Instead, what most people call a loan concluded at the dealership should be called a credit sale of property — a transaction significantly different from getting a loan of cash from a bank. And the auto lender that buys the finance contract should be called a credit company, Hudson said.
In a spot delivery, for instance, the dealer is legally the creditor, not the credit company that eventually buys the contract, Hudson said in an interview. The dealership theoretically could collect on the loan instead of selling the contract to a bank or a captive finance company.
Hudson is managing partner of Hudson Cook LLP of Linthicum, Md., and a principal in Consumer Credit Compliance Co., which publishes the CARLAW newsletter.
Why does it matter? The legal terms are important if a customer sues the dealership because loans and credit sales are governed by different laws in most states, he said. Federal disclosure requirements also differ for the two types of transactions. In general, fewer restrictions are put on credit sales than on loans.
“If a plaintiff’s lawyer can convince some judge ... that what is really happening is a loan from the finance company to the customer, the judge will then apply state loan laws (usury limits, limits on other fees and charges, etc.) and federal loan disclosure requirements to the transaction, and (the judge) will find that the transaction violates these laws,” Hudson said in CARLAW.
State usury limits put a ceiling on the interest a lender can charge on a loan, but credit sales provide a way around those restrictions.
Hudson said dealerships should avoid misusing the terms to avoid “giving ammunition to the enemy.”
But he admits that getting people to use the legal terms correctly is probably a hopeless cause — like trying to persuade people to say tissue instead of Kleenex, or copier instead of Xerox. If the dealership’s documents refer to the finance company as the lender or to the transaction as a loan, opposing lawyers can use those documents as proof the dealer and the finance company viewed the transactions as loans, not credit sales, he said.
“The dealer has given the customer the keys to a $25,000 car in exchange for a signed piece of paper. That’s the extension of credit,” Hudson said.
“Later — maybe a millisecond, maybe a week — the dealer will sell the contract to the sales finance company. Even though a sales finance company has agreed to buy the contract, the dealer usually has no contractual obligation to sell the contract to the finance company. In theory, the dealer could keep the contract and collect the payments from the customer,” he said.
“But usually the dealer elects to sell the contract to a finance company. That sale is not an extension of credit. That sale is a commercial transaction, in which one business entity sells an asset to another business entity,” he said.
How important is the difference? Hudson answered the question with the title of a speech he once gave on the subject: “Wanna Buy Your Lawyer a Yacht?”