The Subprime Auto Report

Does Your Special Finance Department Make Credit Decisions?

If you run a special finance department at an auto dealership you’re looking at bad credit all day. If you have any traffic at all, several times a day you’re also making decisions about which subprime lenders to send your customer’s applications to.

That’s a normal part of doing your job. But, if you’ve recently decided that a customer’s credit was too rough to send to any lenders and you sent them home without submitting them, you could be setting yourself up for a lawsuit, if you did not send them an Adverse Action Notice.

What’s An Adverse Action Notice and Why Does It Apply to Special Finance Departments?

An Adverse Action takes place when a customer applies for credit (verbally or otherwise) and a lender denies the application (you probably already know this). Banks, credit card companies, and other creditors regulary review applications and either approve or deny credit. If they choose to turn down an application, The Equal Credit Opportunity Act (ECOA) requires them to send an Adverse Action Notice to the applicant(s) telling them why they were denied. The spirit behind this law is to prevent discrimination by forcing lenders to give specific reasons why they denied credit to anyone.

Because you usually send your customer’s credit applications to at least one lender, your auto dealership has a certain degree of safe harbor from a discrimination lawsuit, as long as those lenders are compliant and send notices.

If you don’t send a customer’s credit application to any lenders, then you alone are required to comply with the notification requirement of the ECOA. In a case called Treadway v. Gateway Chevrolet Oldsmobile, a Chicago area dealership was sued in part for violating the notification requirement of the ECOA.

For the sake of keeping this post short here are the relevant details of the case:

Treadway, a consumer, received a direct mail solicitation targeted at consumers with recent bankruptcies and arrived at Gateway Olds to purchase a car.
Gateway ran her credit and decided she could not qualify for an auto loan and sent her home.
Gateway then called her and said they had a bank willing to give her a loan on a new car if she came up with a co-signer. They did not tell her that they in fact had not submitted her loan to any lenders.
Treadway came to the store and said her godmother, Pearlie Smith, would co-sign. The finance manager then approved Pearlie for an auto loan. The dealer sent someone to Pearlie’s house to sign the paperwork. She did not read the paperwork and did not realise that she alone had bought the car and that her goddaughter was not on the loan (a straw purchase).
After receiving statements from the subprime lender in Smith’s name only, both Treadway and Smith realised what had happened and stopped making payments on the car. Subsequently, Household bank repossessed the car. In 2001 Treadway sued Gateway for discrimination. Specifically they were sued because they made an adverse credit decision against Treadway and did not send an Adverse Action Notice to her.
In 2003 the district court ruled in favor of Gateway over a technicality regarding how the allegations were formed. The case went to appeal in 2004, where the defendant won the case.

Before losing the case on appeal, Gateway defended itself, in part, by saying they are not truly a creditor and therefore were not required to send an Adverse Action Notice to the Plaintiff in this case.

Gateway’s First Defense: “We Can’t Grant Credit. Therefore we can’t deny it either.”

Gateway first attempted to deny that any adverse action had occured to Treadway because they don’t have the ability to grant anyone an approval for an auto loan. Essentially they were saying, “She didn’t get an adverse action notice because we didn’t take any adverse action upon her. We’re just a dealership. We don’t deny credit. Banks do that.”

In their decision, the appeals court wrote:

By unilaterally deciding not to send Treadway’s application to any lender, Gateway effectively denied credit to Treadway. Whether it is the lender or the dealership that makes the decision, both the action and the outcome are the same. In both cases, the decision maker (1) reviews the applicant’s credit report to determine whether she is creditworthy, (2) makes a determination adverse to the applicant (i.e., that she is not creditworthy), (3) decides not to proceed any further in arranging credit and (4) as a result the applicant is not granted credit. There is no logical reason why these same steps would be considered an “adverse action” when taken by a lender but not when taken by a dealership, given that the result is the same in either case.

The lesson here: if you don’t submit credit applications to any lenders, then courts will look to you as a creditor and will hold you to all discrimination laws that your lenders have to comply with. I’m guessing you don’t want that kind of responsibility.

Gateway’s Second Defense: “The ECOA doesn’t require us to send an adverse action notice because we only accept and refer applications to lenders.”

It’s not disputed that dealerships are considered creditors for the purposes of preventing discrimination. The ECOA is clear on that. Gateway argued, however, that it was not a creditor that was required to send Adverse Action Notices because simply referring applications to creditors (what the finance manager does) does not make one a creditor for the purposes of the notice requirements of the ECOA.

However the appeals court found that Gateways’ role was more than that, and that it was required to send adverse action notices. Here’s why:

Gateway admitted that it regulary decided not to send applications to any lenders (therefore it sometimes makes the credit decision itself)
Gateway participates in the credit decision by restructuring or renegotiating the terms of the sale to meet the needs of a lender (more money down or rehashing a deal)
Gateway set the percentage rate and benefitted from doing so

The courts see your special finance department and your dealership as a true creditor. There’s no distinction, legally, between you and your lenders, especially if someone can prove you regularly decide not to send application to any lenders.

Best Way to Avoid Trouble: Always Send Credit Applications to Your Lenders

By not submitting Treadway’s application to anyone at all, Gateway made a credit decision that was adverse to her. By not sending her an Adverse Action Notice, Gateway Chevrolet broke the law. If they had sent the application to at least one lender, that lender would be required to comply with the ECOA. I’m not a lawyer, but based on what I have read, this would have helped them win this lawsuit. Here’s what the appeals court said:

Gateway’s actions are distinguishable from the common scenario in which an automobile dealership decides to send a credit application to a limited number of the many lenders with which it works. The Federal Reserve Board has clearly indicated that merely “selecting creditors to whom applications will be made” does not make one a “creditor” for purposes of the notice requirements of the ECOA. See 68 Fed. Reg. 13155. In that situation, at least one lender is given the opportunity to decide whether to extend credit. Therefore, it is the lender, rather than the dealer, that makes the credit decision. Where the dealer decides not to send out the application at all, however, it is making the credit decision. Moreover, if the dealer sends the application to at least one lender, there is another party that can provide notice to the applicant. Where the dealer decides not send out the application at all, only the dealer can provide notice.

As long as you’re submitting applications to lenders, according to this opinion, your dealership is not a creditor that needs to send adverse action notices to customers.

Best Practices for Special Finance Managers

According to the 2007 DealerTrack Compliance Guide, you should send Adverse Action Notices in the following 3 situations:

you take a consumer’s credit application but don’t send it to any financing sources
no lender approves the customer’s application for credit
you unwind a spotted deal

Adverse Action notices must be sent within 30 days of receiving an application. According to the Guide, you can print a sample Adverse Action Notice in the Documents and Forms section after you’ve logged in to DealerTrack.

Subscribe to TheSubprimeReport here to receive email updates

Disclaimer

I’m not an attorney. Don’t take this as legal advice. Just a friendly chat among friends.