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The Business Lawyer

Spring 2022 | Volume 77, Issue 2

Ladies and Gentlemen: Rev Your Regulatory Engines!

Kevin M McDonald and Kenneth J Rojc


  • Annual review of the major legal and regulatory developments affecting the U.S. automotive finance industry.
Ladies and Gentlemen: Rev Your Regulatory Engines!

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Automotive finance regulatory developments and case law were certainly revving up during the past year. This survey starts with two Consumer Financial Protection Bureau (“CFPB”) consent orders: one with a captive automotive finance company for improper repossession practices and one with a large subprime auto finance company for credit reporting violations. It then covers several important federal and state judicial decisions and settlements. It closes by examining actions brought by the New York State Department of Financial Services modeled largely on the CFPB’s fair lending enforcement actions, but with a remedial twist requiring the use of flat-fee compensation.

Federal Regulatory Developments

CFPB Settlement for Repossession Issues

In October 2020, the CFPB entered into a consent order with Nissan Motor Acceptance Corporation (“NMAC”) to address its conclusions that NMAC wrongfully repossessed accounts under modified payment plans, retained personal property contents of repossessed vehicles until consumers paid a fee for storage, used a third-party service provider that did not explain a pay-by-phone option with a significantly lower convenience fee, and provided consumers deceptive statements in extension agreements that appeared to limit their bankruptcy protections. The CFPB asserted that these actions violated the prohibition on engaging “in any unfair, deceptive, or abusive act or practice.”

The alleged wrongful repossessions were related to servicing activities for default accounts. Consumers in default from 2013 through at least 2018 were informed that they could avoid repossession by bringing their account to sixty days past due, keeping a promise to pay by a certain date, or entering an extension agreement. Nevertheless, NMAC continued repossessing even though customers had met one of these conditions.

In addition, the CFPB found that from 2014 to 2017, repossession agents imposed storage fees for return of the personal property contents of repossessed vehicles; NMAC was allegedly aware of these practices. Although NMAC represented that it could not control the repossession agents, in some cases NMAC directed repossession agents to lower the fees.

Separately, from 2012 through late 2017, NMAC’s payment processor for telephone payments charged consumers $5.00 for electronic-check and in-network debit card payments and $12.95 for credit card and out-of-network debit card payments without informing the consumers of the cost difference. NMAC’s customer-facing materials also did not explain the difference in cost. In addition to setting up a compliance plan, NMAC must refund fees, correct consumers’ credit report information, provide up to $1,000,000 in cash to consumers subject to wrongful repossession, and pay a civil money penalty of $4,000,000.

CFPB Settlement for Credit Reporting Issues

In December 2020, the CFPB entered into a consent order with Santander Consumer USA Inc. (“Santander”) to address its conclusion that Santander violated the Fair Credit Reporting Act (“FCRA”). Each month, Santander voluntarily furnishes consumer credit information (e.g., payment status) about its retail installment contracts and leases to consumer reporting agencies (“CRAs”) using a data format called Metro 2. According to the CFPB, from January 2016 to August 2019, Santander supplied the CRAs with information the company knew or should have known contained “systemic errors” since the data for certain consumer accounts was “internally inconsistent.”

The FCRA prohibits furnishers from providing the CRAs with information about consumers that the furnisher knows or reasonably believes is inaccurate. The consent order recites that Santander knew that it was reporting inaccurate information as of 2016 when it was put on notice of the inaccuracy by at least one CRA. In addition, Santander’s own internal audits also revealed reporting errors. Despite the external and internal reports, Santander continued furnishing incorrect consumer information for several years while also failing to correct them, according to the allegations.

Among other failures, the CFPB identified the failure to furnish accurate information on the account status (open or closed) and whether consumers were carrying a balance or still were obligated to make future payments. According to the order, Santander’s inaccurate reporting “could have negatively impacted consumers’ credit scores and access to credit.” Furthermore, the CFPB found that when Santander later determined that certain furnished information was incomplete or inaccurate, the company failed to provide the necessary updates and corrections.

The order requires Santander to correct all consumer account inaccuracies and errors identified by the CFPB. The company must also improve its policies and procedures to ensure it accurately reports consumer information to the CRAs. Part of these policies and procedures will include monthly reviews of account information to assess the accuracy and integrity of information Santander furnishes and submitting a compliance plan to the regional director of the CFPB. Finally, Santander will pay a $4,750,000 civil penalty.

Federal and State Court Decisions

Wells Fargo Settles GAP Refund Class Action

After over three years in litigation, Wells Fargo Bank, N.A. and Wells Fargo Company (collectively “Wells Fargo”) agreed to settle a nationwide class action through a settlement agreement that was filed in June 2021 in connection with Wells Fargo’s alleged practices of failing to provide refunds on unearned fees arising from GAP agreements that provide payment of the difference between the value of the vehicle and the unpaid balance of the retail installment sale contract when there is a total loss of the vehicle upon a prepayment or early termination of contracts (“GAP Refunds”).

In the litigation, Wells Fargo contended that only thirteen states (“Refund States”) require the creditor to “ensure” that a customer received a GAP Refund while the plaintiffs argued that the laws in the Refund States require the creditor to directly issue the GAP Refund upon prepayment or early termination of the retail installment sale contract. As part of the settlement agreement, the parties agreed to recognize two types of class members entitled to GAP Refunds. The first type was the “Statutory Subclass” defined to include those class members in the Refund States that purchased GAP Agreements and prepaid early but did not receive a GAP Refund from Wells Fargo and for which Wells Fargo did not receive a written confirmation from the dealer or administrator of the refund. The second type was the “Non-Statutory Subclass” defined to include those members outside of the Statutory Subclass. The settlement agreement provided remedial relief to both types of class members. For the Statutory Subclass, the court recognized that Wells Fargo had already paid approximately $33,000,000 to 105,274 class members between February 2019 and March 2021 with an average payment of $316.87. For the Non-Statutory Subclass, Wells Fargo agreed to establish a $45,000,000 supplemental settlement fund for those members outside of the Refund States who submit a claim form that they did not receive a GAP Refund.

The largest remedial component of the settlement agreement was that Wells Fargo will be required to pay an estimated $417,000,000 in GAP Refunds to customers in all fifty states during a four-year period ending January 1, 2026. Wells Fargo also agreed to pay $23,100,000 in attorneys’ fees, $500,000 in costs, and $7,500 for each class representative. The unprecedented size of this settlement underscores the importance of banks and finance companies, who finance GAP Agreements in the context of retail installment sale transactions, to clearly identify where GAP Refunds are required to be paid by the creditor under state law, to identify any trigger points under state law that activate GAP Refund responsibilities, and to implement system-wide operations to manage the GAP Refund process. Based upon this settlement and Wells Fargo’s settlement with fifty state attorneys general, banks and finance companies can expect a high level of scrutiny from federal and state regulators as well as the class action plaintiff ’s attorneys in connection with GAP Refunds.

Recovery of Attorneys’ Fees Not Subject to FTC’s Holder Rule Limit

In January 2021, the California Court of Appeal held in Pulliam v. HNL Automotive Inc. that a debtor’s recovery of attorneys’ fees is not subject to the limit described in the FTC’s Holder Rule. In this case, the plaintiff purchased a used vehicle pursuant to a retail installment sales contract from HNL Automotive Inc. (“HNL”). The contract was subsequently assigned to TD Auto Finance, LLC. A couple of months after the purchase, the plaintiff filed a lawsuit against HNL and TD Auto Finance claiming, among other things, misrepresentation in violation of the Consumer Legal Remedies Act, breach of implied warranty under California’s Song-Beverly Act Consumer Warranty Act, and fraud. Following a jury trial, the plaintiff was awarded approximately $22,000 in compensatory damages and over $169,000 in attorneys’ fees pursuant to the Song-Beverly Act. HNL and TD Auto Finance appealed.

The Holder Rule requires sellers of goods financed by a retail installment sales contract to include within the contract a notice that the purchaser retains, as to the assignee of the contract, all claims and defenses that the debtor could assert against the original seller of the goods. The final sentence in the Holder Rule states that recovery by the purchaser shall not exceed the amounts paid by the purchaser under the installment sales contract. TD Auto Finance asserted that this cap within the Holder Rule limited the plaintiffs’ recovery of both damages and attorneys’ fees to the amount paid under the contract under two California cases that held that attorneys’ fees come within the cap set by the Holder Rule.

The Pulliam court declined to follow those decisions, reasoning that the term “recovery,” as used in the Holder Rule, does not encompass attorneys’ fees despite the FTC’s interpretation that it does encompass fees. It found that to interpret it as such would be contrary to the Holder Rule’s objective of “reallocating the costs of the seller’s misconduct from the consumer back to the seller and creditor.” The court found deference to an FTC determination that fees come within the cap to be inappropriate because of the informal nature of its consideration of the attorneys’ fees issue and the fact that it did not solicit comments pertaining to that aspect of the Holder Rule. The Pulliam court therefore ruled that the Holder Rule does not include attorneys’ fees within its limit on recovery and that the FTC’s Rule Confirmation stating the contrary is not entitled to deference. As of this writing, this decision is under review by the California Supreme Court.

Manufacturer Cannot Enforce Arbitration Provision in Contract Assigned to Captive Finance Company

In McCarthy v. Toyota Motor Corp., the United States District Court for the Central District of California denied an attempt by Toyota Motor Corp. and Toyota Motor Sales, U.S.A. (collectively “Toyota”) to enforce an arbitration agreement in retail installment sale contracts assigned to Toyota Motor Credit Corporation (“TMCC”) and lease agreements assigned to Toyota Lease Trust. The case arose out of a consolidated class action related to an alleged defect in the “inverter” component of Toyota Priuses from model years 2010 to 2014. The arbitration provision in the motor vehicle lease agreement assigned by the dealer to Toyota Lease Trust contained a provision under which the lessee agreed to arbitrate any claims related to the lease, asserted by the lease, or asserted by the lessee against the “following Covered Parties: Toyota Lease Trust, Toyota Motor Credit Corporation, and/or any of our or its affiliates.” The arbitration provision in the retail installment sale contract assigned to TMCC stipulated that any claim or dispute arising between the vehicle buyer and TMCC is subject to arbitration, including claims relating to the condition of the vehicle.

Toyota moved to compel arbitration based on an equitable estoppel theory and, with respect to the lease arbitration provision, on the theory that Toyota is a third-party beneficiary of the lease agreement. Toyota argued that the defect claims were intimately intertwined with the lease and retail installment contracts because there would be no inverter warranty claims without the purchase or lease of a vehicle, and thus that the plaintiffs should be equitably estopped from enjoying the benefits of the purchase or lease while denying arbitration. Based on Ninth Circuit precedent in Kramer v. Toyota Motor Corp., the McCarthy court concluded that the consumer inverter claims do not rely on or make reference to the terms of the finance contracts (the lease and retail installment contracts), and thus Toyota may not enforce the arbitration provision based on equitable estoppel.

Toyota also argued a third-party beneficiary theory with respect to the lease arbitration provision. Under this theory, a third-party beneficiary is a person or company that may enforce a contract because the contract is made expressly for the benefit of the person or company. The court concluded that the reference to “any of our or its affiliates” in the arbitration provision does not refer to a parent corporation. In addition, the disclaimer of warranties in the lease indicated to the court that the warranty claims are unrelated to the lease and that the manufacturer is not within the scope of parties benefiting from, or obligated under, the lease and its arbitration provision.

Finally, TMCC argued that TMC was a third-party beneficiary based on its corporate relationship with TMC notwithstanding the specific meaning of “affiliate” in the lease (as a trust, Toyota Lease Trust is not a subsidiary of any entity). However, the McCarthy court concluded that the purported assignment of the lease to TMCC by way of Toyota Lease Trust was a “creature of Toyota’s interpretation.” The lease provided for an assignment to Toyota Lease Trust and Toyota did not provide any evidence of assignment to TMCC. The court held that Toyota lacked standing to enforce the arbitration provision and denied Toyota’s motion to dismiss and compel arbitration of the inverter claims.

Federal Court Enforces Electronically Executed Arbitration Clause

As the pandemic drove many dealers, finance sources, and consumers to execute automobile transactions completely electronically, questions continued to arise around the enforcement of key provisions, including the standard arbitration clause. In Gala v. Tesla Motors TN, Inc., the U.S. District Court for the Western District of Tennessee granted Tesla’s motion to compel arbitration against a lessee who sued Tesla, claiming that three weeks after he bought a new Model S, the vehicle accelerated on its own and crashed into his garage. The plaintiffs clicked a button and accepted both the vehicle order and the lease agreement online, a method that the court described as “valid” and “recognized” both in Tennessee and in courts “around the country.” Both contracts contained the same arbitration provision. Together with his wife, a non-signatory to either the vehicle order or the lease, the plaintiff lessee sought rescission of the lease contract or, alternatively, compensatory damages of at least $50,000, as well as $150,000 in punitive damages along with reasonable attorney’s fees under the Magnuson-Moss Warranty Act.

The plaintiffs argued that the arbitration provision was void for vagueness due to its “small claims” carve-out, arguing that the carve-out provision conflicted with the mandatory arbitration provision and that the phrase “small claims court” was vague and open to multiple interpretations. In ruling against this position, the Gala court concluded that the term “small claims” is defined by statute and, even if it were not, the carve-out would be severable under Tennessee law because the arbitration provision included a clause providing for an unenforceable clause to be severed.

Finally, the Gala court concluded that Tesla did not waive arbitration by removing the case to federal court before seeking to compel arbitration given that Tesla’s motions and proceedings were not related to the case’s merits. Instead, Tesla requested additional time due to the COVID-19 pandemic. The plaintiffs recognized that there was no harm or prejudice to them because they did not have to engage in discovery or respond to motions other than the procedural motion to compel arbitration, so the court had no problem granting Tesla’s motion to compel arbitration.

State Regulatory Developments

The first enforcement action by a state regulator enforcing fair lending law against assignees of retail installment contracts occurred in June 2021, when the New York State Department of Financial Services (“NYDFS”) announced settlements with two state-chartered banks. At issue were allegations that the banks violated the state’s fair lending law while engaged in indirect automobile lending. The NYDFS alleged that the banks’ business practices resulted in members of protected classes paying higher interest rates for reasons having nothing to do with creditworthiness.

According to the NYDFS, the banks failed to monitor markup rate discretion, which led to “dealers charging members of protected classes, namely race and ethnicity, more in discretionary [d]ealer [m]arkups than borrowers identified as non-Hispanic White,” resulting in a discriminatory disparate impact of their retail installment sale contract purchasing programs. Since creditors may price loans only on creditworthiness criteria, the NYDFS found no permissible reason for the disparity between protected classes and non-Hispanic white classes. The disparity violated both New York fair lending law and the federal Equal Credit Opportunity Act, which may be enforced by the NYDFS under New York law. The NYDFS found disparate impact using the Bayesian Improved Surname Geocoding (“BISG”) statistical method, which takes a surname probability by race and adjusts it up or down based on a zip code (or other area demographic composition) to adjust the probability of a particular classification.

The first consent order was reached with Adirondack Trust Company. The NYDFS alleged that for retail installment sale contracts purchased by Adirondack between January 1, 2016, through October 31, 2017, Adirondack charged borrowers that NYDFS identified as Black 0.59 percent more in dealer markups than similarly situated non-Hispanic white customers, charged Hispanic customers 0.46 percent more on average, and Asian customers 0.30 percent more on average. The bank, which had voluntarily discontinued its indirect auto lending program in November 2017, agreed to pay a $275,000 civil money penalty, restitute eligible affected borrowers, and contribute $50,000 to local community development organizations.

The second consent order was reached with Chemung Canal Trust Company. The NYDFS alleged that for retail installment sale contracts purchased by Chemung between January 1, 2016, and August 31, 2020, Hispanic borrowers had a higher rate markup on average than non-Hispanic white borrowers. Chemung maintained a policy permitting the difference between the rate offered by Chemung (the “buy rate”) and the contract rate (the difference called the “dealer markup”) to be up to 2.5 percent for transactions with terms up to sixty-nine months and 2.0 percent for transactions over sixty-nine months in the dealer’s discretion. The NYDFS statistical analysis suggested that Chemung charged Hispanic borrowers 0.27 percent more on average than similarly situated non-Hispanic white borrowers between January 1, 2016, and December 31, 2018, and 0.20 percent more between January 1, 2019, and August 31, 2020. The bank agreed to restitute affected borrowers, undertake fair lending compliance remediation efforts to increase its monitoring of dealers participating in its indirect auto lending program, and pay a $350,000 civil penalty.

Perhaps the most important term of this settlement is the requirement that the bank adopt a flat-fee compensation model with indirect auto lending. This requirement goes beyond settlement terms found even in the CFPB’s prior consent orders on this subject. The flat-fee model may kill the bank’s indirect automobile business, because finance companies that adopted flat-fee models in the wake of the CFPB’s initial consent orders, according to industry data, found a dramatic reduction in market share, causing some companies to exit the business.

The opinions expressed are those of the authors and are not intended in any way to represent the views of their employers or clients.