Auto Finance Companies Cannot Avoid Liability by Sending the Contract Back to the Seller
Wednesday, December 27th, 2023
Most vehicles are purchased through a process called indirect lending. Customers sign a contract to buy their vehicle from a seller, then the seller sells that contract to a third-party finance company. The customer then makes their monthly payments to the finance company. The finance company then owns the contract and is what is known as a “holder in due course.” Most vehicles are sold this way. If you have bought a vehicle and made monthly payments on it, this is probably how it happened. As the holder of the contract, the customer is liable to the finance company payment. However, before 1975, the customer could not assert defenses against the finance company since the finance company was not a party to the original sale. This arrangement could create problems for the customer if the original seller did something wrong or sold a bad product. The buyer could be stuck paying the third-party finance company for a vehicle that may be worthless.
In 1975, the Federal Trade Commission created a regulation that allows buyers to assert any claims and defenses against the third-party finance company that they could assert against the original seller. The regulation is known as the FTC Holder In Due Course Rule.
But what if a holder in due course reverses course and sends the contact back to the original seller? The Bank of Oakland had purchased a vehicle contract from an original seller and received several monthly payments from the customer before the customer notified the bank that there was a problem. The bank promptly canceled its transaction with the original seller, returning both the contract and all the payments made. Thus, everyone was in the same position as before the bank bought the contract from the seller.
The bank still got sued by the customer for the actions of the original seller. The bank asked the court to dismiss the lawsuit against it because it was not a party to the contract and it was no longer a holder in due course of the contract. While the trial court agreed with the bank, the court of appeals did not. The bank’s liability under the FTC’s Holder Rule attaches once it buys the contract from the original seller. The fact that the bank might later unwind its deal with the seller is irrelevant.
This ruling furthers the Holder Rule’s goal of making finance companies police the actions of vehicle sellers. The FTC believes that finance companies will avoid bad sellers if they become liable for the sellers actions, thus causing the bad sellers change their behavior. Were a holder able to avoid liability simply by simply reversing the assignment, there would be no need to police the actions of sellers. On the other hand, it does not further the FTC’s goal of preventing the separation of the customer’s liability for payment from the seller’s liability for its actions. In this case, everyone was put back in the same position as they were before the bank became holder of the contract and the customer was left to deal with the same company he chose to buy from.
Read the Full Decision Here: Grayot v. Bank of Stockon