The so-called Holder Rule is an important weapon that debtors can use when the originator of consumer paper has not lived up to its contractual obligations.

In a chapter 13 case before Bankruptcy Judge Robert Jones of Lubbock, Texas, the debtors had traded in their old car to buy a new one. The auto dealer gave the couple a credit of $2,100 toward the purchase price of the new car and undertook a contractual obligation to pay off a $3,900 lien on the old car. Immediately after the transaction, the dealer transferred the lien on the new car to a finance company.

You guessed it. The dealer went bust and didn’t pay off the lien on the old car. The lender on the old car filed a claim in the couple’s chapter 13 case. The debtors objected to the allowance of the claim filed by the holder of the lien on the new car.

As Judge Jones explained in his October 7 opinion, the debtors’ salvation was the Holder Rule, adopted by the Federal Trade Commission in 1975. In a consumer credit contract, the rule requires language saying that “any holder of this consumer credit contract is subject to all claims and defenses which the debtor could assert against the seller . . . . Recovery hereunder by the debtor shall not exceed amounts paid by the debtor hereunder.” 16 C.F.R. § 433.2(a).

Although the debtors had a claim against the bankrupt dealer, Judge Jones said “they may also, under the Holder Rule, hold [the holder of the lien on the new car] liable for actual damages caused by [the bankrupt dealer’s] failure.”

Under the Holder Rule, Judge Jones said that the Fifth Circuit has allowed a consumer debtor to offset a claim against a claim held by the holder of the paper. Green v. Levis Motors, Inc., 179 F.3d 286, 296 (5th Cir. 1999).

Judge Jones sustained the debtor’s objection by allowing the debtors to offset the amount of the lien on the old car, $3,900, plus interest charges, against the claim of the holder of the lien on the new car.