A recent action by the Federal Trade Commission may prompt more lawsuits against banks — and bigger payouts to plaintiffs — in situations where consumers have been defrauded by auto dealers.
The FTC’s move involves an obscure consumer protection rule from the 1970s, but its effects are likely to be substantial. It could result in lenders being on the hook more often for defrauded borrowers’ legal costs, particularly in cases where the car dealership has shut down and customers have nowhere else to turn for a refund.
At the moment, defrauded consumers can go to court to recoup the money they paid for their car, but filing such cases can cost them thousands of dollars. Banks argue they should not be liable for paying customers’ attorney fees in full, and some courts have sided with them.
The legal uncertainty often prompts consumer lawyers to turn down cases because they cannot recoup their costs, said Kevin Faulk, a California-based attorney who has sued auto lenders and dealers.
“A whole lot of cases are never litigated, and people are unable to get their money back,” said Faulk, who estimates he turns down two or three cases a week.
Auto lenders have relied on the FTC’s Holder rule, which has been in place since 1975, to argue that their liability is limited only to what car buyers paid in the original sales contract. The rule applies to both banks and nonbank lenders that offer auto loans through dealerships, an arrangement known as indirect lending.
In an advisory opinion last month, the FTC said that its rule does not supersede any state laws that put more liability on banks that are the “holders” of a loan contract.
“Some courts and finance companies have misinterpreted the Commission’s statements to suggest that the rule preempts state laws that authorize attorney fee awards against loan holders,” the FTC said in a press release. “The advisory opinion emphasizes that the Rule does not eliminate any rights a consumer may have as a matter of separate state, local or federal law.”
Although the FTC’s opinion is not binding, it is already figuring heavily in a case currently pending before the California Supreme Court.
Consumer lawyers in other states will also likely pore over state and federal laws to see whether the FTC’s opinion may help them in their own cases, corporate attorneys say.
“This will be a source of work for lawyers, and bad news for finance companies,” said Alan Wingfield, a partner at the law firm Troutman Pepper who represents auto lenders.
The more immediate impact is likely to come in California, where a customer named Tania Pulliam is suing TD Auto Finance over a used car she bought in 2016.
Pulliam, who is disabled, alleges that she realized the car did not have cruise control and adjustable seat features, as the dealer had advertised, only after making the purchase. She sued both the dealer and TD — and argued the bank, as the holder of the loan, was liable for the dealer’s actions.
A state court ruled Pulliam was eligible for $21,957 in damages, plus nearly $170,000 in attorneys fees. An appeals court upheld that decision.
The total award was 15 times more than the roughly $12,500 that Pulliam paid for the car, TD’s lawyers have said. But Pulliam’s lawyers argue that TD exposed itself to more liability by fighting the case rather than settling in the early stages of litigation.
In a filing last year, Pulliam’s lawyers wrote that TD’s goal was to make it “impossible for consumers to sue the holders of their consumer credit contracts when they have been cheated by fraudulent sellers.”
TD wrote in its appeal to the state Supreme Court that the Holder rule is clear that “consumers cannot obtain fifteen times” the amount they spent on the car. The bank has pointed to language in the rule that says customers’ potential to recover money “shall not exceed amounts paid by the debtor hereunder.”
“If creditors risked uncapped attorney’s fees when financing consumer contracts, they would be less likely to take that risk and finance those contracts,” TD’s lawyers wrote in a filing last year.
TD also said that if banks were to get sued in those circumstances, the “blameless creditors would be discouraged from mounting a legal defense,” and instead would offer to settle more cases upfront, because of the “threat of paying hundreds of thousands in attorney’s fees for a several thousand dollar consumer claim.”
The American Bankers Association and the Consumer Bankers Association, two leading industry groups, filed a brief with the California Supreme Court supporting TD Bank’s position.
The FTC’s advisory opinion is already playing a role in the case, with Pulliam’s lawyers writing in a filing that “this new clarification from the FTC should help” the court in its analysis. “The FTC’s conclusion that it did not intend to preempt state law under the circumstances raised in this case should be determinative,” Pulliam’s lawyers wrote.
But TD’s lawyers replied last week that because the Holder rule is “not ambiguous, there is no need to delve into FTC commentaries on the rule.” They argued the Holder rule’s language is clear in capping lenders’ liability, and they said the relevant California law was passed years after the 2016 auto purchase and shouldn’t be applied retroactively.
Consumer advocates hope the FTC’s opinion and the California Supreme Court case will push auto lenders to vet the dealers they work with more closely.
Rosemary Shahan, president of Consumers for Auto Reliability and Safety, said lenders should be ensuring that used-car dealers are not selling vehicles that are listed as totaled in a federal database.
“If they see a pattern there of dealers selling these totaled vehicles, that’s a red flag,” Shahan said.
Wingfield, the Troutman Pepper lawyer, said the FTC opinion “moved the needle,” so he is advising auto lender clients to assess the increased risk they face from litigation.
Steps that lenders can take include reviewing their compliance programs and performing quality checks on the loans that auto dealers send them, as well as reviewing legal agreements with dealers to ensure there is an “appropriate allocation of risk,” Wingfield said.
Despite the increased legal risk, Wingfield noted that the auto lending industry is currently booming, with loan originations soaring and delinquencies remaining at low levels.
“This is, in a way, the best time possible for a bank or a finance company to address this increased risk, because times are good,” Wingfield said. “This is the time to do it.”
