The Massachusetts Attorney General recently settled a major consumer fraud case against subprime auto lender Credit Acceptance Corporation.
The case is long and complicated, but the issue that caught my eye is the argument about the true purchase price of a vehicle.
For example, assume a dealer sells a vehicle for $10,000 and the buyer signs an 18% loan spread over 60 months at $253.93 per month. Then, assume the dealer immediately sells the loan to a subprime lender for $8,000 cash.
What is the true purchase price of the vehicle? Is it $8,000 or is it $10,000.
FORM OVER SUBSTANCE
I would argue the true sales price is $8,000 because that is what the dealer actually received. In fact, I’m quite certain the dealer would report on its tax return that the vehicle was sold for $8,000. And the financial records subprime lender probably reports that it acquired the loan for $8,000 as well. So, isn’t that the true sales price?
But all the purchase documents state a purchase price of $10,000. All the finance charges and disclosure statements say the cost was $10,000 and that the interest rate is only 18%.
If, however, substance rules over form, both the car dealer and the subprime lender have a major problem. The problem is that they are lying about the true sales price of the vehicle and the true interest rate being charged. If the true sales price is $8,000, then the actual interest rate is actually 29%, not 18%. And by failing to disclose the true interest rate, the dealer and lender have committed a violation of the Truth in Lending Act disclosure.
CHAPTER 13 BANKRUPTCY ISSUE
Determining the real purchase price of a vehicle also has importance in a chapter 13 case when the vehicle was purchased within 910 days of filing bankruptcy. Under Section 1325(a)(9) of the Bankruptcy Code, a debtor must pay a lender the current balance of the loan, even if the vehicle is worth less than the balance of the loan.
So it makes a BIG difference if the actual loan amount is $8,000 instead of $10,000. It also makes a big difference if the true interest rate is 29% and not 18%.
The legal consequence of violating Nebraska laws on usury is that a creditor is entitled to no interest at all. See Nebraska Statute 45-1024. (“If any amount, in excess of the charges permitted, is charged, contracted for, or received, the loan contract shall not on that account be void, but the licensee shall have no right to collect or receive any interest or other charges whatsoever.”)
Interest rates for installment loans in Nebraska are capped at 24% on the fist $1,000 and 21% on balances above 21%. If Nebraska Courts rule that the true purchase price of a car is $8,000 and not $10,000, that automatically triggers a violation of these interest rate caps.
So, in theory, a debtor could propose to pay off the car loan at $8,000 and offer no interest to the creditor as a penalty for violating Nebraska Statute 45-1024. That’s a big deal.
WILL THE COURTS BUY THE ARUGUMENT?
Our courts have routinely ruled that we apply the law to the facts at hand and disregard the forms of a transaction. Labels do not control.
- Lease to Own Transactions: The most common form over substance transaction we find is where a creditor tries to disguise a purchase in the form of a lease. Several years ago I litigated against a company called Cash In a Flash Inc. that disguised high interest rate title loans in the form of a lease. The Nebraska bankruptcy court and Nebraska Department of Banking ruled that the transactions were really loans and the lender had violated Truth in Lending disclosure requirements.
- Reasonable Compensation: Tax courts routinely take issue with business owners who evade payment of Social Security taxes by paying themselves artificially low salaries.
- IRS Disguised Sales Rules: The IRS commonly recharacterizes transactions between partners under Section 707 of the Internal Revenue Code.
- Time Sale Transaction: “It appears quite clearly that the transaction was a loan to Jones disguised as a conditional or time sale with defendant as surety or guarantor. As such it is usurious and subject to the forfeiture of interest. See §§ 45–105 and 45–138(3), R.R.S.1943.” Midstates Acceptance v. Voss, 202 N.W.2d 822, 189 Neb. 411 (Neb. 1972). Midstates Accceptance v. Voss, 202 N.W. 2d 822, 189 Neb. 411 (Neb. 1972)
But when it comes to the subprime auto lending two-step dance, our courts fail to confront the nonsense of these transactions.
Overcharging is not in itself usury
The Michigan bankruptcy court confronted this issue in the case of Allen-Morris v. Nicholas Fin., Inc. (In re Allen-Morris), 523 B.R. 532 (E.D. Mich. 2014). In that case the debtor claimed that the auto dealership was inflating the price of the auto to disguise a usurious rate of interest (above 25%). The debtor attempted to prove the hidden interest rate by relying on NADA and Kelly Blue Book values to prove the cars were sold at inflated prices.
The bankruptcy court disagreed, and on appeal the district court ruled that “overcharging is not in itself usury.” The court also stated that “even overcharging solely because a product is being sold on credit rather than for cash in not in itself usury.” However, the court also stated that the debtor did not allege that he was forced to purchase the vehicle at an inflated price to secure the loan, so perhaps the door is not completely shut on this argument.
LESSONS LEARNED: SHOP FOR THE LOAN BEFORE SHOPPING FOR THE VEHICLE
What I take away from this is that it is so important to shop for the auto loan before shopping for the vehicle itself.
There is an incestuous relationship between car dealers and subprime lenders. In the above example the car dealer is clearly selling the vehicle for $8,000, but the bill of sale says $10,000. It is also clear that the dealer does not care if the buyer pays the $8,000 cash or if it is paid by the subprime lender. The case price is $8,000.
I suspect that most buyers would object to paying 29% interest on a car loan. But from what I can see, if your credit is hurting and you agree to finance a car at 18% interest, chances are you are really paying 29% but just don’t realize it.
Cash talks. When consumers walk onto a car lot with their loan already secured, they tend to negotiate lower prices. Instead of paying $10,000 they negotiate the price down to $8,000.
Never depend on a car dealer to supply financing. Always shop the loan before shopping the car.
Image courtesy Flickr and Nicole Yeary.