In response to customer demand, retailers are offering new payment options for their products beyond simple cash and card transactions. One of these options surging in popularity is an arrangement that allows customers to split their purchases into several smaller – often four –payments. These programs appeal to retailers because they can offer their customers more flexible payment options while receiving full payment upfront. Customers also appreciate the flexibility to take home their purchases before making payment in full. While these arrangements may appear new, they are a variant of what is often referred to as a retail installment sales contract (RISC).
The Different Types of RISC-y Businesses
Today's RISCs come in different forms and are backed by well-funded technology companies. For example, two RISC providers, AfterPay and Quadpay, allow eligible customers to pay for purchases in four, two-week installments through a linked debit or credit card. While these companies do not charge interest, customers who fail to make timely payments will incur late fees.
Other companies, such as Affirm and Klarna, offer more traditional credit arrangements through partnerships with regulated entities, such as banks. These programs also offer more variable payment schedules and terms, with payment schedules from as short as a few months to several years, and with interest rate terms ranging from 0% to 30%. The fees for late payments are governed by the terms of the loan.
These programs also vary in how the retailer relationship with the customer is structured. With AfterPay, the retailer enters into a RISC with the customer which the retailer then assigns to AfterPay. In other arrangements, the RISC is entered into between a customer and a financial institution or directly between a customer and a RISC provider. But even these models differ in their specifics. For example, one provider allows for the creation of a "virtual card" that can be used at any retailer that accepts Visa. Another requires a link to an existing credit card and makes a reservation for the purchase amount on the customer's line of credit before collecting a monthly, interest-free installment.
Generally, today's RISCs are designed to avoid application of certain federal and state laws. For example, the federal Truth in Lending Act's Regulation Z applies only to consumer credit "that is subject to a finance charge or is payable by a written agreement in more than four installments." Many state laws also exclude contracts that do not charge interest or finance charges, or require four or fewer payments. California's Retail Installment Sales Act (referred to as the "Unruh Act"), for example, governs certain RISCs that provide for payment in more than four installments, contain a finance charge, or where the goods or services are available at a lesser price if paid for by either cash or credit card. Both federal and state RISC laws regulate disclosure and substantive requirements.
Even if a RISC falls outside the scope of federal or state-specific RISC laws, these types of payment programs still must comply with anti-discrimination lending laws, such as those implemented by Regulation B, and other consumer protection regulations that prohibit unfair, deceptive, and abusive acts and practices (UDAAP).
Part of the appeal to retailers of RISCs is that customers can make larger purchases seemingly at no or little additional cost. And the data show that customers who pay using RISCs tend to spend more than they would using other forms of payment. Despite the potential for increased sales, retailers should understand that even though customers may be offered interest free terms, they can incur fees and charges and harm their credit scores if they miss or are late on payments. Under one popular model, a customer is assessed late fees that can eventually reach up to 25% of the purchase price. Another model claims never to impose late fees or interest payments, but will report charge offs to credit bureaus and can make referrals to collection agencies.
Things to Consider Before Taking on RISCs
Retailers should consider the extent to which payment installment options are beneficial to their long-term business model. Even though a retailer does not assess the fees associated with RISCs, it may nonetheless face reputational harm, as customers may not distinguish between the retailer and the RISC provider, as well as diminished purchasing power from such customers if their access to credit becomes impaired. This latter result, in particular, has the potential to attract the attention of regulators and consumer groups. Additionally, the ability to link to a merchant's website from a RISC provider (and vice versa) may contribute to customer confusion regarding the relationship between a merchant and a RISC provider.
The federal Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC) both have authority to investigate complaints and bring actions against persons engaged in unfair or deceptive sales practices. States with strong consumer protection laws also may consider enforcement in this space, and may even revisit their own RISC laws, many of which have not been updated in decades. While RISC providers operating today have largely avoided scrutiny, they should be prepared for regulatory questioning of their services and practices.
Retailers also should understand the nature of their relationship with their customers. As explained above, at least one RISC arrangement has the retailer entering into a RISC directly with the customer and then assigning it to a third party. In this case, the retailer should assure itself of its legal authority to enter into such a contract with a customer, as well as its continued compliance with any applicable regulatory requirements (such as Regulation B) in each jurisdiction in which it offers the payment service. Retailers also should assess the legal and regulatory requirements of assigning the contract to third parties.
In other scenarios, the RISC is entered into between a customer and a financial institution or directly between a customer and a RISC provider. Due to the varied structures and methods used by RISC providers, these arrangements and the regulatory hurdles they may entail also warrant close attention.
Finally, companies offering RISCs typically insist on being an exclusive extended payments provider and may enter into a joint marketing program with the retailer. Accordingly, retailers should evaluate their legal and reputational liabilities from any joint marketing efforts, as well as the customary profiling of retailers on the RISC provider's website. Retailers should consider the appropriate level of diligence needed to assure themselves that any co-branded marketing materials comply with applicable federal and state laws.
Retailers exploring adding RISCs to their list of possible payment methods should carefully consider the legal and reputational risks of engaging in what is still a nascent and less regulated part of the financial services industry.