A dealership cannot roll negative equity -- the amount a customer owes on a trade-in after its value is deducted -- into the purchase price of another vehicle, a California court has ruled.
The California Court of Appeals ordered that dealerships must disclose negative equity in writing on sales finance contracts. Failure to do so, the court said, would illegally inflate sales prices.
In so doing, the court ruled, dealerships would violate state and federal disclosure laws. They would create more risk for lenders. And they would overcharge customers for sales tax and license and registration fees, which are based on the cash price of vehicles, the court said.
The defendant in the case is a motor home dealership. It did not respond to an inquiry about whether it plans to appeal the ruling.
The court's decision has implications for car dealers as well, says Peter Welch, president of the California Motor Car Dealers Association.
Like motor home dealerships, Welch notes, car dealerships finance vehicles. Many customers have liens on their trade-in vehicles. Federal and California laws require dealerships to disclose negative equity.
"The court said it was fraud to inflate the selling price without telling the customer what you are doing," Welch says.
Charles Ognibene, a Boston attorney who represents auto finance companies, says most states allow dealerships to finance negative equity.
"The real limiting factor is credit policies of the banks and finance companies," Ognibene says.
Jim Ganther, an attorney with Continental-National Service Corp. in Tampa, Fla., which sells insurance products to dealerships, says the California ruling leaves dealerships with a tough choice.
Lenders often refuse to finance negative equity, Ganther says. When dealerships disclose negative equity, they generally lose the financing and the sale, he adds.
Ognibene says a dealership can face legal problems even if a lender agrees to finance negative equity.
"The laws of some states are a barrier," Ognibene says. "Advancing money to pay off a customer's old contract is selling on credit. It is making a loan."
To pursue such a transaction in those states, he says, the dealer needs a lending license.
Jon Sheldon, an attorney with the National Consumer Law Center in Boston, says he is aware of at least three similar decisions involving car dealerships since 1988.
Sheldon calls the practice of inflating the trade-in value and sales price "an attempt to deceive the consumer or the lender."
Ganther says plaintiff's lawyers could use disclosure of negative equity to file class-action lawsuits against car dealerships around the country.
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