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Court of Appeal, Fifth District, California.

Loyd S. DRENNAN, etc., Plaintiff and Appellant, v. SECURITY PACIFIC NATIONAL BANK, etc., Defendant and Respondent.

Civ. 4092.

Decided: February 29, 1980

Young, Wooldridge, Paulden & Self and David R. Griffin, Bakersfield, for plaintiff and appellant. Sheppard, Mullin, Richter & Hampton, Pierce T. Selwood and Roy G. Wuchitech, Los Angeles, for defendant and respondent.



This appeal is from a judgment of dismissal following the trial court's sustaining of respondent's demurrer without leave to amend. The issue presented is whether appellant may obtain relief, under the law of adhesion contracts, from enforcement of a prepayment clause in a standardized conditional sales contract. The clause in question sets forth the method for computing how much unearned finance charge will be refunded by simply referring to the “rule of 78's” without explaining how this method operates.1

Appellant filed a complaint, on behalf of himself and others similarly situated, seeking damages and declaratory relief in connection with a conditional sales contract for the purchase of a mobile home. Appellant alleged he purchased a mobile home in June 1974 and financed his purchase pursuant to the terms of respondent's standardized contract.2 The complaint alleged the contract is an adhesion contract and that the prepayment clause therein is “vague, ambiguous and uncertain” because it fails to explain the rule of 78's and does not clearly advise the buyer that he will be penalized in the event of prepayment.3 Appellant sought a declaration that this clause was null, void and unenforceable. Damages were also sought in favor of each class member who sold a mobile home within the past four years and was compelled to pay a “prepayment penalty” under this type of clause.

Respondent demurred to the complaint on the ground that appellant failed to state a cause of action based upon ambiguous, unenforceable language in a contract of adhesion. Respondent argued that as a matter of both state and federal law, a reference to the “rule of 78's” constitutes full, fair and unambiguous disclosure of the method of computing the unearned portion of the finance charge due the buyer upon prepayment.

The trial court sustained respondent's demurrer without leave to amend and the judgment was entered from which appellant appeals. Judge Woolpert commendably issued a four-page order explaining the reasons for his ruling; he concluded that the reference to the rule of 78's in the prepayment clause was, as a matter of law, not unenforceable for ambiguity. The court's conclusion was based on the fact that disclosure requirements under federal and state consumer protection legislation are satisfied by reference to the name of this rule, without an explanation of how the rule operates.


Whether the trial court properly refused to declare the clause unenforceable because a reference to the rule of 78's is, as a matter of law, sufficient unambiguous disclosure of the method of computing a prepayment finance charge refund.DISCUSSION

Appellant does not challenge the rule of 78's as an unlawful method of calculating a finance charge refund,4 nor does he contend that it constitutes a penalty. He merely argues that this method of computation is unenforceable where the contract fails to clearly advise the buyer of the consequences of prepayment.

Thus, the gravamen of appellant's contention is that the language of the loan agreement fails to further explain or define the “rule of 78's” in simple “layman” terms. Appellant concedes that mere reference to the name of this rule without further explanation will satisfy the disclosure requirements of regulation Z of the Federal Truth in Lending Act (Bone v. Hibernia Bank, supra, 493 F.2d 135, 141). Appellant also acknowledges that a mere reference to the rule of 78's is sufficient to satisfy the disclosure requirements of California's consumer protection legislation including the Unruh Act and the Rees-Levering act which is applicable to the contract in the present case (Civ.Code, s 1803.3, subd. (n)(1); s 2982).5 However, appellant contends that although a mere reference to the rule of 78's may satisfy statutory requirements, this does not preclude application of the judicially developed law of adhesion contracts to protect a consumer forced to accept a contract containing such terms. Appellant asks the court to impose more stringent disclosure requirements than the statutes do.

If the Legislature had been silent in this area, appellant's arguments would be much more compelling for relief under the law of adhesion contracts. Certainly, the contract in the present case appears to be a classic example of such a contract, namely, “a standardized contract, which, imposed and drafted by the party of superior bargaining strength, relegates to the subscribing party only the opportunity to adhere to the contract or reject it.” (Neal v. State Farm Ins. Cos. (1961) 188 Cal.App.2d 690, 694, 10 Cal.Rptr. 781, 784; see also Kessler, Contracts of Adhesion (1943) 43 Colum.L.Rev. 629.) The body of law which has developed to protect the reasonable expectations of the party with inferior bargaining power in this type of situation is aimed at the prevention of oppression and unfair surprise (see generally 1 Witkin, Summary of Cal.Law (8th ed. 1973) s 13, pp. 35-36; Comment, Unconscionability in Standard Forms (1976) 64 Cal.L.Rev. 1151, 1158). However, the courts have recognized that the use of standardized or mass produced agreements is a fact of life in modern society and such contracts are valid and enforceable in the absence of uncertainty or ambiguity; the result of establishing the adhesion classification is only to permit a favorable construction of uncertain or ambiguous terms (Neal v. State Farm Ins. Cos., supra, 188 Cal.App.2d 690, 694-695, 10 Cal.Rptr. 781; Witkin, Summary of Cal.Law (8th ed. 1978 supp. to vol. 1) s 13, p. 7).

Appellant argues that his contract with respondent was ambiguous because the mere reference to the rule of 78's in the prepayment clause failed to advise him what to expect in the event of prepayment, and because there is nothing to bring home to the buyer that there will be any adverse or detrimental consequences of early payment of the loan. A cogent argument is made by appellant that enforcement of this type of contractual provision may defeat the buyer's “reasonable expectations,” because there is nothing in the contract to warn the average buyer that if he pays off his loan in advance, he may be compelled to pay more than the amount originally borrowed, even though he has already made a substantial number of monthly payments. We recognize that a mere reference to the rule of 78's may not be a meaningful disclosure to the average consumer. Nevertheless, we conclude that appellant's argument must fail for the reasons to be explained.

In Bone v. Hibernia Bank, supra, 493 F.2d 135, it was alleged that Hibernia Bank had violated the Truth in Lending Act, as implemented by the Federal Reserve Board's regulation Z. The bank's disclosure statement provided that its method of rebating the unearned pre-computed portion of the finance charge on the vehicle involved would be “According to the rule of 78's.” (Emphasis added.) The district court had held that this simple reference did not provide meaningful disclosure to the average credit consumer and had granted Bone a summary judgment and awarded him damages. In reversing, the appellate court upheld the administrative discretion of the Federal Reserve Board which had issued an interpretive rule providing that the mere reference to the “rule of 78's” sufficed to be the “identification” requirement of regulation Z (12 C.F.R. s 226.8(b)(7) (1979)).

The reasoning for the board's interpretation allowing such a reference to be sufficient disclosure is to be found in the statement of the board of governor's vice chairman, J. L. Robertson quoted in Bone, supra, at page 140:

“Following the June hearings before the National Commission on Consumer Finance, we again studied the problem of disclosure of the method of rebating unearned finance charges. We agree that a simple explanation as to what the Rule of 78ths encompasses would certainly be more meaningful to the consumer than the statement that rebates are figured on the Rule of 78ths. Unfortunately, we have found no simple way to solve this problem. The alternative would seem to require a lengthy and complicated mathematical statement which, we suspect, would be equally as uninformative to the consumer, and would have the added disadvantage of further complicating the disclosure statement and detracting from other important disclosures.”

In California, the Legislature has enacted a very comprehensive and detailed scheme for the regulation of automobile sales finance contracts. Civil Code section 2982 is specific and detailed in setting forth the items which must be contained in every such contract. The Legislature has obviously given careful and continued scrutiny to this area of consumer protection.6 Since we perceive the policy considerations underlying Civil Code section 2982 to be essentially the same as the reasons behind the judicial creation of the adhesion contract law i. e., the prevention of oppression and unfair surprise this court is constrained to hold that the specific disclosure requirements expressly provided by the Legislature are to be considered as guidelines for the courts in application of the doctrine of adhesion contracts. This appears to be an appropriate area for judicial restraint. Since the contract in question satisfied the applicable statutory disclosure requirements, the trial court did not err in concluding as a matter of law that appellant was not entitled to have the clause declared unenforceable.

However, there remains a procedural problem not raised by the parties, namely, whether it was proper for the trial court to sustain a general demurrer on the ground appellant was not entitled to declaratory relief. Witkin points out that there are conflicting decisions on the question of whether a demurrer will lie if the complaint shows on its face that the plaintiff is not entitled to a Favorable declaration. (3 Witkin, Cal. Procedure (2d ed. 1971) s 730, pp. 2350-2351.) Several older cases held that if the plaintiff's claim set forth in the complaint is untenable, he has failed to state a cause of action for declaratory relief and a demurrer will lie. However, the newer and better practice is that if the complaint sets forth facts showing the existence of an actual controversy, the court must declare the rights of the parties whether or not the facts alleged establish that the plaintiff is entitled to a favorable declaration. Our Supreme Court stated recently in Wellenkamp v. Bank of America (1978) 21 Cal.3d 943, 148 Cal.Rptr. 379, 582 P.2d 970:

“A complaint for declaratory relief is legally sufficient if it sets forth facts showing the existence of an actual controversy relating to the legal rights and duties of the parties under a written instrument or with respect to property and requests that the rights and duties of the parties be adjudged by the court. . . . If these requirements are met and no basis for declining declaratory relief appears, the court should declare the rights of the parties whether or not the facts alleged establish that the plaintiff is entitled to favorable declaration.” (Id., at p. 947, 148 Cal.Rptr. at pp. 381-382, 582 P.2d at pp. 972-973.)

However, reversal is not required because we have concluded that the trial court was correct on the merits. As stated in Teachers Management & Inv. Corp. v. City of Santa Cruz (1976) 64 Cal.App.3d 438, 449, 134 Cal.Rptr. 523, 530:

“. . . (I)f it is clear that the order sustaining the demurrer amounted to a correct decision on the legal merits of the case, a reversal is not required; instead, the appellate court may simply modify the judgment so as to declare that plaintiff was entitled to no relief.”

Therefore, the judgment is modified to declare that plaintiff is entitled to no relief and the judgment is affirmed as modified.



1.  The operation of the rule of 78's (also known as the rule of 78 or rule of 78ths) has been explained as follows: “The ‘Rule of 78,’ or ‘sum of the digits method’ is an accounting technique employed in computing prepayment refunds relating to instalment credit transactions. Its operation is described in CCH Instalment Credit Guide, paragraph 38, p. 1545, as follows:‘As an example, the Rule of 78 would operate on a 12-month loan as follows: The number 1 through 12 added together provide the figure 78. This is the denominator. The sum of the months expired at the date of prepayment supplies the numerator. The first month of a 12-month loan is considered as 12 because the outstanding balance is 12 times as large during the first month as it is for the last month. The second month is 11, and so on, to 1. The portion of interest considered earned each month is for the first month, 12/78; second month, 11/78; and so on down to the 12th month. The numerator for a 24-month contract is obtained by beginning with 24, instead of 12, as for a 12-month contract, or 36 in the case of a 36-month contract.’ “ (40 Ops.Cal.Atty.Gen. 190, 191-192 (1962); see also Bone v. Hibernia Bank (9th Cir. 1974) 493 F.2d 135, 137.)

2.  Under this contract, appellant financed $21,965 to be paid in 180 equal monthly installments of $277.56 including interest on the unpaid balance at the rate of 12.98 percent per annum. Appellant alleged that after he had made the monthly payments for nearly three years, he wanted to sell the mobile home and was informed by respondent that the amount required to pay off the loan at that time was $22,306.79 about $341 more than the original amount financed.

3.  The prepayment clause in question provided: “In the event Buyer prepays the indebtedness hereunder in full prior to maturity, Buyer is entitled to a refund of the unearned portion of the Finance Charge computed in accordance with the ‘Rule of 78's' except that no refund of less than $1.00 shall be made.”

4.  Under both the Rees-Levering Motor Vehicle Sales and Finance Act (Civ.Code, s 2981 et seq.), applicable to appellant's mobile home purchase, and the Unruh Act (Civ.Code, s 1801 et seq.), applicable to retail installment sales of goods and services other than motor vehicles, the rule of 78's is an authorized method of computing the refund of unearned portions of the finance charge (40 Ops.Cal.Atty.Gen. 190-192, Supra ; Civ.Code, s 2982 and s 1806.3, subd. (a)(1)).

5.  At the time appellant entered his contract with respondent, Civil Code section 2982 did not specifically refer to the rule of 78's, but did authorize disclosure in terminology required or permitted under regulation Z, as in effect on the date of the contract (see former s 2982, subd. (g)). Since reference to the rule of 78's satisfied regulation Z by implication, it satisfied the Rees-Levering act. Civil Code section 2982 was amended in 1979 to expressly provide that “Reference to the Rule of 78's . . . constitute(s) a sufficient identification of the method of computing the unearned portion of the finance charge.” The 1979 amendment to section 2982 also provided, in the text of that section operative January 1, 1981, that every conditional sales contract including a finance charge which is determined on the precomputed basis shall contain the following provisions in at least eight-point bold type if the contract is printed: “Notice to the buyer: . . . (3) You can prepay the full amount due under this agreement at any time and under certain conditions obtain a partial refund of the finance charge. Because the refund will be figured by the Rule of 78's, the time when you prepay may affect the ultimate cost of credit under this agreement.” (Civ.Code, s 2982, subd. (a) 17(A).) The interim version of section 2982 to be operative during 1980 provides that the subject contracts may contain either the above provision or the provision required under the former version of that code section simply the first sentence of the above provision. Retroactive application of these recent statutory amendments to the contract in question would be an unconstitutional impairment of contractual obligations (see generally 5 Witkin, Summary of Cal.Law (8th ed. 1974) s 619, p. 3918).

6.  The Rees-Levering Motor Vehicles Sales and Finance Act (Civ.Code, s 2981 et seq.) was enacted in 1961 effective January 1, 1962, and was amended in 1963, 1969, 1970, 1971, 1975, 1976, 1978 and 1979. As noted Ante in footnote 5, the Legislature has recently reexamined the disclosure requirements regarding prepayment consequences and as of January 1, 1981, subject contracts must contain a brief caveat regarding the rule of 78's in bold face print.

BALLANTYNE, Associate Justice.* FN* Assigned by the Chairperson of the Judicial Council.

GEO. A. BROWN, P. J., and ZENOVICH, J., concur.

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