew that their motion to compel arbitration had no factual basis,

James moved for Rule 11 sanctions. I granted the motion.

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H. Problems With Discovery

During discovery, James sought documents and information relating to the loans

offered by National since September 20, 2010, including an electronic copy of the data

from any database containing the loan information. National moved for a protective

order, contending that the discovery was overbroad. I partially granted National‘s motion,

but I also required National to respond to particular requests or narrowed versions. See

Dkt. 44 (the ―First Discovery Order‖). Most pertinently, I required National to provide

specified categories of information about loans made between September 20, 2010, and

September 30, 2013 (the ―Loan History Information‖).

On February 28, 2014, National produced an Excel spreadsheet that purported to

provide the Loan History Information (the ―Initial Spreadsheet‖). The Initial Spreadsheet

did not include all of the Loan History Information.

Using the few loan documents he had, James‘ counsel checked the APRs for those

loans against the limited data provided on the Initial Spreadsheet. The figures did not

match. He then deposed McFeeters, who suggested that the Initial Spreadsheet contained

errors. McFeeters also testified that the Delaware State Banking Commission had audited

National between four and ten times after he purchased the company and had expressed

concerns about inaccurate APRs.

On May 6, 2014, James filed an amended complaint that added a claim that

National violated the federal Truth in Lending Act (―TILA‖), 15 U.S.C. § 1501 et seq.,

by failing to accurately disclose APRs on its loan agreements. James sought further

discovery regarding the APR issue. On July 17, James again moved to compel production

16
of the Loan History Information. I entered a second order requiring National to provide it.

Dkt. 120 (the ―Second Discovery Order‖).

National did not comply with the Second Discovery Order, resulting in a written

decision granting James‘ motion for sanctions. See James v. Nat’l Fin. LLC, 2014 WL

6845560, at *1 (Del. Ch. Dec. 5, 2014). The decision held that because of National‘s

discovery misconduct, it was established for purposes of trial that the APRs disclosed on

an updated spreadsheet of Loan History Information were incorrect and fell outside the

tolerance permitted by TILA. Id.

On March 25, 2015, I denied James‘ motion for class certification. The case

proceeded to trial solely on James‘ individual claims.

II. LEGAL ANALYSIS

James proved at trial that the Loan Agreement was unconscionable, and the

Disputed Loan is rescinded on that basis. Because the Disputed Loan is invalid, this

decision need not consider whether National breached the implied covenant of good faith

and fair dealing. James also proved that National violated TILA.

A. The Regulatory And Public Policy Backdrop

This case was about the Disputed Loan, but both sides litigated against a backdrop

of regulatory and public policy issues that numerous jurisdictions are confronting. Put

mildly, widespread controversy exists over high-interest credit products that are

predominantly marketed to and used by lower-income, credit-impaired consumers.

Products falling into this category include traditional payday loans, pawnbroker loans,

installment loans, subprime credit cards, automobile title loans, income tax refund

17
products, and credit substitutes like rent-to-own financing. Labels for the category

include ―fringe products‖ and ―alternative financial services.‖ The products fall within

the larger heading of subprime credit.

An extensive and growing body of scholarship exists about alternative financial

products, with the bulk focusing on traditional payday loans. The empirical evidence to

date, however, has considerable gaps. Studies have reached different findings, and

researchers have drawn different inferences.5 Moreover, although the total volume of

scholarship is large, much of it seems repetitive and polarized.

Consumer groups uniformly condemn alternative financial products.6 The Pew

5
For example, some scholars have found a correlation between payday loans and
certain types of bankruptcy filings. See JX 46 at 45 n.45 (identifying authorities); JX 49
at PL87-88 (same); Nathalie Martin & Koo Im Tong, Double Down-and-Out: The
Connection Between Payday Loans and Bankruptcy, 39 Sw. L. Rev. 785, 788 (2010)
[hereinafter Payday Loans and Bankruptcy]; see also Rebecca Borné et al., Ctr. for
Responsible Lending, Big Bank Payday Loans: High-Interest Loans Through Checking
Accounts Keep Customers in Long-Term debt 3 (2011) (citing research showing that
―payday lending can lead to negative financial outcomes for borrowers; these include
difficulty paying other bills, difficulty staying in their home or apartment, trouble getting
health care, increased risk of credit card default, loss of checking accounts, and
bankruptcy‖). Others have found no correlation at all or a correlation between eliminating
payday lending and increasing bankruptcy filings. See JX 46 at 46 nn.46 & 47
(identifying authorities).
6
For example, in 2013, the AARP, the Center for Responsible Lending, the
Consumer Federation of America, the Leadership Conference on Civil and Human
Rights, the NAACP, the National Consumer Law Center, and the National Council of La
Raza jointly submitted a white paper to the FDIC and the Office of the Comptroller of the
Currency seeking restrictions on payday lending. See JX 49. Other policy papers by these
groups and similar organizations include: Nicholas Bianchi, Nat‘l People‘s Action,
Profiting from Poverty: How Payday Lenders Strip Wealth from the Working-Poor for
Record Profits (2012); Borné et al., supra; Keith Ernst et al., Ctr. for Responsible

18
Charitable Trust has published a series of reports that criticize the payday loan industry.7

The Department of Defense and representatives of the armed services also have opposed

payday lending.8 Aligned with these groups are scholars who write from the consumer

perspective. Nathalie Martin, a law professor from the University of Arizona, is a leading

critic of alternative financial products.9 She testified as an expert for James at trial.

Lending, Quantifying the Economic Cost of Predatory Payday Lending (2004); Uriah
King & Leslie Parish, Ctr. for Responsible Lending, Springing the Debt Trap: Rate Caps
Are Only Proven Payday Lending Reform (2007); Uriah King et al., Ctr. for Responsible
Lending, Financial Quicksand: Payday Lending Sinks Borrowers in Debt with $4.2
Billion in Predator Fees Every Year (2006).
7
See Pew Charitable Trusts, Payday Lending in America: How Borrowers Choose
and Repay Payday Loans (2013) [hereinafter How Borrowers Repay]; Pew Charitable
Trusts, Payday Lending in America: Policy Solutions (2013); Pew Charitable Trusts,
Payday Lending in America: Who Borrows, Where They Borrow, and Why (2012)
[hereinafter Who Borrows].
8
See Dep‘t of Defense, Report on Predatory Lending Practices Directed at
Members of the Armed Forces and Their Dependents (2006).
9
Martin‘s extensive writings on the subject include: Timothy E. Goldsmith &
Nathalie Martin, Interest Rate Caps, State Legislation, and Public Opinion: Does The
Law Reflect The Public’s Desires?, 89 Chi.-Kent L. Rev. 115 (2014) [hereinafter Interest
Rate Caps]; Nathalie Martin, 1000% Interest—Good While Supplies Last: A Study of
Payday Loan Practices and Solutions, 52 Ariz. L. Rev. 563 (2010) [hereinafter Good
While Supplies Last]; Nathalie Martin & Ozymandias Adams, Grand Theft Auto Loans:
Repossession and Demographic Realities in Title Lending, 77 Mo. L. Rev. 41 (2012);
Nathalie Martin & Ernesto Longa, High-Interest Loans and Class: Do Payday and Title
Loans Really Serve The Middle Class?, 24 Loy. Consumer L. Rev. 524 (2012)
[hereinafter High Interest Loans and Class]; Payday Loans and Bankruptcy, supra;
Nathalie Martin, Public Opinion and the Limits of State Law: The Case for Federal
Usury Cap, 34 N. Ill. U. L. Rev. 259 (2014) [hereinafter Public Opinion]; Nathalie
Martin & Joshua Schwartz, The Alliance Between Payday Lenders and Tribes: Are Both
Tribal Sovereignty and Consumer Protection at Risk?, 69 Wash. & Lee L. Rev. 751
(2012).

19
 Championing a competing view is the industry‘s national trade organization, the

Community Financial Services Association of America, and a group of scholars who

draw heavily on economic theory. Todd J. Zywicki, a law professor from George Mason

University, is a prominent defender of alternative financial products and a co-author of a

recent treatise on consumer credit. See Thomas A. Durkin et al., Consumer Credit and the

American Economy (2014) [hereinafter Consumer Credit]. He testified as an expert for

National at trial.

This court‘s task is not to regulate the payday loan industry in Delaware. It is only

to rule on the Disputed Loan. Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d

34, 51 (Del. 1994) (―It is the nature of the judicial process that we decide only the case

before us. . . .‖). Nevertheless, in the course of evaluating the record, I have read Martin‘s

and Zywicki‘s expert reports, as well as many of the works that they cited. I agree with

both experts that although the Disputed Loan was not technically a traditional payday

loan, the literature provides helpful background.

B. Unconscionability

The doctrine of unconscionability stands as a limited exception to the law‘s broad

support for freedom of contract. ―Delaware courts seek to ensure freedom of contract and

promote clarity in the law in order to facilitate commerce.‖ ev3, Inc. v. Lesh, 114 A.3d

527, 530 n.3 (Del. 2014). ―There is . . . a strong American tradition of freedom of

contract, and that tradition is especially strong in our State, which prides itself on having

commercial laws that are efficient.‖ Abry P’rs V, L.P. v. F & W Acq. LLC, 891 A.2d

1032, 1059-60 (Del. Ch. 2006) (Strine, V.C.). ―When parties have ordered their affairs

20
voluntarily through a binding contract, Delaware law is strongly inclined to respect their

agreement, and will only interfere upon a strong showing that dishonoring the contract is

required to vindicate a public policy interest even stronger than freedom of contract.‖

Libeau v. Fox, 880 A.2d 1049, 1056-57 (Del. Ch. 2005) (Strine, V.C.), aff’d in pertinent

part, 892 A.2d 1068 (Del. 2006). ―As a matter of ordinary course, parties who sign

contracts and other binding documents, or authorize someone else to execute those

documents on their behalf, are bound by the obligations that those documents contain.‖

Official Comm. of Unsec. Motors Liquid. Co. v. JPMorgan Chase Bank, N.A., 103 A.3d

1010, 1015 (Del. 2014).

But as with many areas of the law, there are countervailing principles that prevent

an indisputably important and salutary doctrine from operating as a tyrannical absolute.

One such ground is unconscionability, traditionally defined as a contract ―such as no man

in his senses and not under delusion would make on the one hand, and no honest or fair

man would accept, on the other.‖ Tulowitzki v. Atl. Richfield Co., 396 A.2d 956, 960

(Del. 1978) (quotation marks and citation omitted). It would be difficult to improve on

Chancellor Allen‘s incisive summary of the interplay between the core concept of

contractual freedom and the residual protection against unconscionability:

The right of competent persons to make contracts and thus privately to
acquire rights and obligations is a basic part of our general liberty. This
ability to enter and enforce contracts is universally thought not only to
reflect and promote liberty, but as well to promote the production of wealth.
Thus, the right to make and enforce contracts is elemental in our legal
order. But not every writing purporting to contain a promise or every
document purporting to make a transfer will be given legal effect. A large
body of law defines when valid contracts are formed and when and how
they can be enforced.

21
 ....

It is a general rule, recited by courts for well over a century, that the
adequacy or fairness of the consideration that adduces a promise or a
transfer is not alone grounds for a court to refuse to enforce a promise or to
give effect to a transfer. This rule, present in 17th and 18th century cases,
achieved its greatest dignity in the jurisprudence of 19th century classical
liberalism. Thus, the classical liberal‘s premise concerning the subjectivity
(and thus non-reviewability) of value has plainly been a dominant view in
our contract law for a very long time. . . . But as standard as that
generalization is, it has not precluded courts, on occasion, from striking
down contracts or transfers in which inadequacy of price is coupled with
some circumstance that amounts to inequitable or oppressive conduct. That
is, the ―rule‖ that courts will not weigh consideration or assess the wisdom
of bargains has not fully excluded the opposite proposition, that at some
point, courts will do so even in the absence of actual fraud, duress or
incapacity.

Ryan v. Weiner, 610 A.2d 1377, 1380-81 (Del. Ch. 1992) (Allen, C.) (citations and

footnote omitted).

In Ryan, Chancellor Allen delineated the history of the doctrine of

unconscionability, describing it as ―old when Justice Story summarized it in 1835‖ as part

of his Commentaries on Equity Jurisprudence. Id. at 1381. After citing a range of cases

from the twentieth century, Chancellor Allen observed that

[s]tatutory developments over the last thirty years reflect an explicit
legislative endorsement of this ancient equitable doctrine. The most
important example of this mid-twentieth century codification is the
unconscionability provision contained in Section 2-302 of the Uniform
Commercial Code. That provision has, of course, been adopted in almost all
of the states and applies to the sale of all goods.

Id. at 1383. Delaware‘s version of Section 2-302 states:

(1) If the court as a matter of law finds the contract or any clause of the
contract to have been unconscionable at the time it was made the court may
refuse to enforce the contract, or it may enforce the remainder of the
contract without the unconscionable clause, or it may so limit the

22
 application of any unconscionable clause as to avoid any unconscionable
result.

(2) When it is claimed or appears to the court that the contract or any clause
thereof may be unconscionable the parties shall be afforded a reasonable
opportunity to present evidence as to its commercial setting, purpose and
effect to aid the court in making the determination.

6 Del. C. § 2-302. Although technically limited in scope to sales of goods, Delaware

decisions have applied Section 2-302 more broadly.10

This estimable pedigree does not mean that the doctrine of unconscionability will

be invoked freely. ―Unconscionability is a concept that is used sparingly.‖ Ketler v.

PFPA, LLC, --- A.3d ---, 2016 WL 192599, at *2 (Del. Jan. 15, 2016). Chancellor Allen‘s

words again capture the essential point:

The notion that a court can and will review contracts for fairness is apt for
good reason to strike us as dangerous, subjecting negotiated bargains to the
loosely constrained review of the judicial process. Perhaps for this reason,
courts have evoked this doctrine with extreme reluctance and only when all
of the facts suggest a level of unfairness that is unconscionable.

Ryan, 610 A.2d at 1381. A finding of unconscionability generally requires ―the taking of

an unfair advantage by one party over the other.‖ Tulowitzki, 396 A.2d at 960 (quotation

marks omitted). ―A court must find that the party with superior bargaining power used it

to take unfair advantage of his weaker counterpart.‖ Graham v. State Farm Mut. Auto.

Inc. Co., 565 A.2d 908, 912 (Del. 1989). ―For a contract clause to be unconscionable, its

10
See, e.g., Reserves Mgmt., LLC v. Am. Acq. Prop. I, LLC, 86 A.3d 1119, 2014
WL 823407, at *9 (Del. Feb. 28, 2014) (ORDER) (testing whether amendment to
restrictive covenants on land was unconscionable using Section 2-302); Worldwide Ins.
Gp. v. Klopp, 603 A.2d 788, 790 (Del. 1992) (holding that features of an insurance
contract could be ―unconscionable within the meaning of‖ Section 2-302).

23
terms must be so one-sided as to be oppressive.‖ Id. (quotation marks and citation

omitted).

Whether a contract is unconscionable is determined at the time it was made.

Lecates v. Hertich Pontiac Buick Co., 515 A.2d 163, 173 (Del. Super. 1986); see

Restatement (Second) of Contracts § 208 (1981) (―If a contract or term thereof is

unconscionable at the time the contract is made a court may refuse to enforce the

contract. . . .‖). The outcome turns on ―the totality of the circumstances.‖ Tulowitzki, 396

A.2d at 962; see Restatement (Second) of Contracts § 208, cmt. a (―The determination

that a contract or term is or is not unconscionable is made in light of its setting, purpose

and effect.‖).

This court has identified ten factors to guide the analysis of unconscionability. See

Fritz v. Nationwide Mut. Ins. Co., 1990 WL 186448 (Del. Ch. Nov. 26, 1990). In the

language of the Fritz decision, they are:

(1) The use of printed form or boilerplate contracts drawn skillfully by the
party in the strongest economic position, which establish industry wide
standards offered on a take it or leave it basis to the party in a weaker
economic position[;]

(2) a significant cost-price disparity or excessive price;

(3) a denial of basic rights and remedies to a buyer of consumer goods[;]

(4) the inclusion of penalty clauses;

(5) the circumstances surrounding the execution of the contract, including
its commercial setting, its purpose and actual effect[;]

(6) the hiding of clauses which are disadvantageous to one party in a mass
of fine print trivia or in places which are inconspicuous to the party signing
the contract[;]

24
 (7) phrasing clauses in language that is incomprehensible to a layman or
that divert his attention from the problems raised by them or the rights
given up through them;

(8) an overall imbalance in the obligations and rights imposed by the
bargain;

(9) exploitation of the underprivileged, unsophisticated, uneducated and the
illiterate[;] and

(10) inequality of bargaining or economic power.

Id. at *4-5 (citations omitted). Although this opinion uses the ten Fritz factors, it analyzes

them in a different order and under two broader headings: substantive unconscionability

and procedural unconscionability.

The concept of substantive unconscionability tests the substance of the exchange.

An agreement is substantively unconscionable if the terms evidence a gross imbalance

that ―shocks the conscience.‖ Coles v. Trecothick, 32 Eng. Rep. 592, 597 (Ch. 1804). In

more modern terms, it means a bargain on terms ―so extreme as to appear unconscionable

according to the mores and business practices of the time and place.‖ Williams v. Walker-

Thomas Furniture Co., 350 F.2d 445, 450 (D.C. Cir. 1965) (quoting 1 Arthur L. Corbin,

Corbin on Contracts § 128 (1963)).

The concept of procedural unconscionability examines the procedures that led to

the contract with the goal of evaluating whether seemingly lopsided terms might have

resulted from arms‘-length bargaining. Courts focus on the relative bargaining strength of

the parties and whether the weaker party could make a meaningful choice. The concept is

―broadly conceived to encompass not only the employment of sharp bargaining practices

and the use of fine print and convoluted language, but a lack of understanding and an

25
inequity of bargaining power.‖ 1 E. Allan Farnsworth, Farnsworth on Contracts § 4.28,

at 583-84 (3d ed. 2004) (footnotes omitted).

The two dimensions of unconscionability do not function as separate elements of a

two prong test. The analysis is unitary, and ―it is generally agreed that if more of one is

present, then less of the other is required.‖ Id. § 4.28, at 585.

1. Factors Relating To Substantive Unconscionability

Six of the Fritz factors relate to the concept of substantive unconscionability. They

are:

 A significant cost-price disparity or excessive price.

 The denial of basic rights and remedies.

 Penalty clauses.

 The placement of disadvantageous clauses in inconspicuous locations or among
fine print trivia.

 The phrasing of disadvantageous clauses in confusing language or in a manner that
obscures the problems they raise.

 An overall imbalance in the obligations and rights imposed by the bargain.

Within this lineup, the first factor tests for a threshold indication of fundamental

unfairness. The second and third factors examine two types of contract terms where

overreaching may occur. The fourth and fifth factors ask about other types of contract

terms and whether they are adequately disclosed and comprehensible. The sixth factor

examines the agreement as a whole.

a. A Threshold Indication Of Unfairness

The first Fritz factor considers whether there is a threshold indication of

26
unfairness, such as ―a significant cost-price disparity or excessive price.‖ Fritz, 1990 WL

186448, at *4. ―[G]ross disparity between price and value can be used to demonstrate

unconscionability.‖11 ―Inadequacy of consideration does not of itself invalidate a bargain,

but gross disparity in the values exchanged may be an important factor in a determination

that a contract in unconscionable . . . .‖ Restatement (Second) of Contracts § 208, cmt. c.

―Such a disparity may also corroborate indications of defects in the bargaining

process . . . .‖ Id. ―[A]n unreasonably high or exorbitant price at the very least is a factor

to be considered in determining whether a particular provision is harsh and whether one

party has in fact been imposed upon by another party in an inequitable or unconscionable

manner.‖ 8 Williston on Contracts § 18:15 (4th ed. 2015).

In this case, there are obvious indications of unfairness. The Loan Agreement

called for finance charges of $1,620 for a $200 loan, resulting in a disclosed APR of

838.45%. That level of pricing shocks the conscience. Even defenders of fringe credit

have recognized that ―[a]t first glance, it would seem irrational for any consumer to

borrow money at an interest rate exceeding 400% under any circumstance.‖12 Zywicki

11
Tulowitzki, 396 A.2d at 961; see Ryan, 610 A.2d at 1385 (―[T]he financial
aspects of the sale are shocking.‖); see also REDUS Peninsula Millsboro, LLC v. Mayer,
2014 WL 4261988, at *5 (Del. Ch. Aug. 29, 2014) (holding that a complaint stated a
claim that a cable television billing arrangement was unconscionable where developer
charged a 50% markup on the cost of services).
12
Edward C. Lawrence & Gregory Elliehausen, A Comparative Analysis of
Payday Loan Customers, 26 Contemp. Econ. Policy 299, 299 n.1 (2008); see, e.g., JX 49
at PL75 (describing rates of ―225% to 300%‖ as ―extraordinary by any measure‖); see
also High Interest Loans and Class, supra, at 525 (collecting authorities supporting 36%

27
conceded that ―to a layman in some sense, it just looks kind of shocking to see a price

this high.‖13 More broadly, Zywicki and his co-authors admit in their recent book that the

finance charges for fringe products ―are indeed high when expressed in terms of [APR].‖

Consumer Credit, supra, at 352. When making this observation, they cited APRs that

―often exceed 100 percent.‖ Id. The rate for the Disputed Loan was eight times that level.

as a benchmark for ―responsible and fair small dollar loan frameworks,‖ including
jurisdictions that have statutory caps at that level); Interest Rate Caps, supra, at 120-22
(same); id. at 127 (describing survey results finding that approximately 86% of
participants believed that rates on fringe products should be capped at an APR of 25% or
less); Public Opinion, supra, at 269-73 (describing surveys showing bipartisan public
support for interest rate caps at APRs of 36% or less). In 2006, Congress passed the John
Warner National Defense Authorization Act for Fiscal Year 2007, codified at 10 U.S.C. §
987(b), which capped interest rates on payday loans, tax refund loans, and car title loans
to military troops at 36%. The federal bill provides secondary evidence suggesting that
higher rates are unconscionable and deleterious. See Public Opinion, supra, at 261-62
(arguing for a federal cap on fringe credit products similar to the military cap); Creola
Johnson, Congress Protected the Troops: Can the New CFPB Protect Civilians from
Payday Lending, 69 Wash. & Lee L. Rev. 649, 650 (2012) (same). Martin contrasts
fringe credit products with more typical consumer rates:

If the likely reader of this law review Article walked into a bank or credit
union and asked for a small short-term loan, the person would likely pay an
interest rate of 10-18%. . . . A loan from a traditional financial institution,
like a bank or credit union, on an unencumbered auto might run such a
person anywhere from 5% for a good credit risk up to 21% for a poor credit
risk.

Public Opinion, supra, at 267-68 (footnotes omitted).
13
Tr. 505 (Zywicki); accord Mark Flannery & Katherine Samolyk, Payday
Lending: Do the Costs Justify the Price? 3 (FDIC Ctr. for Fin. Research, Working Paper
No. 2005-09, 2005) (―[T]he maximum fees (per $100 borrowed) imply unusually high
APRs on account of the loans‘ small principal amounts and short maturities. These APRs
substantially exceed the rates associated with mainstream consumer credit products,
although some mainstream services (e.g., overdraft protection fees or credit card late
payment fees) might translate into similar APRs . . . .‖ (footnote omitted)).

28
 Zywicki recognized that the interest rate on the Disputed Loan was high in other

ways as well. He testified that the APRs for unsecured consumer installment loans

generally cluster around 150%.14 Unlike the Disputed Loan, consumer installment loans

―are amortized with part of each payment repaying principal so that the loan is paid in

full by the last scheduled payment.‖ Consumer Credit, supra, at 355. The Disputed Loan

was a twenty-six period interest-only loan culminating in a balloon payment at the year

mark.

The rate charged for the Disputed Loan exceeded even the rates charged for

traditional payday loans. Zywicki testified that the industry average for payday loans is a

block rate of $15 per $100, half what National charged. Tr. 589-90, 594 (Zywicki). Other

sources cite similar figures.15 The rate for the Disputed Loan also far exceeded what

14
Tr. 588 (Zywicki); accord Thomas A. Durkin & Gregory Elliehausen, Assessing
the Price of Short-Term Credit 14 n.12 (Bd. of Governors of the Fed. Reserve Sys., Div.
of Research & Statistics, Working Paper, 2013) (stating that ―[i]n the market place, rates
and finance charges on installment loans, when available, tend to be lower than the rates
in this example [which used an APR of 360%]‖).
15
See Consumer Credit, supra, at 357 (observing that finance charges for payday
loans ―are typically between $15 and $20 per $100 of the loan amount.‖); Durkin &
Elliehausen, supra, at 7 (―Maximum rates for payday loans are commonly between $12
and $20 per $100 borrowed.‖); Michael A. Stegman & Robert Faris, Payday Lending: A
Business Model that Encourages Chronic Borrowing, 17 Econ. Dev. Q. 8, 19 (2003)
(citing median fee in North Carolina of $36 on a loan of $244); see also Borné et al.,
supra, at 5 (citing typical bank payday loan charge as $10 per $100 borrowed and
describing it as ―very expensive‖).

29
Zywicki and his co-authors report as typical rates for other fringe products.16

National‘s efforts to explain the cost of the Disputed Loan were unconvincing.

McFeeters would not say what would be an excessive price for a loan. He only would

say, ―I follow the state laws, and that‘s what I follow.‖ Tr. at 435 (McFeeters). Delaware

does not impose any cap on interest rates, so McFeeters effectively was saying that no

price is too high.17

Zywicki advanced two types of arguments to explain the price of the Disputed

Loan. First, he contended that an APR of 838% could, in theory, result from a

competitive market. Second, he argued that there could be situations where it would be

rational for a consumer to use a high-interest credit product.

i. Arguments About Market Pricing

To support his claim about market pricing, Zywicki cited academic studies which

have observed that some features of the alternative financial product market are

consistent with meaningful price competition, such as low barriers to entry and a large

number of stores. Like many aspects of the industry, however, evidence on this issue is

16
See Consumer Credit, supra, at 354 (typical pawnbroker loan at 161.14%); id. at
359 (typical automobile title loan at 300%); id. at 360 (typical tax refund loan at
162.43%); id. at 367 (typical rent-to-own arrangement involving cost of credit of
145.71%).
17
In 1981, the General Assembly enacted a statute that allowed out-of-state bank
holding companies to establish limited-function state-chartered banks in Delaware. See 5
Del. C § 802; Dennis S. Aronowitz & Robert Volk, Developments in Banking Law 1980-
81, 1 Ann. Rev. Banking L. 1, 4-5 (1982). The statute also eliminated usury caps. See
Aronowitz & Volk, supra, at 4-5.

30
mixed, and other researchers have identified evidence consistent with a variety of

strategic pricing practices.18 Importantly for this case, Zywicki did not conduct any

analysis of the Disputed Loan itself, nor did he assess the competitiveness of the

Wilmington market. At the same time, he admitted that prices in Wilmington were higher

than the ranges he expected. He also recognized that consumers who use fringe products

generally lack meaningful alternatives.

In a variant of his market pricing argument, Zywicki contended that the price of

the Disputed Loan should not be viewed as excessive unless National was able to

generate supra-normal economic profits, which he equated with monopoly rents. Zywicki

emphasized one study that has questioned whether payday loan companies generate

supra-normal economic profits.19 The broader evidence is again mixed, with the authors

of a study on payday-loan profitability noting that ―a recent private analysis for potential

investors . . . asserts that a store set up for $30,000 will generate more than $258,000 in

operating cash flow over its first five years of operation, which implies an extraordinary

average annual pretax rate of return—around 170 percent—on the initial investment.‖

18
See, e.g., Robert de Young & Ronnie J. Phillips, Payday Loan Pricing 27-28
(The Fed. Reserve Bank of Kansas City, Econ. Research Dep‘t, Working Paper No. 09-
07, 2009) (finding evidence of competition in early-stage markets that gives way to
evidence of strategic pricing behavior in more mature markets, including the charging of
higher prices at stores in largely minority neighborhoods and other markets where
demand should be relatively inelastic).
19
See JX 46 at 45 (discussing Aaron Huckstep, Payday Lending: Do Outrageous
Prices Necessarily Mean Outrageous Profits?, 12 Fordham J. Corp. & Fin. L. 203, 229-
30 (2007)).

31
Flannery & Samolyk, supra, at 4 (citation omitted). In their own study, the same authors

found that ―mature stores appear to earn quite healthy operating profits—on average

$18.73 per loan made, or approximately $1.89 per average dollar of loans outstanding.‖

Id. at 19. They declined to take a position on whether this level of returns could be

described in the abstract as ―high‖ or ―reasonable.‖ Id. Opponents of fringe products

point to other indicators, such as marketing materials from payday loan franchisors that

describe high profit levels and the rapid expansion of the industry, which suggests

attractive returns.20 For purposes of this case, Zywicki again did not conduct any analysis

specific to Wilmington or National, and he could not offer any opinion as to whether

National enjoyed supra-normal profits.

As a third basis for his market-pricing claim, Zywicki posited that high-interest

loans are very costly to make, due in part to high default risk. He contended at trial that

default rates ―are usually in the range of 15, 20, to 25 percent.‖ Tr. 505 (Zywicki). A

study by the Pew Charitable Trust found that loan loss rates for payday loans are only

3%. See How Borrowers Repay, supra, at 6. Zywicki again did not do any analysis

specific to this case. He did not analyze default rates in the Wilmington area, nor did he

20
See Bianchi, supra, at 7-8 (citing rapid industry growth); Flannery & Samolyk,
supra, at 21 (―Today‘s payday loan industry does not appear to be in equilibrium.‖);
Good While Supplies Last, supra, at 564 (―Payday and other short-term loan outlets
nearly tripled in number between 1999 and 2006.‖); id. at 8-9 (citing franchisee sales
materials from payday lending franchisors and concluding that ―[p]ayday lending is a
tremendously profitable business‖); Stegman & Faris, supra, at 10 (―Reliable estimates of
the industry‘s financial status are hard to come by, but various sources suggest that
payday lending generates large revenues and is highly profitable.‖).

32
examine National‘s default rates.

Zywicki‘s opinion that an APR of 838% could, in theory, result from a

competitive market was just that—a theoretical possibility. It was not a persuasive

response to the facially shocking price of the Disputed Loan.

ii. Arguments About Hypothetically Rational Uses

Zywicki‘s second explanation for the price of the Disputed Loan rested on the

sensible claim that the price of a consumer product should be assessed, among other

things, ―by reference to the utility of the loan to the consumer.‖ JX 46 at 43. This

approach posits that there can be situations where it is rational and wealth-enhancing for

consumers to use high-cost loans. Zywicki touched on these justifications at trial when he

explained that consumers can use alternative credit products ―to avoid what might kind of

be bigger catastrophes like eviction and that sort of thing.‖ Tr. 541 (Zywicki).

In their book on consumer credit, Zywicki and his co-authors offer an expanded

version of this argument which asserts that high-interest, small-dollar loans ―can facilitate

the accumulation of household assets even when they are not used directly to finance the

household investment by enhancing overall liquidity, even at high cost.‖ Consumer

Credit, supra, at 369; accord Lawrence & Elliehausen, supra, at 302. They provide two

examples of situations where it could be rational for a consumer to take out a $200

payday loan at a block rate of $15 per $100 (half the rate of the Disputed Loan).

The simplest scenario involves a looming bill, such as a utility payment, where

non-payment will trigger a late fee exceeding the finance charge for the loan. Assuming

the borrower can repay the loan on schedule, the borrower does better by paying the

33
lower finance charge rather than the higher late fee. A slightly more complex variant

involves a late fee that may not exceed the finance charge, but where failing to pay the

bill will generate other hardships, such as the loss of electricity for a period of time.

Again assuming the borrower can repay the loan on schedule, the borrower does better by

paying the finance charge and avoiding the combination of the late fee and the negative

consequences. See Consumer Credit, supra, at 369.

A second and more nuanced scenario posits a borrower who can use the loan

proceeds to make a net-present-value-positive choice, such as repairing an automobile

immediately instead of delaying the repair while saving the money to pay for it. To

construct a viable example, Zywicki and his co-authors assume that until the repair is

completed, the consumer will (i) pay fees for public transit and (ii) lose leisure time to

commuting, which they value at the consumer‘s hourly wage. Depending on the

assumptions, the model supports scenarios where it makes sense for the consumer to use

a payday loan with a nominally high APR of 309% to repair the car sooner rather than

later. See id. at 370-72.

In each of these cases, the viability of using high-cost credit rationally depends on

the consumer having a use for the funds which generates monetary and non-monetary

returns that exceed the price of the loan. To their credit, the authors recognize that the

ability of a consumer to overcome a high APR (309% in their model) depends largely on

―the very short term to maturity‖ for a single-period payday loan. Id. at 371. They

observe that ―[t]his would not be the case for a long-term loan,‖ and that ―[e]xtended use

of this sort of credit is where it becomes most highly controversial.‖ Id. at 372.

34
 And there‘s the rub. The Disputed Loan was not structured as a short-term loan. It

was a twelve-month, interest-only installment loan. The Disputed Loan also charged an

interest rate that was more than double what Zywicki and his co-authors modeled (838%

vs. 309%). Zywicki did not identify any scenarios in which it could be rational for a

consumer to borrow on the terms contemplated by the Disputed Loan.

Perhaps anticipating this disconnect, Zywicki attempted at trial to re-characterize

the Disputed Loan as a short-term loan by pointing out that James had the option to

prepay. The decision to prepay parallels the decision to pay a traditional payday loan on

time. Consumer groups have modeled the likelihood that a typical user of high-cost credit

will repay a traditional payday loan in a single period and avoid a cycle of long-term

indebtedness. The Center for Responsible Lending provides the example of a borrower

making $35,000 per year who obtains a payday loan for $200 plus a finance charge of

$20. Assuming average levels of consumer expenditures for food, housing, utilities,

transportation, healthcare, and other essentials, and excluding costs such as childcare and

clothing, the borrower finishes the next pay period with a $96 deficit, forcing a loan

rollover. See Borné et al., supra, at 8-9. The same report examines how a payday loan

affects the account balance of a typical borrower on a fixed income, such as social

security. It demonstrates that although the loan temporarily boosts the customer‘s bank

balance, the combination of the balloon payment and fees makes the borrower worse off

35
and necessitates another loan.21 A report by the Pew Charitable Trust concludes that

the lump-sum repayment model appears to make it difficult for borrowers
to avoid renewal. Pew‘s analysis of state and industry data indicates that
borrowers are indebted for an average of about five months of the year.
According to one study, 76 percent of these loans, including renewals, are
borrowed within two weeks following an existing payday loan‘s due date,
meaning the borrower could not pay back the loan and make it to the next
payday without another loan. In addition, Pew‘s analysis of data from
Oklahoma finds that more borrowers use at least 17 loans in a year than use
just one.

Who Borrows, supra, at 7 (footnotes omitted). A follow-up study found that ―[o]nly 14

percent of borrowers can afford enough of their monthly budgets to repay an average

payday loan,‖ although most could afford to pay the interest-only fee to roll over the

loan. How Borrowers Repay, supra, at 6. The study observed that ―[a]verage borrowers

end up indebted for five months, paying $520 in finance charges for loans averaging

$375.‖22

It may be that a consumer with the wherewithal to repay a high-cost loan after one

period could rationally use some high-cost products in a wealth-enhancing way, but that

thought experiment does not persuasively justify the pricing and terms of the Disputed

Loan. The loan James obtained was a twenty-six period, interest-only loan followed by a

21
See id. at 10-11; accord King & Parish, supra, at 8 (similar example using 2005
data).
22
Id. at 4; see Good While Supplies Last, supra, at 577 (―Given the demographics
of the payday loan customers in this study and the typical expenses of people within this
demographic, coupled with the loan design, very few customers can afford to pay back
the loans.‖)

36
twenty-seventh period balloon payment at an APR of 838%. As noted, Zywicki and his

co-authors recognize that it is difficult to imagine a situation where it would make sense

for a consumer to use a multi-period loan at the interest rates charged for payday loans.

See Consumer Credit, supra, at 370-72. Zywicki‘s testimony about the hypothetically

rational use of some high-cost credit products failed to legitimize the Disputed Loan‘s

facially disturbing price.

iii. Fundamental Unfairness

The economic terms of the Disputed Loan are so extreme as to suggest

fundamental unfairness. The price of the Disputed Loan is particularly egregious given its

multi-period, non-amortizing structure. The finance charges incurred over the course of

the loan are so high that no rational borrower would agree to pay them, unless under

duress or operating under a misapprehension of fact. The first Fritz factor is satisfied.

b. Contract Provisions Suggesting Unfairness

The next four Fritz factors focus on contract provisions that can contribute to a

finding of unfairness. They include provisions that deny or waive ―basic rights and

remedies,‖ ―penalty clauses,‖ and ―disadvantageous‖ clauses that are hidden or difficult

to identify and understand. 1990 WL 186448, at *4. The more general question is

whether the contract provisions evidence ―[a]n overall imbalance in the obligations and

rights imposed by the bargain.‖ Id. at *5. Specific provisions might not be

unconscionable in isolation or under different circumstances, yet still may contribute to a

37
finding of unconscionability in a given case.23

The Loan Agreement contains provisions that raise concerns, but they are not

sufficiently onerous to support a finding of unconscionability standing alone. They

contribute to the overall assessment of the Loan Agreement, but as a secondary factor.

One category of provisions called out in Fritz encompasses waivers and denials of

basic rights and remedies that a consumer otherwise would possess. The Loan Agreement

included a waiver of the right to a jury trial, which extended to ―any dispute you may

have against us or a related third party.‖ JX 19 at 3. It did not define what it meant by

―related third party.‖ The Loan Agreement also contained an arbitration provision in

which the borrower gave up the right to sue in court (other than in small claims court)

and the right to arbitrate on a class-wide basis. The Loan Agreement did give James sixty

calendar days to opt out of the arbitration provision, and it contained some procedural

features to make arbitration less onerous. Had James moved forward with arbitration, her

greatest disadvantage would have been limited discovery. As shown by National‘s

23
See, e.g., Trethewey v. Basement Waterproofing Nationwide, Inc., 1994 WL
680072, at *4 (Del. Ch. Oct. 19, 1994) (recognizing that a waiver of consequential
damages can be valid, but finding a limitation of liability for consequential damages was
unconscionable on the facts of the case); Architectural Cabinets, Inc. v. Gaster, 291 A.2d
298, 30 (Del. Super. 1971) (recognizing that ―confession of judgment clauses are not in
themselves unconscionable‖ but holding it was unconscionable on the facts presented);
see also Consumer Credit, supra, at 410 (―[P]ossible loan terms, such as prepayment
penalties, balloon payments, or loans based on collateral rather than the ability to repay,
may be perfectly fine for borrowers who understand their uses and how agreeing to such
terms may be useful in bargaining for more favorable interest rates or other terms. But the
same terms . . . not understood fully by unsophisticated borrowers may be predatory in
both intent and effect.‖).

38
conduct in this case, it took a determined attorney with the benefit of court-ordered

discovery to obtain responsive information from National, and even then National did not

produce all of its responsive information.

The jury waiver and the arbitration provision fall within the meaning of the Fritz

factor that focuses on waivers of rights and remedies, but they do not contribute

meaningfully to a finding of unconscionability. The same is true for penalty clauses,

which is another category of provisions that Fritz identifies. 1990 WL 186448, at *4. The

Loan Agreement contemplates a late fee ―on any installment not paid in full within 5

days after its due date as originally scheduled, in the amount of 5% of the unpaid amount

of the delinquent balance.‖ JX 19 at 3. A 5% late fee is authorized by statute. See 5 Del.

C. § 2231(2). The Loan Agreement also gives National the right to declare a default after

a missed payment and to cause all outstanding amounts to accelerate, and it obligates the

borrower ―to pay the actual expenditures, including reasonable attorneys‘ fees, for legal

process or proceedings to collect the amounts owing hereunder.‖ JX 19 at 3-4. This type

of attorneys‘ fee provision is also permitted by statute. See 5 Del. C. § 2236. As with the

discussion of waivers of rights and remedies, these provisions satisfy the Fritz factor that

focuses on penalty clauses, but they do not contribute meaningfully to a finding of

unconscionability.

The Fritz decision also calls for consideration of ―disadvantageous‖ clauses that

are ―inconspicuous,‖ as well as ―language that is incomprehensible to a layman‖ or seems

designed to ―divert his attention from the problems raised by them or the rights given up

through them.‖ 1990 WL 186448, at *4. Two aspects of the Loan Agreement warrant

39
mention.

The first involves the provisions addressing ACH withdrawals. Comprising fifteen

single-spaced paragraphs and subparagraphs, and written in what appears to be eight-

point font, the provisions span a full page of the six-page agreement. These provisions are

highly favorable to National, but the Loan Agreement portrays them as beneficial to the

consumer. At one point, it states that ―THIS ACH AUTHORIZATION IS FOR YOUR

CONVENIENCE IN PAYING AMOUNTS OWED AND RECEIVING THE LOAN

PROCEEDS.” JX 19 at 3. Elsewhere the Loan Agreement states, ―For your protection,

this form authorizes Loan Till Payday to automatically collect each periodic payment due

under the terms of this Contract.‖ Id. at 6. The provisions are actually a form of security

interest that is for National‘s protection and convenience.

The provisions governing ACH withdrawals are confusing because they speak of

making ―ACH‖ transfers from ―the checking or savings account specified in your

Application/Data Verification form (‗Your Bank Account‘).‖ Id. at 2. National, however,

treats the authorization as covering debits from a pre-paid debit card like James‘ Nexis

card, and National repeatedly debited James‘ account. Further complicating matters, the

signature page where the borrower specifically authorizes the withdrawals appears under

the heading ―Credit Card Authorization.‖ Id. at 6. Despite this language, National does

not accept credit cards, and James did not have a credit card; she had a debit card.

The inconsistent language in the Loan Agreement could easily confuse an

unsophisticated customer like James. The difficulties with National‘s language had

particular salience for this case, because when James obtained the Disputed Loan, she

40
told Reilly that she did not want electronic withdrawals made from her account. Reilly

made two notes in the Payday Loan Manager. One stated ―No ACH debits,‖ and another

stated, ―Customer wants to walk in cash payments.‖ JX 29B at 659. Yet National debited

James‘ Nexis card and made at least one ACH withdrawal from her Nexis account.

James‘ instruction and National‘s acknowledgement catches National on the horns

of a dilemma. To the extent that National‘s witnesses took a narrow and legalistic view at

trial by arguing that James only opted out of ACH withdrawals and not debits from her

Nexis card, then the same logic meant that James only granted ―Credit Card

Authorization,‖ not debit card authorization. To the extent that National‘s witnesses

argued broadly at trial that the ―Credit Card Authorization‖ encompassed all types of

electronic withdrawals, then James‘ insistence that she did not want ACH withdrawals

should have been sufficient to opt out. In neither case did National get the authorization it

needed to debit James‘ account.

The debate over whether James validly opted out of ACH transfers identifies a

second problem with the ACH provisions: they make it extremely difficult for a customer

to avoid granting National the authorization it wants. In the fourteenth of fifteen

paragraphs and subparagraphs addressing ACH transfers, the Loan Agreement does say

that the ACH authorization is optional, but the borrower can opt out only ―BY

MANUALLY CROSSING OUT ALL ACH AUTHORIZATION LANGUAGE IN

THIS AGREEMENT.‖ JX 19 at 3. The formal authorization then comes three pages

later, under the heading ―Credit Card Authorization,‖ in a paragraph that makes no

reference to ACH debits and does not contain the abbreviation ―ACH.‖ See id. at 6. There

41
is nothing to alert customers to the fact that by signing the language under the heading

―Credit Card Authorization,‖ they are agreeing to ACH transfers.

Once a customer has authorized ACH transfers, it is difficult to terminate them.

According to the Loan Agreement,

You may terminate one or all of the authorizations to initiate ACHs from
Your Bank Account set forth above by calling us at 302-328-1370 and by
writing us at 1511 North DuPont Highway, New Castle, DE 19720 and
specifying which authorizations you would like to terminate. We will
discontinue initiating any ACHs you specify as soon as we reasonably can
and in any event within three business days after receiving your termination
request.

....

This ACH Authorization will remain in full force and effect until (i) we
have received written notification from you of its termination in such time
and in such manner as to afford us and the Depository a reasonable
opportunity to act on it or (ii) upon full and final payment of the amount
you owe us under this Agreement.

Id. at 3 (emphasis added). McFeeters testified that he would insist on full compliance

with the language of the contract before terminating an ACH authorization, meaning that

a customer only could terminate ACH withdrawals by calling the phone number and

confirming in writing.

The Loan Agreement skews the ACH withdrawal provisions in National‘s favor in

another way as well: National can withdraw whatever amount it wants from a customer‘s

account, up to the full amount of the outstanding loan plus fees and charges, without prior

notice to the customer that a higher amount will be debited. The operative language

states:

42
 Please note that you have the right to receive notice of all transfers varying
in amount, and that by signing this ACH Authorization you acknowledge
that we have elected to offer you a specified range of amounts for debiting
(in lieu of providing the notice of transfers in varying in amount [sic]). The
amount of any ACH debit will range from (i) the payment amount provided
in the payment schedule (which may be less than a scheduled payment if
partial prepayments have been made), to (ii) an amount equal to the total
outstanding balance (which may be greater than or less than a payment
based upon your actual payments), plus as applicable, any returned
payment charges and/or any late charges you may owe under the
Agreement. For any debit outside of this specified range, we will send you
a notice. Therefore, by agreeing to the terms of this ACH Authorization you
are choosing to only receive notice when a transfer amount exceeds the
range specified above.

JX 19 at 3. National relied on this paragraph to debit James‘ account for amounts greater

than her scheduled payment, without prior notice to James. For National‘s cash-

constrained customers, a higher withdrawal easily could overdraw their account or sweep

up the bulk of their available cash.

In my view, the provisions governing ACH withdrawals are ―disadvantageous,‖

drafted in ―language that is incomprehensible to a layman,‖ and appear designed to

―divert [the customer‘s] attention from the problems raised by them or the rights given up

through them.‖ Fritz, 1990 WL 186448, at *4. As drafted and implemented, the ACH

provisions support a finding of unconscionability.

The same is true for the provisions governing rescission and prepayment, which

the Loan Agreement combines confusingly in a single paragraph. The Delaware Code

addresses these concepts separately. One statutory section addresses prepayment. See 5

Del. C. § 2234. A separate statutory section requires a right of rescission. See id. §

2235A(a)(3). The Loan Agreement, by contrast, shoves the right of rescission into the

43
middle of six sentences addressing prepayment. The paragraph in question states:

You shall have the right to make payment in advance and in any amount on
this Loan Agreement at any time. You will not incur an additional charge,
fee or penalty for prepayment. Prepayments of principal may reduce the
total amount of interest you are scheduled to pay under this Loan
Agreement. To rescind future payment obligations under this Loan
Agreement and receive a refund of the finance charge, you must (i) inform
us by visiting a store of your intent to rescind no later than 4:00 PM
Eastern Time on the next business day immediately following the
Disbursement Date (“Rescission Deadline”), and (ii) give us written
authorization to effect a debit entry to Your Bank Account, defined in the
Repayment Authorization below, for the principal amount of the loan. If we
receive payment of the principal amount of the loan via such authorization,
then we will refund the interest owing and rescind the future payment
obligations under this Loan Agreement. Thereafter, if you prepay this Loan
Agreement in full or in part, no earned interest will be refunded. To process
a partial or full prepayment or receive a payoff balance, you should call us
(302-328-1370) or visit a store of your intent to prepay. Please note that the
payoff amount will be calculated as of the date we debit Your Bank
Account for the balance owing.

JX 19 at 2 (emphasis added). As structured, the first three sentences address prepayment,

including the customer‘s right to prepay any amount at any time. The italicized portion

shifts to the customer the right to rescind the loan agreement within the first twenty-four

hours after obtaining the loan. The last three sentences return to the concept of

prepayment.

In my view, this is another provision that is ―disadvantageous,‖ drafted in

―language that is incomprehensible to a layman,‖ and designed to ―divert [the

customer‘s] attention from the problems raised . . . or the rights given up.‖ Fritz, 1990

WL 186448, at *4. As drafted and implemented, it supports a finding of

unconscionability.

National argues that because James did not read the Loan Agreement, none of its

44
terms should matter in the unconscionability analysis. When a business relies on a

contract of adhesion, a court does not take into account whether the consumer has read

the document: ―Such a writing is interpreted wherever reasonable as treating alike all

those similarly situated, without regard to their knowledge or understanding of the

standard terms of the writing.‖ Restatement (Second) of Contracts § 211(2) (emphasis

added). ―[C]ourts in construing and applying a standardized contract seek to effectuate

the reasonable expectations of the average member of the public who accepts it.‖ Id. §

211, cmt. e. This approach rests on the rationale that

[a] party who makes regular use of a standardized form of agreement does
not ordinarily expect his customers to understand or even to read the
standard terms. One of the purposes of standardization is to eliminate
bargaining over details of individual transactions, and that purpose would
not be served if a substantial number of customers retained counsel and
reviewed the standard terms. Employees regularly using a form often have
only a limited understanding of its terms and limited authority to vary them.
Customers do not in fact ordinarily understand or even read the standard
terms. They trust to the good faith of the party using the form and to the
tacit representation that like terms are being accepted regularly by others
similarly situated. But they understand that they are assenting to the terms
not read or not understood, subject to such limitations as the law may
impose.

Id., § 211 cmt. b.

The final factor relating to the contract terms is whether the agreement evidences

―[a]n overall imbalance in the obligations and rights imposed by the bargain.‖ Fritz, 1990

WL 186448, at *5. Some insight into this factor can be gleaned from the degree to which

the Loan Agreement devoted attention to particular subjects.

The Loan Agreement covered six pages. Five contained substantive provisions.

The sixth was a signature page. Of the five substantive pages, one full page of text

45
(spanning most of page one and part of page two) created the most significant imbalance

in the agreement: the financial terms. In return for a loan of $200, James agreed to repay

National $1,820, structured as twenty-six non-amortizing, interest-only payments of $60

followed by a balloon payment of $260. Another full page (spanning part of page two and

most of page three) detailed National‘s ability to make ACH withdrawals. A page and a

half (spanning the bulk of page four and the bulk of page five) addressed the arbitration

provision.

In total, the Loan Agreement devoted nearly two-thirds of its contents to these

three subjects, evidencing their importance to National. Through these provisions,

National imposed onerous financial terms and gave itself the right to collect unilaterally

from James any amount it wished, up to the full amount of the loan plus fees and charges.

National ensured that in any challenge to the Disputed Loan, James would not be able to

represent a class. She would have to challenge National alone, based on a loan where the

amount in question would make the representation economically irrational for a lawyer

unless he could recover his fees from National. Moreover, unless James opted out of the

arbitration provision within sixty days—something that no customer other than James has

ever done—then James would have to challenge the Disputed Loan in arbitration, which

was National‘s chosen forum. Taken as a whole, for purposes of the Fritz factors, the

Loan Agreement evidences ―[a]n overall imbalance in the obligations and rights imposed

by the bargain.‖ Id.

2. Factors Relating To Procedural Unconscionability

The next four Fritz factors shed light on the concept of procedural

46
unconscionability. They are:

 Inequality of bargaining or economic power.

 Exploitation of the underprivileged, unsophisticated, uneducated, and illiterate.

 The use of printed form or boilerplate contracts drawn skillfully by the party in the
strongest economic position, which establish industry-wide standards offered on a
take it or leave it basis to the party in a weaker economic position.

 The circumstances surrounding the execution of the contract, including its
commercial setting, its purpose, and actual effect.

As I see it, these factors help a court test the degree to which a seemingly

disproportionate outcome could have resulted from legitimate, arms‘-length bargaining.

The first and second factors plumb this issue by considering the extent to which the

parties to the agreement were capable of bargaining at arms‘-length. A court rarely will

intervene when the contracting parties are both commercial entities or otherwise

sophisticated. By contrast, a court may be more concerned where the contracting process

involved significant inequalities of bargaining power, economic power, or sophistication,

particularly between a business and a consumer. An aggravated version of this scenario

arises when one of the parties is an individual who is underprivileged, uneducated, or

illiterate.

The third and fourth factors similarly contribute by examining the degree to which

actual bargaining took place. The third factor considers whether the agreement is a

contract of adhesion. The fourth factor takes into account the contracting environment,

including the commercial setting and the purpose and effect of the disputed agreement.

Together, these factors weigh an initial showing of unfairness against the

47
bargaining dynamic. If the contract resulted from legitimate negotiation, then a court

should not intervene. ―There is a significant distinction between an unconscionable

contract and a bad bargain.‖ Obaitan v. State Farm, 1997 WL 208959, at *3 (Del. Ch.

Apr. 17, 1997). ―Parties have a right to enter into good and bad contracts, the law

enforces both.‖ Nemec v. Shrader, 991 A.2d 1120, 1126 (Del. 2010). But if the contract

appears fundamentally unfair and there are valid reasons to suspect that the outcome did

not result from legitimate negotiation, then a different picture emerges.

a. The Attributes Of The Parties

The first two factors that fall under the heading of procedural unconscionability

examine the relative attributes of the parties and whether they were capable of

bargaining. The first of the two factors examines whether there is an ―inequality of

bargaining or economic power.‖ Fritz, 1990 WL 186448, at *5. The second considers

whether the contract involved ―exploitation of the underprivileged, unsophisticated,

uneducated and the illiterate.‖ Id. To my mind, the second is an aggravated version of the

first.

These factors do not mean that the law censures every power imbalance. To the

contrary, ―[a] bargain is not unconscionable merely because the parties to it are unequal

in bargaining position, nor even because the inequality results in an allocation of risks to

the weaker party.‖ Restatement (Second) of Contracts § 208, cmt. d. After all,

―bargaining power will rarely be equal.‖ Progressive Int’l Corp. v. E.I. Du Pont de

Nemours & Co., 2002 WL 1558382, at *11 (Del. Ch. July 9, 2002) (Strine, V.C.)

(quoting Farnsworth on Contracts § 4.28 (2d ed. 2000)). Consequently, a ―mere disparity

48
between the bargaining power of parties to a contract will not support a finding of

unconscionability.‖ Graham v. State Farm Mut. Auto. Inc. Co., 565 A.2d 908, 912 (Del.

1989); accord Tulowitzki v. Atl. Richfield Co., 396 A.2d 956, 960 (Del. 1978) (―Superior

bargaining power alone without the element of unreasonableness does not permit a

finding of unconscionability or unfairness.‖).

―But gross inequality of bargaining power, together with terms unreasonably

favorable to the stronger party, . . . may show that the weaker party had no meaningful

choice, no real alternative, or did not in fact assent or appear to assent to the unfair

terms.‖ Restatement (Second) of Contracts § 208, cmt. d. The inequality must be

sufficiently great such that one side is placed at a meaningful disadvantage, and the court

must find as part of its overall analysis that the stronger party used its position ―to take

unfair advantage of his weaker counterpart.‖ Graham, 565 A.2d at 912.

This approach manifests itself in a judicial reluctance to invalidate contracts

between business entities or other sophisticated parties. For example, Delaware courts are

―particularly reluctant to find unconscionability in contracts between sophisticated

corporations.‖ Reserves Mgmt., LLC v. Am. Acq. Prop. I, LLC, 86 A.3d 1119, 2014 WL

823407, at *9 (Del. Feb. 28, 2014) (ORDER). By contrast, courts are more willing to step

in when a contract involves a business and a consumer.24 Delaware decisions also exhibit

24
See, e.g., Trethewey, 1994 WL 680072, at *4 (stressing that the contractual
provision found to be unconscionable arose in ―a situation where a business was dealing
with a homeowner‖); see also REDUS Peninsula, 2014 WL 4261988, at *5 (finding
complaint stated claim that arrangement between developer and homeowners was

49
sensitivity to situations in which a sophisticated actor has taken advantage of someone

who is underprivileged, unsophisticated, uneducated, or illiterate. In the Ryan decision,

for example, Chancellor Allen recognized that a constellation of attributes such as

poverty, financial distress, and lack of sophistication can make an individual vulnerable.

Ryan v. Weiner, 610 A.2d 1377, 1385 (Del. Ch. 1992) (Allen, C.). He noted that although

these disadvantages do not prevent a person from making a valid contract, they are

factors that a court can take into account. See id.

The Disputed Loan was a contract between a business and a consumer. It therefore

falls within the category of contracts where courts are relatively more likely to invoke the

unconscionability doctrine.

More importantly, the Loan Agreement was a contract between (i) a specialized

business addressing a target market of underprivileged, cash-constrained, and credit-

rationed consumers, and (ii) an unsophisticated member of the target market. The

Disputed Loan thus raises concerns about predatory lending.25 Indeed, the experts and the

unconscionable). See generally 8 Williston on Contracts § 18:8 (―The principle is one of
the prevention of oppression and unfair surprise and not of disturbance of allocation of
risks because of superior bargaining power. It is for this reason as much as any other that
unconscionability is not as commonly found in contracts between business persons as
when consumers or other less sophisticated parties are involved.‖ (quotation marks and
citation omitted)).
25
Cf. Consumer Credit, supra, at 410 (―Most observers and commentators contend
that subprime lending is a necessary but not sufficient condition for predatory lending.
Thus, to most observers, not all subprime lending is predatory, but most or all predatory
lending is subprime.‖).

50
supporting literature on alternative financial services find rare agreement on two points.

First, the consumers who use the products tend to be cash-constrained and credit-

rationed, meaning that they have limited resources and few, if any, credit alternatives. 26

Second, consumers typically use high-interest financial products for necessities, such as

26
See, e.g., Tr. 541 (Zywicki describing users of fringe products as ―basically
being credit rationed‖); id. at 617 (same); JX 46 at 34 (―[T]hose who use alternative
lending products . . . tend to be more ‗credit constrained‘ than those who use more
mainstream products . . . .‖); id. at 47 (―Those who use short-term loans such as small-
dollar installment loans often, but not always, have impaired credit, which restricts their
access to mainstream credit products.‖); id. at 48 (―[T]hose who use payday loans
generally either do not have access to preferred types of credit such as credit cards or
would trigger expensive fees from credit card use . . . .‖); id. at 50 (―[F]ew who would
otherwise use payday loans can switch to less-expensive alternatives . . . .‖); Neil Bhutta,
Paige Marta Skiba & Jeremy Tobacman, Payday Loan Choices and Consequences 10-11
(Vand. U. Law & Econ., Working Paper No. 12-30, 2012) (finding that payday loan
customers are more likely than the general population to be delinquent on credit accounts
and were generally unsuccessful in obtaining credit other than through alternative credit
products); Flannery & Samolyk, supra, at 6 (―[I]ndividuals with impaired credit histories
are more likely to use payday loan[s] as a source of funds.‖); High Interest Loans and
Class, supra, at 526-27 (citing authorities charging that providers of fringe products prey
on racial and ethnic minority groups and target the poor); Lawrence & Elliehausen,
supra, at 310 (finding that only half of payday loan customers have a general purpose
bank credit card and over 60% reported refraining from using the card within the
previous year to avoid exceeding their credit limit); Rob Levy & Joshua Sledge, Ctr. for
Fin. Servs. Innovation, A Complex Portrait: An Examination of Small-Dollar Credit
Consumers 15-16 (2012) (finding that over half of those who used alternative credit
products did not qualify for a credit card, had ―maxed out‖ their credit, or could no longer
use credit cards); id. at 14 (finding that 66% of consumers who used fringe products had
no savings and 16% could not pay their bills); Stegman & Faris, supra, at 14 (―[T]here is
widespread agreement that most payday loan customers are credit constrained.‖); see also
Who Borrows, supra, at 4 (―[A]fter controlling for other characteristics, there are five
groups that have higher odds of having used a payday loan: those without a four-year
college degree; home renters; African Americans; those earning before $40,000 annually;
and those who are separated or divorced.‖).

51
food, rent, utility bills, and mortgage payments,27 meaning that they face an urgent need

for funds.28 Defenders and critics of high-interest products differ only in how they spin

these facts. Defenders view fringe products as virtuous because they provide a form of

credit, albeit at high cost, to consumers who otherwise would not have any. Critics charge

that high-interest lenders take advantage of people in economic duress.

27
See, e.g., Tr. 538-39 (Zywicki) (―People who use small-dollar loans are people
who tend to live pretty close to the margin. And the literature finds that, you know,
roughly two-thirds use it for things like food—I‘m sorry. Rent and groceries. . . . [W]e‘re
talking about people who live on the edge, live on the margin.‖); Durkin & Elliehausen,
supra, at 18 (reporting on survey data from a series of surveys facilitated by an industry
trade association which indicate that ―payday loans are generally used to address urgent
needs‖); Good While Supplies Last, supra, at 609 (reporting on survey data indicating
that many customers use loans to cover regular bills); Levy & Sledge, supra, at 4 (finding
that consumers typically use high-interest lending products to meet important financial
obligations, such as rent, utility bills, and mortgage payments); Who Borrows, supra, at
4-5 (―[S]urvey respondents from across the demographic spectrum clearly indicate that
they are using the loans to deal with regular, ongoing living expenses. . . . 69 percent used
[a first-time payday loan] to cover a recurring expense, such as utilities, credit card bills,
rent or mortgage payments, or food.‖); Jonathan Zinman, Restricting Consumer Credit
Access: Household Survey Evidence on Effects Around the Oregon Rate Cap 9 (Fed.
Reserve Bank of Phila., Working Paper No. 08-32, 2008) (finding payday loan customers
primarily use proceeds for bills, emergencies, food, and debt service).
28
Consumer Credit, supra, at 381 (―In sum, most customers used small consumer
finance loans because they had an urgent need and did not have better alternatives.‖); id.
at 380 (―[M]ost customers faced an urgent need for funds . . . .‖); id. at 383 (―Most
customers used payday loans because they had an urgent need and had few
alternatives.‖); How Borrowers Repay, supra, at 9-10, 21 (noting that 58% of payday
loan customers reported having trouble paying their bills more than half of the time and
37% said they were so desperate to pay their bills that they would take a payday loan on
any terms offered).

52
 i. National

National specializes in providing high interest loans to underprivileged consumers

who are cash-constrained and lack alternative sources of credit. When McFeeters

acquired National, he applied to have National‘s banking licenses renewed. See JX 4 (the

―Licensing Application‖). National disclosed in its Licensing Application that many of its

customers ―have had credit problems in the past or have reached the maximum limit on

their bank cards.‖ Id. at 510; see Tr. 371-72 (McFeeters).

National is a well-funded operation. The Licensing Application projected that

National‘s business model would generate free cash flow of $1.5 million to $2 million

per year. Its actual performance has been on the order of $1 million per year.

National‘s owner and its personnel are sophisticated and knowledgeable.

McFeeters acquired National after working in the payday loan industry for approximately

ten years. In 2013, National had fourteen stores throughout Delaware, which it ran using

a centralized model. At trial, National maintained that it had a manual setting out its

policies and procedures. Tracey Annand, a District Manager at National, trained all of

National‘s personnel. National employed legal counsel to draft its loan agreements.

National‘s employees recognize that its customers have difficulty predicting how

long their loans will be outstanding and virtually never estimate correctly when they will

be able to repay their loans. Customers who believe they will have a loan outstanding

typically end up keeping the loan for ―a couple months.‖ See Tr. 341 (Carter).

ii. James

James is unsophisticated and undereducated. She dropped out of school in the

53
tenth grade, then obtained her GED approximately ten years later. She tried to improve

her skills through a nine-month course on medical billing and coding, but she stopped

two months short of graduation. Evidencing her lack of financial sophistication, she

believed that the financial aid she received for the program was a grant. It was actually a

loan that she struggled to pay back.

Further evidence of James‘ lack of financial sophistication comes from her

testimony about why she uses a pre-paid Nexis card. At trial, James explained that she

previously had a checking account with PNC Bank but switched to her Nexis card

because she did not like paying a monthly fee to maintain the checking account. Before

making the Disputed Loan, National obtained a sixty-day transaction history for the

Nexis account. It shows that during that period, James paid Nexis a total of $127.07 in

transaction fees. Each time the Hotel DuPont paid James by direct deposit, Nexis charged

her a load fee equal to 2% of the direct deposit amount. The load fees totaled $44.07.

Each time James used her card to pay for a transaction and authorized it with her

signature, Nexis charged her a signature transaction fee of $1. She signed for twelve

transactions for total signature fees of $12. Each time James used her card to pay for a

transaction and authorized it with her pin number, Nexis charged her a PIN transaction

fee of $1.50. She completed thirteen PIN transactions for total PIN fees of $19.50. Each

time, James attempted a transaction and her card was declined, Nexis charged her a

decline fee of $0.50. Her card was declined fourteen times for total decline fees of $7.

Each time she withdrew cash, Nexis charged her an ATM usage fee of $2.50. She

withdrew cash on twenty-one occasions for total fees of $52.50. The amounts of the cash

54
withdrawals suggest that the ATM provider also charged a withdrawal fee that was

incorporated into the amount of the debit.

James does not appear to have comprehended the magnitude of the per-transaction

fees that Nexis charged her, or the reality that those fees far exceeded the flat monthly fee

that a bank would charge for a no-minimum-balance checking account, particularly

where the client had direct deposit. She seems only to have considered the headline fee

charged for the account each month.

James‘ perception of the financial charge for the Disputed Loan reflected a similar

short-term focus. National contended James understood the block rate she would pay,

which was $30 on $100. It is true that James could recite the block rate, but that does not

mean she understood its implications. To the contrary, the evidence convinced me that

National used a block rate and de-emphasized the APR to mislead its customers and

make them think their cost of credit was an order of magnitude lower than it really was.

James did not understand how interest accrued, and she did not understand what would

happen upon default.

James underestimated her likelihood of repaying the Disputed Loan quickly. She

thought she could pay it off in two payments, but she failed to do so. She similarly mis-

remembered her success in repaying previous loans. She thought she paid off each of her

previous loans in one or two payments, but for the previous loans from National (the only

loans in the record), James took longer. For the loan immediately preceding the Disputed

Loan, there were seven attempted payments, four of which were declined.

James is also underprivileged. In 2013, she took home approximately $1,100 per

55
month, and her annualized income of approximately $13,200 represented 115% of the

federal poverty line for a single-person household. She lived paycheck to paycheck and

had no savings to fall back on. She did not have access to alternative sources of credit. By

2013, when James took out the Disputed Loan, she had been using high-interest,

unsecured loans for four to five years, perhaps longer. She did not use the loans in

response to unforeseen emergencies. She used them on a relatively regular basis for

essential needs. She obtained the Disputed Loan because she needed money for groceries

and rent. James‘ frequent use of high-cost loans was a detriment and should have been a

red flag to National.

At trial, National tried to turn James‘ weakness into a strength, arguing that she

was an experienced consumer who was competent to use high-interest financial products.

Zywicki stressed this point, contending that James‘ prior use of similar loans

―suggest[ed] that she was familiar with the material terms of the loan, understood the

risks, and the like.‖ Tr. 509 (Zywicki); see id. at 523-24, 549-50. In contrast to National‘s

arguments at trial, both defenders and critics of payday loans generally agree that

frequent use is problematic. 29

29
See, e.g., Oren Bar-Gill & Elizabeth Warren, Making Credit Safer, 157 U. Pa. L.
Rev. 1, 44 (2008) (―The problem lies with the substantial subset of consumers who take
out multiple [payday loan] advances and pay the $30 fee many times over.‖); Durkin &
Elliehausen, supra, at 21 (―Most customers with a large number of loans had intervals
between borrowings, but some had payday loan sequences lasting 14 weeks or longer. . . .
Such frequent payday loan use undoubtedly did not help some borrowers to manage their
finances, however; and it may well have exacerbated the difficulties of others.‖); id. at 21
n.18 (―Factors associated with difficult in managing finances such as not saving,

56
 Given the relative attributes of National and James, the Disputed Loan involved

both ―inequality of bargaining or economic power‖ and the ―exploitation of the

underprivileged, unsophisticated, [and] uneducated.‖ Fritz, 1990 WL 186448, at *5.

These factors favor a finding of unconscionability.

b. A Take-It-Or-Leave-It, One-Sided Form Agreement

The next Fritz factor asks directly whether there was actual bargaining involved.

As framed in Fritz, the court should consider ―[t]he use of printed form or boilerplate

contracts drawn skillfully by the party in the strongest economic position, which establish

industry wide standards offered on a take it or leave it basis to the party in a weaker

economic position.‖ Id. at *4. The type of standardized contract that this factor describes

is also called a contract of adhesion. See Worldwide Ins. Gp. v. Klopp, 603 A.2d 788, 790

(Del. 1992); Graham v. State Farm Mut. Auto. Inc. Co., 565 A.2d 908, 912 (Del. 1989).

―[A] contract of adhesion is not unconscionable per se, and . . . all unconscionable

contracts are not contracts of adhesion.‖ Restatement (Second) of Contracts § 208,

relatively heavy credit card indebtedness, and overdrawing checking accounts are
associated with frequent use of payday loans.‖); Flannery & Samolyk, supra, at 21 (―For
many observers, the main consumer concern about payday lending is the high price of
chronic use.‖); Lawrence & Elliehausen, supra, at 313 (finding that ―frequent users have
long-term difficulty in managing finances and their less favorable attitudes toward credit
reflect difficulties in handling credit‖); id. at 315 (―[R]eliance on payday loans for an
extended period of time . . . may exacerbate rather than relieve financial problems some
consumers face.‖). See generally JX 49 at PL87-89, 90-92 (collecting empirical studies
supporting the proposition that consumers who borrow at high rates that are nevertheless
below what National charged on the Disputed Loan generally end up in a cycle of
increasing debt that culminates in default).

57
Reporter‘s Note, cmt a. Contracts of adhesion provide many benefits:

Standardization of agreements serves many of the same functions as
standardization of goods and services; both are essential to a system of
mass production and distribution. Scarce and costly time and skill can be
devoted to a class of transactions rather than to details of individual
transactions. Legal rules which would apply in the absence of agreement
can be shaped to fit the particular type of transaction, and extra copies of
the form can be used for purposes such as record-keeping, coordination and
supervision. . . . Operations are simplified and costs reduced, to the
advantage of all concerned.

Id. § 211, cmt. a.

But standardized agreements also carry a heightened risk of unfair terms:

Standardized agreements are commonly prepared by one party. The
customer assents to a few terms, typically inserted in blanks on the printed
form, and gives blanket assent to the type of transaction embodied in the
standard form. He is commonly not represented in the drafting, and the
draftsman may be tempted to overdraw in the interest of his employer.

Id., § 211, cmt. c. This dynamic creates an ―obvious danger of overreaching.‖ Id. ―The

weaker party, in need of the good or services, is frequently not in a position to shop

around for better terms, either because the author of the standard contract has a monopoly

(natural or artificial) or because all competitors use the same clauses.‖ 8 Williston on

Contracts § 18:13 (quoting Weaver v. Am. Oil Co., 276 N.E.2d 144, 147 (Ind. 1971)).

All else equal, the fact that an agreement is a contract of adhesion makes it

relatively more likely that the agreement will be found unconscionable. Like the other

Fritz factors, the fact that an agreement is a contract of adhesion is not sufficient,

standing alone, to render an agreement unconscionable.

The Loan Agreement is a contract of adhesion. It was form agreement, drafted by

National, and provided to James on a take-it-or-leave-it basis. James had no ability to

58
negotiate the terms of the Loan Agreement. Other than to rely on the truism that a

standard form agreement is not inherently unconscionable, National does not dispute this

factor. National‘s position is correct, but this factor nevertheless favors a finding of

unconscionability.

c. The Bargaining Environment

The final Fritz factor considers the ―[t]he circumstances surrounding the execution

of the contract.‖ 1990 WL 186448, at *4. One pertinent attribute is the commercial

setting. Id. Another is whether a party confronts ―an absence of meaningful choice.‖

Ketler v. PFPA, LLC, --- A.3d ---, 2016 WL 192599, at *2 (Del. Jan. 15, 2016) (quotation

marks omitted). A third is the ―purpose and actual effect‖ of the agreement. Fritz, 1990

WL 186448, at *4; see 6 Del. C. § 2-302(2) (instructing a court to consider ―the purpose

and effect‖ of the contract when evaluating unconscionability). For the Disputed Loan,

that necessarily takes into account its relationship to the Payday Loan Law.

i. The Commercial Setting

James obtained the Disputed Loan from a small, store-front office. She was given

the documents and told where to sign. Reilly‘s main role was to try to induce her to take

out twice the loan amount she wanted ($400 instead of $200). Those were not ideal

conditions, but they were not inherently oppressive. They are consistent with a

standardized financial transaction accomplished through a contract of adhesion.

A more problematic issue is that National‘s employees denigrate the importance of

the APR while describing the interest rate in simplistic ways that are designed to mislead

customers. For example, National takes the position that the APR ―has nothing to do with

59
the loan.‖ Tr. 335 (Carter). National‘s employees suggest to borrowers that that the APR

is ―irrelevant‖ unless the loan remains outstanding for an entire year. Tr. 337 (Carter). If a

customer only plans to keep the loan outstanding for a few weeks, then National‘s

employees discount the APR as ―meaning[less].‖ Tr. 337-38 (Carter).

Instead of focusing on the APR, National‘s employees describe the interest rate in

terms that make the cost of the loan seem much lower. At trial, for example, James‘

counsel and Vazquez had the following exchange:

Q: Typically, if someone comes in to borrow $100 at Loan Till Payday,
what is the interest rate that they pay?

A: 30 percent

Q: Your understanding is they pay 30 percent? Is that right?

A: It‘s a 30 percent block rate.

Tr. 246 (Vazquez). Vazquez did not know how a 30% block rate compared to an APR.

Tr. 254 (Vazquez).

These statements are highly problematic. By ―describ[ing] the loan cost in terms

of a misleading‖ bi-weekly rate, National understated the total cost of the Disputed

Loan.30 Because National framed the price as ―$30 on $100,‖ James thought she would

30
State v. B & B Inv. Gp., Inc., 329 P.3d 658, 667 (N.M. 2014); see Bar-Gill &
Warren, supra, at 44 (―The fee structure of payday loans makes it difficult for consumers
to compare directly the costs associated with a payday loan to the costs associated with
other consumer credit products.‖); Good While Supplies Last, supra, at 568 (―The
data . . . show that many consumers cannot easily compare the cost of this form of credit
to other forms of credit, and that many customers are unable to accurately describe how
much they will ultimately pay for the small sums they borrow.‖); see also id. at 599-600
(reporting on survey data indicating that many customers do not understand how interest-

60
pay $60 for the $200 when she actually agreed to pay $1,620 in finance charges. James

understood the simple block rate, but she did not understand the more complex financing

arrangement captured by the Loan Agreement.

ii. Lack Of Meaningful Choice

A more significant aspect of the circumstances surrounding the Loan Agreement

was James‘ lack of a meaningful choice. When affirming a finding that a contract of

adhesion for membership in a fitness club was not unconscionable, the Delaware

Supreme Court observed that ―[t]here is no deprivation of meaningful choice if a party

can walk away from the contract.‖ Ketler, --- A.3d ---, 2016 WL 192599, at *2.

Unlike the choice to spend discretionary income on a fitness contract, James

needed money for food and to pay her rent. She lived paycheck to paycheck, had no

savings to fall back on, and did not have access to alternative sources of credit. She had

reached a point where she was using high-interest, unsecured loans on a regular basis to

make ends meet. As a practical matter, James‘ precarious financial situation meant she

did not have meaningful options other than a high-interest loan like the Disputed Loan.

iii. The Purpose And Effect Of The Loan Agreement

Perhaps the most critical aspect of the bargaining environment was the purpose

only loans work, do not know the APR, and cannot predict the total dollar cost of their
loan); id. at 604 (reporting that customers could not describe fundamental loan terms or
explain how much the loan would cost if the borrower needed to kept it out for a month
or longer); id. at 606 (reporting on survey data indicating that many customers
erroneously believe that payday loans are less expensive than credit cards).

61
and effect of the Loan Agreement, which was to evade the Payday Loan Law. To

reiterate, a traditional payday loan was a short-term loan designed to be repaid in a single

balloon payment on the borrower‘s next payday, usually within two weeks or, if the

borrower was paid monthly, within one month. See Consumer Credit, supra, at 356 (―A

payday loan is a small, short-term, single-payment consumer loan.‖). Many borrowers,

however, did not repay their loans when the balloon payments were due. When that

happened, the payday loan company rolled the outstanding balance into a new payday

loan for the total amount of unpaid principal and interest, plus fees. The short-term loan

effectively became a longer term loan at the same high interest rate. Consumer advocates

regarded the rollover as ―[p]erhaps the most dangerous feature of the payday-loan

product.‖31

To address the interest-only rollover problem in Delaware, the General Assembly

adopted the Payday Loan Law. The synopsis of the bill stated:

This bill limits to five the number of short-term consumer loans (sometimes
called payday loans) that any one borrower may obtain in a twelve month
period. It changes the definition of short-term consumer loan to include
loans up to $1000 rather than $500. The bill also provides for establishment
of a database to track the number of short-term consumer loans an
individual has obtained in a twelve month period. Finally, the Banking
Commissioner is directed to provide a report on the prevalence and nature
of these payday loans to the General Assembly.

31
Bar-Gill & Warren, supra, at 55; accord Good While Supplies Last, supra, at
581 (―Consumer groups consider rollovers a particularly insidious problem because they
trap a consumer into potentially paying the interest on a loan indefinitely without ever
reducing the principal balance.‖).

62
Del. H.B. 289 syn., 146th Gen. Assem. (2012).

The centerpiece of the legislation was the cap on the number of payday loans that

any one consumer could obtain in a single twelve-month period, combined with a

provision that defined a rollover as a new loan. The pertinent statutory language stated:

Notwithstanding any other provision of law, no licensee shall make, and no
borrower shall receive, a short-term consumer loan that would cause the
borrower to have more than five (5) short-term consumer loans from all
licensees in any twelve-month period. For the purposes of this section a
rollover or a refinancing shall be considered a short-term consumer loan.
Any loan made or collected in violation of this paragraph is void, and the
licensee does not have the right to collect, receive, or retain any principal,
interest, fees or other charges. A violation of this section is a violation of
Chapter 25 of Title 6 of the Delaware Code.32

32
Chapter 25 of Title 6 of the Delaware Code identifies prohibited trade practices.
Section 2533 of that chapter identifies potential remedies, which include the following:

(a) A person likely to be damaged by a deceptive trade practice of another
may be granted an injunction against it under principles of equity and on
terms that the court considers reasonable. Proof of monetary damage, loss
of profits, or intent to deceive is not required. . . .

(b) The court in exceptional cases may award reasonable attorneys‘ fees to
the prevailing party. Costs or attorneys‘ fees may be assessed against a
defendant only if the court finds that defendant has willfully engaged in a
deceptive trade practice.

(c) The relief provided in this section is in addition to remedies otherwise
available against the same conduct under the common law or other statutes
of this State. If damages are awarded to the aggrieved party under the
common law or other statutes of this State, such damages awarded shall be
treble the amount of the actual damages proved.

....

(e) If a court of competent jurisdiction finds that any person has willfully
violated this subchapter, upon petition to the court by the Attorney General

63
5 Del. C. § 2235A(a)(1) (the ―Five Loan Limit‖; footnote added). The Five Loan Limit

sought to help borrowers avoid being trapped in longer-term, ultra-high interest loans by

capping the number of times that payday lenders could roll over payday loans.

Importantly, the Payday Loan Law only applied to short-term consumer loans,

which the statute defined as ―a loan of $1,000 or less made to an individual borrower that

charges interest and/or fees for which the stated repayment period is less than 60 days

and is not secured by title to a motor vehicle.‖ Id. § 2227(7). But the Payday Loan Law

also incorporated an anti-evasion provision, which stated:

A licensee or licensee‘s agent shall not engage in any device or subterfuge
intended to evade the requirements of this chapter through any method
including, but not limited to, mail, telephone, Internet or any electronic
means, including:

(1) Offering, making, or assisting a borrower to obtain a loan in
violation of [the Five Loan Limit], or brokering or acting as an agent
for a third party in such a transaction, regardless of whether
approval, acceptance or ratification is necessary to create a legal
obligation for the third party.

(2) Disguising a short-term consumer loan as a revolving line of credit
or making or assisting a borrower to obtain a revolving line of credit
for the purpose of avoiding the requirements of [the Five Loan
Limit].

Id. § 2235A(f) (the ―Anti-Evasion Provision‖).

in the original complaint or at any time following the court‘s finding of a
willful violation, the person shall forfeit and pay to the State a civil penalty
of not more than $10,000 for each violation.

6 Del. C. § 2533.

64
 The Payday Loan Law was enacted before McFeeters acquired National. Under its

prior owner, National responded to the Payday Loan Law by capping the number of times

a customer could rollover a payday loan. Loan Till Payday‘s website described

National‘s ―Quick Payday Loan‖ product as follows:

Term: One pay period (usually 2 weeks or 1 month)

Fee/Rate: $20 per $100 borrowed ($30 per $100 borrowed if you get paid
monthly)

Payment Type: Payment in full due on each pay date. Option to roll over
loan 4 times by paying the interest only. After the 4th rollover, payment in
full (principle [sic] + interest) is due

Due: On each Pay Date[.]

JX 9 at 6. By limiting the customer to four rollovers, National stayed under the Five Loan

Limit.

Once McFeeters acquired National, he caused National to stop making payday

loans and switch to installment loans. The new structure built the rollover problem into

the design of the loan.

In its initial manifestation, National‘s installment loan product was a seven-month

term loan called the Flex Pay Loan. Its economic substance mirrored a one-month payday

loan that was rolled over seven times (or a two-week payday loan that was rolled over

fourteen times). Loan Till Payday‘s website described the Flex Pay Loan product as

follows:

Term: 7 Months

Fee/Rate: $20 per $100 borrowed ($30 per $100 borrowed if you get paid
monthly)

65
 Payment Type: Interest Only, Principle [sic] due at end of loan (Balloon
Payment). You can pay more than interest and lower your principle [sic]
balance at any time.

Due: On each Pay Date[.]

Id.; see Tr. 272-73 (Vazquez). Because it was designed to be outstanding for seven

months, the Flex Pay Loan fell outside the coverage of the Payday Loan Law.

From an economic standpoint, however, the Flex Pay Loan product and the Quick

Payday Loan product were functionally equivalent.33 The Quick Payday Loan product

ostensibly contemplated full repayment in one period but could be extended longer with

interest-only payments leading to a final balloon payment. The Flex Pay Loan product

ostensibly contemplated a series of interest-only payments followed by a final balloon

payment, but the customer could pay it off earlier.34

National later developed the Flex Loan product that it sold to James. The main

difference was that the Flex Loan product contemplated twelve months of bi-weekly,

interest-only payments before the final balloon payment.

33
See Durkin & Elliehausen, supra, at 13 (comparing an installment loan to a
single period loan with a finance charge that costs a fixed amount to renew and observing
that the resulting APRs are ―quite close‖ because ―both are, in effect, installment loans‖).
34
The reciprocal nature of the Quick Payday Loan and the Flex Pay Loan is an
example of put-call parity, which in turn demonstrates their functional equivalence. A
call option gives its holder the right buy property at a contractually-determined strike
price; a put option is its mirror image, giving its holder the right to sell property at the
strike price. See Stewart C. Myers & Richard A. Brealey, Principles of Corporate
Finance 566 (7th ed. 2003). Call and put options with the same terms provide identical
payoffs, no matter the value of the underlying property. Id. at 572. This means call and
put options are functionally equivalent and that a call option can be reframed as a mirror
image put option to obtain the same financial result.

66
 Put simply, National designed its installment loan products to evade the Five Loan

Limit. From National‘s standpoint, the shift was actually beneficial, because the new

products built the concept of interest-only rollovers into the loans themselves.

The Anti-Evasion Provision recognized the risk that a lender might disguise ―a

short-term consumer loan as a revolving line of credit.‖ 5 Del. C. § 2235A(f)(2). National

took the opposite approach. It disguised a short-term consumer loan as an interest-only,

non-amortizing installment loan. National‘s shift to interest-only installment loans as a

means of evading the Five Loan Limit followed a strategy employed by payday lenders in

other jurisdictions.35

35
See State v. B & B King Inv. Gp., Inc., 329 P.3d 658, 663, 673-74 (N.M. 2014)
(noting that in response to legislation in New Mexico and Illinois that limited short
duration loans, providers restructured their products as installment loans; holding that
under New Mexico law, restructured installment loan was unconscionable because,
among other reasons, it was ―specifically designed to make an end run around the
consumer protections of the Small Loan Act‖); JX 44 at 5 (opining that in response to
laws limiting short duration loans, ―[a] typical lender work-around is to offer only longer
loans to which the legislation does not apply. This change in practice has led to high cost
‗installment loans.‘‖); Good While Supplies Last, supra, at 579 (same); Interest Rate
Caps, supra, at 119 (explaining that payday lenders in New Mexico responded to a state
law regulating short-term loans by creating an ―installment loan‖ that required repayment
in ―twenty-six bi-weekly installments‖ with an APR of 1,147%); Robert Mayer, One
Payday, Many Payday Loans: Short-Term Lending Abuse in Milwaukee County
(Working Paper, Aug. 6, 2009) (noting that payday lenders in Illinois responded to a state
law regulating cash advances of 30-days or less by creating a 31-day cash advance);
Public Opinion, supra, at 268 (explaining that ―[l]enders making installment loans can
avoid state payday loan laws by making loans with [longer] durations‖); see also Paul
Kiel, How Payday Lenders Escape State Crackdowns, Mother Jones, Aug. 7, 2013
(explaining that payday lenders respond to legislation by modifying their products, noting
that ―[t]he most popular alternative to payday loans are ‗longer term, but still very high-
cost installment loans,‘‖ and citing Delaware‘s Payday Loan Law as an example of
legislation that can be circumvented using alternative products such as ―a seven-month

67
 3. Balancing The Factors

All of the Fritz factors point in favor of a finding of unconscionability, albeit to

varying degrees. The most telling factors include (i) the economic terms of the Disputed

Loan, which support a prima facie case of substantive unconscionability, (ii) the purpose

and effect of the installment loan structure in circumventing the Payday Loan Law and

the Five Loan Limit, and (iii) the exploitation of an underprivileged, undereducated, and

financially vulnerable person. Secondary factors include (a) the use of a contract of

adhesion, (b) the overall imbalance of rights and obligations, and (c) National‘s practices

when describing the block rate finance charge versus the APR, which present a

misleading picture of the cost of credit.

On balance, the Loan Agreement is unconscionable. No one would borrow

rationally on the terms it contemplated unless that person was delusional, mistaken about

its terms or a material fact, or under economic duress.

4. The Remedy For The Unconscionable Agreement

Because the Loan Agreement is unconscionable, it is voidable. The proper remedy

is to declare it invalid. See Restatement (Second) of Contracts § 208, cmt. g.

Declaring the Loan Agreement invalid is likewise appropriate because National

sought to use an interest-only, non-amortizing, installment loan to evade the Payday Loan

Law. ―Equity always attempts to . . . ascertain, uphold, and enforce rights and duties

installment loan‖), available at http://www.motherjones.com/politics/2013/08/payday-
lending-state-laws.

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which spring from the real relations of parties.‖ 2 John Norton Pomeroy, Equity

Jurisprudence § 378, at 41 (Spencer W. Symons ed., 5th ed. 1941). ―[E]quity regards

substance rather than form.‖ Monroe Park v. Metro. Life Ins. Co., 457 A.2d 734, 737

(Del. 1983). Equity also ―regards that as done which in good conscience ought to be

done.‖ Id. In substance, the Disputed Loan was a payday loan designed to roll over

twenty-six times, which contravened the Five Loan Limit.

National loaned James $200. James has repaid National $197. As a consequence

of rescinding the Loan Agreement, James owes National another $3. James may satisfy

this obligation by setting it off against amounts that this decision orders National to pay.

James also asked for a permanent injunction barring National from collecting on

similar loans it made to other customers. That relief is too broad to be granted in the

current case and would embroil this court in on-going oversight of National‘s business.

C. The Truth In Lending Act

James separately provided at trial that National violated TILA. Originally enacted

in 1968, TILA‘s stated goal is 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, and to protect the consumer against

inaccurate and unfair credit billing and credit card practices.‖ 15 U.S.C. § 1601(a). The

Board of Governors of the Federal Reserve System implemented this disclosure-based

regime through Regulation Z, which requires lenders to calculate and disclose interest

rates according to a prescribed formula. See 12 C.F.R. part 226 (2011). Consumers have

standing to enforce the Federal Reserve‘s rules through private litigation. See 26 Causes

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of Action 2d § 409 (2004).

TILA applies to closed-end consumer credit transactions like the Disputed Loan.36

A lender violates TILA if it discloses an APR on a consumer loan that is ―more than 1/8

of 1 percentage point above or below‖ the APR determined in accordance with certain

actuarial methods. 12 C.F.R. § 226.22(a)(2). There is a statutory defense for inadvertent

mistakes made in good faith:

A creditor or assignee may not be held liable in any action brought under
this section or section 1635 of this title for a violation of this subchapter if
the creditor or assignee shows by a preponderance of evidence that the
violation was not intentional and resulted from a bona fide error
notwithstanding the maintenance of procedures reasonably adapted to avoid
any such error. Examples of a bona fide error include, but are not limited
to, clerical, calculation, computer malfunction and programming, and
printing errors, except that an error of legal judgment with respect to a
person‘s obligations under this subchapter is not a bona fide error.

15 U.S.C. § 1640(c) (the ―Bona Fide Error Defense‖). For purposes of APR calculation

errors, the Federal Reserve has issued a regulation providing that a creditor can establish

a Bona Fide Error Defense by proving that ―(1) [t]he error resulted from a corresponding

error in a calculation tool used in good faith by the creditor; and (2) upon discovery of the

error, the creditor promptly discontinue[d] use of that calculation tool for disclosure

purposes and notifie[d] the [Federal Reserve] in writing of the error in the calculation

tool.‖ 12 C.F.R. § 226.22(a)(1) n.45d. This decision applies the regulatory test for the

36
15 U.S.C. § 1638; see In re Ferrell, 358 B.R. 777, at *783 (B.A.P. 9th Cir.
2006) (―TILA applies to payday loans . . . .‖), aff’d, 539 F.3d 1186 (9th Cir. 2008); Open-
End Credit, 65 Fed. Reg. 17,129 (Mar. 31, 2000) (final rule issued by the Federal Reserve
clarifying that Regulation Z applies to payday loans).

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Bona Fide Error Defense because it speaks specifically to an APR calculation error. Cf.

Ford Motor Credit Co. v. Milhollin, 444 U.S. 555, 557 (1980) (stating that courts should

give ―a high degree of deference‖ to the Federal Reserve‘s interpretation of TILA).

As a sanction for National‘s discovery misconduct, this court previously

determined that the ―APRs for the loans disclosed on the Updated Spreadsheet fell

outside the acceptable range set forth in TILA.‖ James v. Nat’l Fin. LLC, 2014 WL

6845560, at *13 (Del. Ch. Dec. 5, 2014). The Disputed Loan was one of the loans on the

spreadsheet. The operative question is whether National established a Bona Fide Error

Defense.

National failed to prove its Bona Fide Error Defense. Although National claims to

have relied on computer software to calculate the APR, the Delaware Bank

Commissioner told National on multiple occasions that it had concerns about National‘s

APR calculations. National did not promptly discontinue its use of its computer software

and did not provide notice in writing to the Federal Reserve. National only discontinued

its use of the software in 2014, a year after making the Disputed Loan.

TILA contemplates an award of actual damages if the plaintiff proves that she

relied on the incorrect APR. See, e.g., Turner v. Beneficial Corp., 242 F.3d 1023, 1026-

28 (11th Cir. 2001) (collecting cases and analyzing TILA‘s history). James did not rely

on the incorrect figure, so she cannot recover actual damages.

TILA also contemplates statutory damages. 15 U.S.C. § 1640(a)(2). In the event of

a violation, a court should award ―in the case of an individual action twice the amount of

any finance charge in connection with the transaction.‖ Id. § 1640(a)(2)(A)(i). The

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finance charge ―is the cost of consumer credit as a dollar amount‖ and includes interest,

transaction charges, fees, and any other charges other than repayment of principal. 12

C.F.R. § 226.4(a)-(b).

The finance charge for the Disputed Loan was $1,620. Twice this amount is

$3,240. Offsetting the $3 that James still owes National results in a judgment for James in

the amount of $3,237.

TILA directs the court to award reasonable attorneys‘ fees and costs ―in the case

of any successful action to enforce‖ liability under § 1640(a)(2)(A)(i). 15 U.S.C. §

1640(a)(3). James is entitled to a fee award.

III. CONCLUSION

The Disputed Loan is invalid. Judgment is entered in favor of James in the amount

of $3,237. Pre- and post-judgment interest on this amount will accrue at the legal rate,

compounded quarterly, beginning on May 7, 2013. James is awarded her attorneys‘ fees

and costs. Counsel shall submit a Rule 88 affidavit. If the parties can agree on an amount,

then they shall submit a form of final order and judgment that is agreed as to form.

Otherwise they shall propose a schedule for a fee application.

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