In June of 2000, I wrote an article titled “Wanna Buy Your Lawyer a Yacht?” The article bemoaned the fact that people in the car business were aiding and abetting the plaintiffs' lawyers and consumer advocates intent on bringing lawsuits against dealers and finance companies.
I urged a vocabulary change. In the 11 years since then, I'm sorry to report that things haven't changed much. Here's some of what I said back then.
At a recent conference of subprime finance companies and dealers, every agenda item and every speaker seemed to deal with “loans” or “lenders.” Finally, I could stand it no longer. When the time came for me to speak, I ranted instead. Why? Because no one at the conference was making loans, and no one there was a lender. And what you call things can sometimes matter — a lot.
In a typical motor vehicle retail installment sales transaction, a dealer extends credit to a consumer. How? The dealer exchanges a perfectly good (we hope) vehicle for a piece of paper containing the consumer's promise to pay for the car over a time period of, say, 36 months. The dealer and the consumer have not engaged in a “loan” transaction, they have engaged in a “credit sale.”
The dealer then sells the credit contract to a finance company. Note that the finance company isn't lending money to anyone; it is buying a contract from a dealer in what is, in reality, a secondary market commercial transaction. OK — if you are an Ohio dealer, you may actually be acting as agent for a bank that is really making a loan to your buyer, and some Colorado dealers use a very peculiar credit sale form that is titled as a note — I'm talking here about normal dealers.
Does anyone (besides blood-sucking lawyers) really care what you call this transaction? Well, you need to care, unless you feel like paying a lot of money to those lawyers.
Here's the problem. The documents a dealer uses to complete a credit sale have been designed to comply with state retail installment sales laws and federal laws regulating credit sales.
These laws are different from the laws that govern loans. A plaintiff's class-action lawyer may allege the transaction is not really a credit sale but rather a disguised loan.
The lawyer's next step is to argue that the dealer, or the dealer and the finance company, should have complied with the loan laws rather than the credit sale laws.
Lawyers call this a “recharacterization” attack. The plaintiff's lawyer is trying to “recharacterize” the credit sale as a loan.
If the judge takes the bait and agrees with this argument, the defendants are in trouble, because the judge's next step will be to declare that all the transaction documents violate the loan laws — laws that the dealer and the finance company never intended to abide by.
Imagine your dealership or finance company is the defendant in one of these suits. What will the plaintiff's lawyer find during the discovery process. Will your internal documents be filled with incorrect references to “loans” and “lenders”?
If so, you are arming the enemy. These references, by themselves, probably won't be decisive, but the plaintiff's lawyer will beat the judge or jury over the head with your own references to “loans” and “lenders.”
So, how do you defend against one of these attacks? The plaintiff will argue that the dealer never carries his own paper, and that the dealer would never enter into a credit transaction with a consumer if the dealer had to carry its own paper, and doesn't enter into such a transaction with a consumer until some bank or finance company has reviewed the consumer's credit history.
The argument that naturally follows is that the dealer is the agent of the finance company or bank and that the finance company is actually a “lender.”
Here's the defense. The dealer is the creditor. Sure, the dealer assures that he can sell the consumer's contract before he completes the credit sale. But think about a typical dealer agreement with a finance company.
After the dealer gets an approval from the finance company of the consumer's credit and enters into the contract with the consumer, what happens if the dealer decides not to assign the contract to that finance company?
Can the finance company force the dealer to assign the contract? Nope. Under most agreements, the finance company has to buy the contract from the dealer if the finance company has approved the consumer's credit and everything else is as the dealer has represented, but the dealer has no obligation to assign any contracts.
Let's say that the dealer enters into a contract with every intention of selling that contract to a finance company, then decides that rather than selling the contract to the finance company, he'll keep it and collect payments directly from the consumer — the finance charge that results from an 18% APR looks like a pretty good return for his retirement program. Is there anything the finance company can do about the dealer's change of heart?
Nope. The finance company has no right to force the dealer to assign the contract. If that's so, how can the dealer be the finance company's agent? Once a judge or jury understands this, the dealer should win the case.
The plaintiff's lawyer will argue that this scenario is theoretical — that the dealer has never held onto a contract and never will. But the dealer's theoretical right to hold the contract is, or should be, controlling.
Let's make it even tougher for the plaintiff's lawyer. Let's quit talking about “loans” and “lenders.” Let's get those references out of our records. Let's call these things by their correct names. Let's deprive the plaintiff's lawyer of the easy evidence. Maybe he'll think twice and not bringing the suit.
The message of this article is more relevant today. With the Federal Trade Commission and the new Consumer Financial Protection Bureau breathing down the necks of dealers and sales finance companies, it's becoming more important for us to accurately describe how indirect auto finance works.
I'm betting, though, I'll be writing this article, or one like it, in 2020.
Tom Hudson is a law partner at Hudson Cook, LLP.