The Federal Trade Commission’s final trade regulation rule is designed to transform the vehicle shopping and financing experience for auto dealers and consumer customers, but it will not necessarily improve the experience for either group. The FTC has suspended the effective date of the so-called CARS Rule originally set for July 30, 2024, while the U.S. Court of Appeals for the Fifth Circuit considers the Petition for Review filed by the National Automobile Dealers Association and the Texas Automobile Dealers Association. If the rule survives the court’s review, the FTC will set a new effective date, and dealers will once again be working hard to ensure they are ready for the FTC’s enforcement and the potentially devastating penalties for noncompliance.
But auto dealers are not the only entities potentially affected by the rule. Auto creditors, including banks, credit unions, and finance companies, also have potential liability to consumers and states if a dealer’s compliance is not perfect. This article examines how the risk to auto creditors, which are not directly covered by the rule’s requirements, comes into play and what steps creditors can take to mitigate those risks.
How a Rule Aimed at Covered Auto Dealers Can Create Risks for Auto Creditors
By its plain terms, the CARS Rule applies only to “Covered Dealers.” The final rule carved some vehicle dealers out of the rule, such as RV, boat, and motorcycle dealers, so Covered Dealers are mostly those who sell or lease cars and trucks. Financial institutions that finance these sales and leases are not directly covered, but that does not mean that these creditors are not at real risk of liability for compliance failures by dealers. How does that happen?
The path to liability for creditors begins with rules that have abrogated the holder in due course doctrine, which was created by English common law in the mid-1700s. This doctrine held that a person who receives or holds a negotiable instrument, such as a promissory note, in good faith and in exchange for value, takes it free of competing claims of ownership and most defenses to payment. For example, if a buyer had claims against a seller, but the seller had assigned the credit contract or arranged for a bank to make the loan financing the sale, the bank often became a holder in due course, which
meant the buyer had to make all payments required by the financing contract, despite the seller’s misconduct. In 1975, the FTC adopted a trade regulation rule that preserved a consumer’s claims and allowed them to become a claim against the holder of the financing contract or a defense to nonpayment. It is commonly known as the Holder Rule.
I remember my law professor railing against the fact that a federal agency run by unelected commissioners—the FTC—had overruled 200 years of common law. But that made no difference because Congress had given the FTC this power. Eventually state legislatures—made up of elected folks—enacted amendments to their states’ versions of the Uniform Commercial Code that accomplished the same result. For several decades, consumers have been able to assert claims they have against sellers, or defenses to nonpayment, against the entities that financed these sales.
The Holder Rule, or the similar provisions in states’ commercial codes, is the first step in potentially making auto creditors liable for a dealer’s violations of the CARS Rule. The next step is that a state law must make the dealer’s conduct unlawful, which is usually accomplished by a law against unfair or deceptive acts or practices, known as a state UDAP law.
Although every state has some form of a UDAP law, not every state UDAP law gives a consumer the right to sue a business. For an auto creditor to be at risk for a dealer’s violations of the CARS Rule, state law in the consumer’s state must:
• prohibit unfair and/or deceptive acts or practices, and
• give consumers the right to sue a business under that law—and include the type of business (e.g., a financial institution) within its scope.
Some state laws say that any finding by the FTC that a practice is unfair or deceptive automatically makes that practice a violation of the state UDAP law. In these states, the consumer must only prove facts—that the dealer did something prohibited by the CARS Rule or failed to do something the rule requires.
If the state law contains a general UDAP prohibition but does not state that the practice at issue is unfair or deceptive, the consumer must prove not only that the dealer engaged in the practice at issue, but also that the practice met the state law standard for being unfair or deceptive. This is a greater burden, but perhaps not too heavy. For instance, if the consumer claimed that the dealer materially misrepresented the features of a protection product, that fact would likely meet the deception standard. On the other hand, if the consumer claimed that an advertised price for a car did not include a mandatory document preparation fee, the proof issue could be tougher. If the state law has an advertising provision that does not require advertised car prices to include the doc prep fee, and the dealer complied with the state law, a court might be reluctant to say that meeting the requirements of a state law on point was nevertheless an unfair practice.
To assess its risk of liability for a dealer’s violation of the CARS Rule in a private suit or class action, the auto creditor will need to carefully evaluate the state UDAP laws in its footprint. The tough reality is that effective risk mitigation generally requires the auto creditor to adopt universal practices that will lessen the risk based on the strongest state UDAP law in its service area.
While dealers and auto creditors are understandably worried about the risk of class actions, we can expect attorneys general in many states to claim that auto finance sources are liable for dealer misconduct. In states where the UDAP law allows the AG to assess large civil penalties and provide consumer redress for unfair practices, this risk is
the greatest.
Note that the FTC Holder Rule and Article 9-404 of the UCC give rights against the assignee to the consumer, not the regulator.
Risk Mitigation Options for Auto Creditors
Risk mitigation options vary in cost to implement and maintain, and they also vary in effectiveness. Each auto creditor must carefully assess its risks and its budget to mitigate those risks. Here are some potentially valuable options for consideration.
1. Customer Complaints. Customer complaints are a potentially rich source of information. They should be carefully monitored for any suggestion of dealer misconduct. These complaints often arise during customer service and collections calls, so creditors should train the call center staff to recognize and be alert for them and to escalate complaints to staff who will then investigate them. If credible indications of a dealer’s misconduct are identified, the auto creditor will want to address the issue with both the customer and the dealer. While the complaint could indicate a one-time problem, it could also indicate a dealership with inadequate CARS Rule compliance practices. In addition to their value as a warning of potential risk from dealer misconduct, a plaintiff will argue that a complaint gave the auto creditor actual notice of the dealer’s unfair or deceptive practice. Although actual knowledge is not necessarily a requirement for assignee liability, evidence of actual knowledge strengthens a plaintiff’s case and can make a critical difference to a court. Complaints can be low-hanging fruit for an auto creditor that is otherwise unaware of a dealer’s misconduct; their value in risk mitigation will almost always be worth the effort.
2. Express, Informed Consent. Auto creditors should consider requiring dealers to include in the funding package the customer’s initialed and signed express, informed consent form. This EIC form should list every item the customer pays for, apart from the car or truck itself. It should list mandatory fees, such as doc prep fees, or charges for items the dealer has pre-installed and is charging for, such as fabric protection. The optional or mandatory nature of every charge should be clearly noted, and the full cost over the term of the financing should be accurately computed.
A missing, incomplete, or inaccurate EIC form is a red flag for a dealer with compliance problems. It is relatively easy to spot and enables the creditor to address the problem before funding. A call with the consumer is likely to clarify whether the customer understood what she was buying/financing and had agreed to pay for the optional products. If so, the dealer may merely need to improve its documentation practices. If the customer expresses any confusion about these items (or worse, contends that she did not agree to buy them or that she was falsely told the items or fees were required, if untrue), a creditor may be at risk for every deal it purchases from this dealership until the compliance problems are corrected.
3. GAP Blocker. The rule forbids a dealer to charge for an item that has no value, including unneeded GAP contracts. Any GAP charge the dealer funds should provide a clear benefit to the customer. It is easy to say that a customer who finances only 60% of the value of a vehicle has no need for GAP, but it is harder to say where the line between value and no value lies. New cars usually depreciate faster than used ones, and some makes and models may depreciate faster than others. Some finance sources have developed “gap blockers,” a software solution that alerts the creditor to the listing of a GAP sale on a low loan-to-value deal.
Some systems will use different thresholds for blocking a GAP sale (or at least financing GAP), depending on the collateral, such as new or used. Any hard-and-fast rule will be over- or under-inclusive for at least some transactions, but these blockers have prevented many questionable sales of GAP.
A second-best alternative is requiring the dealer to submit the GAP calculation the dealer is required to make and retain under the CARS Rule. The auto creditor should have a clear policy for when it will finance GAP and ensure the calculations accurately reflect compliance with its policy.
4. Understand the Add-on Products Dealers Are Selling. Some auto creditors have had a longstanding practice of financing only products they have reviewed and understand. Dealers must understand these products very well to avoid misstating their benefits, which can include failing to warn about material limitations or exclusions. But finance sources must understand them, too. Does a bi-weekly payment option convey benefits after the fees are considered and if the financing is paid off early? Does a theft deterrent product have solid research supporting its value? Does an appearance protection product have material limitations, especially ones that are not clear and conspicuous in the marketing material? Most auto creditors would be unhappy to learn that they financed a product lacking value to the customer.
5. Indemnification/Repurchase Agreements. If your dealer agreement does not give you indemnification/repurchase protections, you should consider adding them. Indemnifications can be a tough pill for a dealer to swallow, and if the dealer has gone out of business, they provide no protection. But it may take only one experience defending an expensive class action for a creditor to decide the dealership should bear the risk of its own misconduct, rather than the creditor.
Striking the right balance between mitigating upstream risk to auto creditors and servicers, compliance program administrability, and reasonable interpretations of the more nuanced aspects of the CARS Rule is not an easy task with clear answers for every creditor. A thoughtful risk assessment, with special attention to higher-risk dealers and higher-risk optional products, should be part of an auto creditor’s compliance management program.
What If the Court Blocks the CARS Rule?
The FTC often says that the CARS Rule imposes no new requirements on dealers, which is clearly not the case. But many of the rule’s provisions do reflect existing law against unfair and deceptive practices, albeit with much greater sanctions. Even if the rule does not go into effect, many—even most—of the banned practices will continue to create UDAP risk for dealers and finance sources. The attention drawn to dealer practices by the rulemaking is likely to increase the scrutiny and risk.
Waiting and seeing what happens in the legal challenge is not a good strategy. If the rule is struck down, federal and state UDAP laws will still exist and will be enforced by federal agencies, states, and consumers. This fact argues for careful attention to enhanced compliance procedures and risk mitigation strategies. The waters for dealerships and their finance sources have seldom been this treacherous.
