Latest Developments in Automotive Finance and Consumer Protection

August 17, 2023

Federal agencies such as the Consumer Financial Protection Bureau (CFPB) and Federal Trade Commission (FTC) have increased their scrutiny of auto loan servicing activities, particularly regarding auto dealers who engage in unfair, deceptive, or abusive acts or practices (UDAAPs).

In cooperation with their state counterparts, these agencies have been using novel legal theories to aggressively pursue claims against dealers for assessing excessive “junk” fees, failing to refund guaranteed asset protection (GAP) overpayments, making deceptive statements, and double billing, among other discriminatory practices. This has resulted in a number of lawsuits against dealers and financial institutions, as well as the promulgation of new agency regulations and stricter state legislation, particularly in California.

CFPB Supervisory Priorities

The CFPB has faced multiple challenges to its authority and has recently relied heavily on blog posts and supervisory highlights to accomplish its regulatory priorities. In addition to focusing on general UDAAP claims, in 2022 the agency issued a joint notification letter with the US Department of Justice (DOJ) reminding auto finance companies of the protections offered to servicemembers and their dependents through the Servicemembers Civil Relief Act (SCRA).

Earlier in 2022, the CFPB issued Compliance Bulletin 2022-04, jointly with the Offices of Supervision Policy and Enforcement, summarizing the agency’s recent supervisory and enforcement actions regarding auto default servicing and repossessions and noting that “[t]he Bureau intends to hold loan holders and servicers accountable for UDAAPs related to the repossession of consumers’ vehicles.”

The agency also identified other areas of concern, including increasing loan-to-value ratios and a lack of competition in subprime indirect auto loans, and promised to work with the FTC to address these issues.

FTC Automotive & Mobility Finance Priorities

While the CFPB does not have actual authority over auto dealers, the FTC does—and has recently made significant use of that power to pursue fair lending actions against dealers. In May 2020, Commissioner Rebecca Kelly Slaughter issued a statement that “[t]he automobile-financing market in the United States is profoundly broken,” effectively announcing the Commission’s renewed focus on this industry and foreshadowing the agency’s recent rulemaking on this front.

In 2022, the FTC proposed its Motor Trade Regulation Rule, which would ban deceptive “bait-and-switch” advertising and certain add-on products deemed “junk.” It would also require dealers to provide a true “offering price.” The Commission received criticism for not extending the comment period on the proposed rule. Morgan Lewis lawyers will be closely monitoring this process and will provide updates when a final rule is established.

Dealer Oversight Expectations

There is a real potential that the proposed rule will interact and overlap with the FTC’s Holder Rule and Trade Regulation Rule (TRR), as well as derivative liability provisions in the Dodd-Frank Act and various state UDAP laws. It could also lead to unintended consequences for auto loan securitizations, as the Structured Finance Association has noted. If this rule is finalized, institutions will need to determine to what extent they can comply with this relatively detailed new regulation.

Additionally, in June 2023, the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, and Federal Deposit Insurance Company released their final interagency guidance on third-party oversight. While much of the guidance was focused on the fintech industry, its key elements—planning, due diligence and selection, contract negotiation, ongoing monitoring, and termination—can apply to financial institutions working in the indirect auto financing market.

This proposed rule is still in the comments period, but covered institutions should start to consider whether the rule will apply to their relationships with auto dealers and, if so, how they will satisfy the rule’s key elements of third-party oversight.

CFPB’s Litigation Against Credit Acceptance Corporation

In a suit against Credit Acceptance Corporation (CAC), a subprime auto finance lender, the CFPB and New York Attorney General put forth several novel legal theories, including the following:

  • Hidden Finance Charges: The CFPB attacked the core business model by claiming that CAC encourages dealers to manipulate the prices of vehicles solely based on borrowers’ projected performance and causes both inflated principal balances and violation of state usury laws.
  • Ability to Repay: The CFPB claimed that CAC made loans without regard to consumers’ ability to repay and that it profited when consumers defaulted.
  • Add-on Products: The CFPB claimed that CAC used financial incentives that caused dealers to add extra products to loans and ignored instances where consumers believed that the add-ons were required as a condition of receiving auto loans.

There are several serious legal issues with these theories. For example, the hidden finance charge theory contradicts the CFPB’s own interpretation of what a finance charge is under Regulation Z. In August 2023, the case was put on hold pending the Supreme Court’s ruling on the constitutionality of the CFPB’s funding structure, so it will be some time before the substantive issues are resolved.

California GAP Waiver Laws

While the CFPB and FTC have approached GAP waiver issues through the broad lens of unfairness, California instead created bright line rules with Assembly Bill 2311. The law, which took effect on January 1, 2023, regulates how GAP waivers can be offered at the point of origination. It creates requirements for new detailed disclosures at the time of purchase, requires notices of ownership transfer of the retail installment contract (RIC), imposes price caps, sets mandatory GAP cancellation triggers, and creates specific obligations for refund calculations.

California Litigation Relating to FTC’s Holder Rule

While the FTC’s Holder Rule permits a consumer to pursue all claims and defenses against the current holder of a consumer credit contract, it notes that “recovery hereunder by the debtor shall not exceed amounts paid by the debtor.” But does this cap on recovery include attorney fees and costs? The FTC opined in 2019 that it does apply, but California’s appellate courts were split on the matter.

In May 2022, the California Supreme Court resolved the split, holding that the cap does not apply where the debtor seeks attorney fees and costs pursuant to the state’s prevailing party statute. This is not inconsistent with the FTC’s interpretation, as the Commission recognized that state law could provide the basis for recovery of fees against a holder (which is the case in California). In January 2023, the US Supreme Court denied certiorari review.

This indicates that dealer fraud cases in California are more problematic for the holder of the auto loan or RIC. Therefore, institutions should consider requiring a dealer buyback provision where permitted, instead of demanding indemnity or tendering a defense.

Key Takeaways

  • Parallel Enforcement. Expect continued cooperation (or collusion) between federal regulators such as the CFPB, FTC, and their state counterparts. This is a now-frequent occurrence seen across multiple industries.
  • Junk Fees. While “junk” is a subjective and ultimately meaningless term, federal regulators are placing heavy scrutiny on fees that are passed onto consumers both in originations and servicing contexts.
  • Understand Third-Party Risks. Conduct due diligence on prospective lending partners, dealers, servicers, and repossession agents, and other parties. Identify key risk indicators and monitor for changes.
  • Litigation. Be alert that California often stands apart from other states in finding ways to provide additional protections for consumers.

Auto dealers, banks, and other institutions that handle financing for auto loans should be wary of these new developments and take proactive steps to ensure they are in compliance with the latest regulatory regimes. Morgan Lewis’s Auto Industry lawyers will continue to monitor these trends and provide updates as necessary.

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