Glaire v. La Lanne-Paris Health Spa, Inc.

Our only concern in this case is whether plaintiff has succeeded in stating a cause of action. In assessing the sufficiency of a com-, plaint against a general demurrer, we must treat the demurrer as admitting all material facts properly pleaded. (Scott v. City of Indian Wells (1972) 6 Cal.3d 541 , 549 [ 99 Cal.Rptr. 745 , 492 P.2d 1137 ]; Daar v. Yellow Cab Co. (1967) 67 Cal.2d 695 , 713 [ 63 Cal.Rptr. 724 , 433 P.2d 732 ].) Furthermore, we bear in mind our well established policy of liberality in reviewing a demurrer sustained without leave to amend; “the allegations of the complaint must be liberally construed with a view to attaining substantial justice among the parties.” (Youngman v. Nevada Irrigation Dist. (1969) 70 Cal.2d 240 , 244-245 [ 74 Cal.Rptr. 398 , 449 P.2d 462 ]; see also Scott v. City of Indian Wells (1972) supra; MacLeod v. Tribune Publishing Co. (1959) 52 Cal.2d 536 , 542 [ 343 P.2d 36 ]; Lemoge Electric v. County of San Mateo (1956) 46 Cal.2d 659 , 664 [ 297 P.2d 638 ]; Matteson v. Wagoner (1905) 147 Cal. 739 , 742 [ 82 P. 436 ]; Code Civ. Proc., § 452.)

From the complaint the following facts emerge. Plaintiff, whose posture typifies that of her class, purchased a seven-year membership in a health club owned and operated by La Lanne. The price of the membership was $408, regardless of whether the sum was paid in cash at the outset or paid over a two-year period in monthly installments of $17 each. Plaintiff elected to pay over time, as do most of La Lanne’s customers, and accordingly entered into a standard form contract which declared that no “service charge” was made for the extension of credit and provided that any default in installment payments would render the entire balance due. As a matter of course in its business practice, La Lanne thereupon sold plaintiff’s contract to Universal at a discount of 37.5 percent. La Lanne thus immediately received $255 in cash and plaintiff became obligated to Universal for the full $408 payable over two years. La Lanne and Universal are interlocking corporations with common ownership and control, and Universal regularly assists La Lanne in its financing by accepting chattel paper at a discount.

In order to encourage the informed use of credit, Truth-in-Lending requires merchants who regularly extend credit to disclose to each consumer certain information relevant to the cost of deferring payment. (15. U.S.C. §§ 1602, 1631.) Among other facts, a merchant must, prior to consummating a sale, conspicuously indicate the cash price, the total amount deferred, the finance and other charges, and the annual percentage rate of interest. ( 15 U.S.C. § 1638 .) Failure to so disclose may result in civil liability to the consumer for a penalty of twice the amount of the finance charge, though not less than $100 nor more than $1,000, and for the costs of the litigation including reasonable attorney’s fees. ( 15 U.S.C. § 1640 .)

The terms of Truth-in-Lending are necessarily broad. In debating its coverage, Congress fully recognized that “[w]hatever legislation was passed had to deal not only with the myriad forms in which credit transactions then occurred, but also with those which would be devised in the future.” (Mourning v. Family Publications Service, Inc. (1973) supra, 411 U.S. 356 , 365 [ 36 L.Ed.2d 318 , 327].) Accordingly, in order to compel the meaningful disclosure of credit information in the extensive variety. of consumer transactions and to discourage deceptive practices designed to circumvent the purposes of Truth-in-Lending, Congress delegated wide authority to the Federal Reserve Board to interpret the act’s provisions and to promulgate such regulations as may be deemed necessary to preserve the act’s effectiveness. ( 15 U.S.C. § 1604 .)

In her complaint, plaintiff alleged that regardless of whether a finance charge was in fact imposed, La Lanne failed to make certain disclosures required under the Four Installment Rule. Although the rule plainly applies to the transaction at hand, the trial court sustained defendant’s demurrer to the cause on the basis of a decision by the United States Court of Appeals which held the Four Installment Rule to be an unconstitutional conclusive presumption of a finance charge in violation of due process and to be a regulation in excess of the Federal Reserve Board’s delegated authority. (Mourning v. Family Publications Service, Inc. (5th Cir. 1971) 449 F.2d 235 .) Since that time, however, the United States Supreme Court has reversed the circuit court decision in Mourning and has affirmed the validity of the Four Installment Rule. (Mourning v. Family Publications Service, Inc. (1973) supra, 411 U.S. 356 .) As a result, the trial court’s ruling on this point cannot stand: plaintiff has raised a justiciable question of fact as to whether La Lanne satisfactorily complied with the disclosure responsibilities triggered by the Four Installment Rule.

The Four Installment Rule “was intended as a prophylactic measure; it does not presume that all creditors who are within its ambit assess finance charges, but, rather, imposes a disclosure requirement on all members of a defined class in order to discourage evasion by a substantial portion of that class.” (Mourning v. Family Publications Service, Inc. (1973) supra, 411 U.S. 356 , 377 [ 36 L.Ed.2d 318 , 334].) In addition to relying on the Four Installment Rule, however, plaintiff also contended in her complaint that defendants’ cooperative method of financing consumer contracts was designed to conceal the imposition of actual finance charges which are properly 'subject to disclosure under Truth-in-Lending.

Truth-in-Lending requires disclosures by only those merchants who satisfy the statutory meaning of the term “creditor.” ( 15 U.S.C. § 1631 (a).) That term is defined in the act to include “creditors who regularly extend, or arrange for the extension of, credit for which the payment of a finance charge is required, whether in connection with loans, sales

Except to the extent required under the Four Installment Rule, neither extenders nor arrangers of credit are compelled to make disclosures under Truth-in-Lending unless the payment of a finance charge is exacted. (15 U.S.C.. § 1602 (f).) The term “finance charge” is defined in the act as “the sum of all charges, payable directly or indirectly by the person to whom the credit is extended, and imposed directly or indirectly by the creditor as an incident to the extension of credit, including . . . (1) Interest, time price differential, and any amount payable under a point, discount, or other system of additional charges . . . .” ( 15 U.S.C. § 1605 (a).) The regulations repeat the statutory definition, but add that a finance charge is to be considered such “whether paid or payable by the customer, the seller, or any other person on behalf of the customer to the creditor or to a third party ....” ( 12 C.F.R. § 226.4 (a).)

Plaintiff’s theory is that because of the continuing business relationship and interlocking ownership of La Lanne and Universal and because of La Lanne’s customary practice of systematically discounting its chattel paper to Universal, La Lanne qualifies as an arranger of credit under Truth-in-Lending and Universal in fact extends the credit. According to plaintiff, La Lanne’s practice of offering to its customers unitary price contracts, i.e., contracts in which the price payable in cash at the outset would equal the sum to be paid in installments over time, is merely a device to conceal the actual cost of credit to the consumer, which corresponds to the amount of the discount La. Lanne regularly allows to Universal. Thus, when La Lanne charges $408 to be paid in installments, it in fact receives only $255 for its services, with Universal ultimately recouping the $255 which it paid at once to La Lanne for the contract and gaining an additional $153 in return for the risk of permitting the consumer to pay over time. It is this differential of $153 between the amount La Lanne receives

Three recent federal court decisions have upheld contentions virtually identical to those advanced by plaintiff in circumstances remarkably similar to the case at bar. (Kriger v. European Health Spa, Inc., of Milwaukee, Wis. (E.D.Wis. 1973) 363 F.Supp. 334 ; Garza v. Chicago Health Clubs, Inc. (N.D.Ill. 1972) 347 F.Supp. 955 ; Joseph v. Norman’s Health Club, Inc. (E.D.Mo. 1971) 336 F.Supp. 307 .) In each case the plaintiff and others similarly situated entered into a contract to pay a net sum in installments in return for the right to use certain health club facilities. As in the case before us, the contracts were promptly sold to finance companies at a standard and substantial discount.

In two of the cases, Joseph and Garza, the court refused to grant defense motions for summary judgment on a theory either that third-party finance companies have no disclosure responsibilities under Truth-in-Lending or that unitary price contracts contain no finance charge as a matter of law. In Garza, the court acknowledged that the theory of recovery relied upon by plaintiff in the present case constitutes a proper cause of action: “assignees of consumer retail installment contracts who regularly extend or arrange for the extension of credit to consumers through the assignors of such contracts may themselves be ‘creditors’ within the meaning of, and subject to liability under, Truth in Lending. To put it another way, lenders may not escape TIL status as creditors by using sales companies as ‘front men.’ ” (347 F.Supp. at p. 964; see also Joseph v. Norman’s Health Club, Inc. (E.D.Mo. 1971) supra, 336 F.Supp. 307 , 318.) In Joseph, the court emphasized that whether the systematic practice of discounting chattel paper operated as a subterfuge to impermissibly conceal a finance charge in violation of Truth-in-Lending was a question of fact for determination at trial: “since plaintiffs have alleged that a finance charge was in fact included in the face amount of the notes, and defendants contend that no finance charge was imposed, a material fact is in dispute and summary judgment is inappropriate.” (336 F.Supp. at p. 318.)

In Kriger, with Joseph and Garza before it, the court went even further. The facts in that case closely parallel those at bar: there a health spa offered to its customers unitary price contracts which it customarily tendered to one bank at a fixed discount; the contracts disclosed no finance charge and no rebate was provided in the event of acceleration or voluntary prepayment. In measuring the scheme against the yardstick of Truth-in-Lending, the court found that the health spa was acting merely as a

In reaching its conclusion, the court in Kriger agreed with Garza that finance companies cannot avoid Truth-in-Lending responsibilities for transactions in which they regularly participate merely by remaining behind the scenes and accepting consumer contracts only after the initial sales have been consummated (363 F.Supp. at p. 336.) The court also agreed with Joseph that the systematic discounting of unitary price contracts may operate to conceal an actual charge for credit in the amount of the discount (id. at pp. 336-337), and in so holding cited the earlier decision of Strompolos v. Premium Readers Service (N.D.Ill. 1971) 326 F.Supp. 1100 , 1103, which considered the problem of buried finance charges: “Merely because a so-called ‘cash’ price is the same as for a thirty installment repayment plan does not indicate that the ‘cash’ price does not include substantial financing charges in a very real sense . . . . [¶] Neither the law, the Federal Reserve Board nor the courts are so simplistic as to believe that a person in the business of extending long term credit should be permitted to abolish the Truth in Lending Act by merely charging a single ‘cash or credit’ price knowing full well that the great bulk of its customers will never pay in less than, for example, thirty months.”

We find persuasive the logic and analysis of these federal decisions. According to the complaint, Universal accepts the vast majority of La Lanne’s installment contracts at a fixed discount contemporaneously with their execution. Universal’s practice of accepting such contracts is functionally equivalent to extending loans directly to La Lanne’s customers at a defined rate of interest: in either case, La Laniie receives a net cash sum and the customer becomes obligated to Universal for a greater amount which includes a charge for the credit risk assumed by Universal. Nevertheless, by employing this method of systematic discounting Universal purports to evade all liability under Truth-in-Lending, whereas a direct loan would be clearly covered under the act.

We have held in closely analogous consumer contexts that a finance company cannot shed the duties and responsibilities of a lender by accepting the assignment of contracts from a seller with which it is intimately connected. (Vasquez v. Superior Court (1971) 4 Cal.3d 800 , 822 [ 94 Cal.Rptr. 796 , 484 P.2d 964 , 53 A.L.R.3d 513 ]; Morgan v. Reasor Corp.

In so holding, we do not, as Universal protests, extend the coverage of the act to commercial credit, which is explicitly exempted from Truth-in-Lending. ( 15 U.S.C. § 1603 ; 12 C.F.R. § 226.3 (a).) Our concern is not the sale of contracts between two commercial entities, La Lanne and Universal, but the fact that such a method of operation may serve to channel credit directly from Universal to the consumer with La Lanne acting merely as a conduit. Furthermore, we cannot accept Universal’s contention that assignees of installment contracts should not be considered as creditors under Truth-in-Lending because the customers do not become obligated to them until the contracts are signed, i.e., subsequent to the time when disclosures are required. Under such a theory, considered and rejected in Kriger and Garza, “no one could be held to account as a ‘creditor’ within the meaning of the act because there would be no creditor until after the debtor signed his contract.” (Garza y. Chicago Health Clubs, Inc. (N.D.Ill. 1972) supra, 347 F.Supp. 955 , 964.)

The Four Installment Rule, by excusing the disclosure of a finance charge, recognizes that in many transactions involving consumer credit we cannot force the lender to break out the price of deferring payment, either because it is too cleverly disguised or because none in fact exists. (See Mourning v. Family Publications Service, Inc. (1973) supra, 411 U.S. 356 , 377, fn. 42 [ 36 L.Ed.2d 318 , 334].) For example, when a merchant offers his customers unitary price contracts for the purchase of goods which he holds and collects upon himself, we cannot estimate with any degree of certainty what portion of the contract price constitutes a charge for the extension of credit. However, should the merchant regularly and systematically discount the contracts at a fixed rate to a third party, we may fairly say that the amount of the discount represents

Defendants suggest that plaintiff is in fact attacking their pricing decision not to allow their customers the opportunity to pay a lower cash price equal to the discounted value of the installment contracts, and that such pricing policy is not monitored by Truth-in-Lending. Again, the argument misses its mark. The thrust of plaintiff’s complaint is not directed at coercing La Lanne into adopting a particular pricing structure, but rather at exposing a method of financing which operates to conceal the actual cost of credit to the consumer. (See Kriger v. European Health Spa, Inc., of Milwaukee, Wis. (E.D.Wis. 1973) supra, 363 F.Supp. 334 , 337.) Similarly, it is unnecessary for plaintiff to allege that La Lanne charged a cash price lower than the credit price in order to establish the existence of a finance charge subject to disclosure. As we have seen, unitary price contracts may contain a real and substantial charge for the right to defer payment. (See id. at pp. 336-337; Joseph v. Norman’s Health Club, Inc. (E.D.Mo. 1971) supra, 336 F.Supp. 307 , 317-318; Strompolos v. Premium Readers Service (N.D.Ill. 1971) supra, 326 F.Supp. 1100 , 1103.)

It follows from the foregoing analysis that plaintiff has succeeded in stating a cause of action against both La Lanne and Universal under the Four Installment Rule and more generally under Truth-in-Lending. Accordingly, the trial court erred in sustaining defendants’ demurrer to the cause.

In her complaint, plaintiff also alleged that the customary discounting of contracts from La Lanne to Universal concealed a hidden interest charge to the consumer which exceeded the usury limitation of the California Constitution. (Art. XX, § 22.) The trial court, however, concluded as a matter of law that the practice did not involve interest and therefore could not have been usurious.

The concept of a finance charge, as set forth in Truth-in-Lending, is clearly a legislative creation: it derives its full content and substance from the 'statutory framework in which the term was developed. Nonetheless,

Defendants urge that the practice of transferring notes at a discount cannot amount to usury regardless of the margin of profit anticipated by the buyer. In so contending, defendants rely on Milana v. Credit Discount Co. (1945) 27 Cal.2d 335 , 340 [ 163 P.2d 869 , 165 A.L.R. 621 ], in which we stated that “[c]ontractors are free to buy and sell their property, and this may include promissory notes and other instruments, at a price agreed upon, and when the bona fides of the parties is established the percentage of profit has no relation to the usury law.” (See also Moe v. Tranis america Title Ins. Co. (1971) 21 Cal.App.3d 289 , 300 [ 98 Cal.Rptr. 547 ].) (4) But as we proceeded to observe in Milana, the good faith of the parties is crucial to the insulation of discount transactions from usury consideration, and good faith is ultimately a question of fact: “lenders, intent on collecting compensation for the use of money in excess of the lawful rate, seek to avoid transacting their business in the form of loans. The courts have been alert to pierce the veil of any plan designed to evade the usury law and in doing so to disregard the form and consider the substance. [Citations.] . . . ‘No case is to be judged by what the parties appear to be or represent themselves to be doing, but by the transaction as disclosed by the whole evidence, and if from that it is in substance a receiving or contracting for the receiving of usurious interest for a loan or forbearance of money, the parties are subject to the statutory consequences, no matter what device they may have employed to conceal the true character of their dealings.’ All of the negotiations, circumstances and conduct of the parties surrounding and connected with their contracts may be material in determining whether the form thereof covered an intent to violate the usury law . . . .” (Id. at pp. 340-341; see also Forte v. Nolfi (1972) 25 Cal.App.3d 656 , 678 [ 102 Cal.Rptr. 455 ]; Mission Hills Dev. Corp. v. Western Small Business Inv. Co. (1968) 260 Cal.App.2d 923 , 926 [ 67 Cal.Rptr. 505 ].)

By sustaining the demurrer, the trial court precluded plaintiff from offering evidence to establish that defendants’ practice of discounting notes in fact operated to conceal the imposition of usurious interest charges, and in so doing the court clearly erred. As we have often noted, substance not form must dictate the treatment that a transaction is to be accorded under the usury law, and the question of substance is predominantly a factual inquiry.

The judgment is reversed.

Wright, C. J., McComb, J., Tobriner, J., Sullivan, J., Clark, J., and Burke, J.,* concurred.

On December 26, 1974, the opinion was modified to read as printed above.