A recent federal court decision in Arizona muddies the issue of whether dealers should disclose negative equity in a car sale.
Negative equity arises when a customer owes more on an auto loan than the vehicle is worth.
The case, Slover-Becker vs. Pitre Chrysler-Plymouth-Jeep of Scottsdale Inc., suggests that dealers can roll negative equity into the price of a vehicle for sale without disclosing it on finance and lease contracts.
The Federal Reserve Board has required dealers to disclose negative equity in contracts since 1998. Other court rulings since have supported disclosure.
Despite the Arizona ruling, industry legal experts warn that dealers should play it safe and disclose.
"We believe that the Federal Reserve Board intended creditors and dealers to bring negative equity into the daylight and not bury it in the cash price of the vehicle," says Kenneth Rojc, a Chicago attorney who represents financial institutions.
Industry attorney Tom Hudson of Hanover, Md., says the Federal Reserve rules are clear. Dealers should include the negative equity in the total amount financed and disclose it as a line item in the section of the contract itemizing the amount financed, he says.
Hudson suggests calling it "prior credit" or "lease balance"; Rojc recommends "amount paid to others."
Negative equity complicates many car transactions. Industry experts estimate that at least 30 percent of car buyers owe more than their trade-ins are worth and that the percentage could climb as loan terms grow. When loans are spread over a longer period, it takes longer for the borrower to build equity in the vehicle.
The Fed disclosure policy also is facing more court tests.
"Last year, we picked up three negative-equity cases in addition to the Arizona case," says Teresa Rohwedder, editor of CarLaw, a Hanover, Md., online publication that tracks legal decisions and regulation. Before then, she says, "We haven't really seen any cases in several years."
Hudson says that even after the Fed required disclosure, some dealers continued to roll negative equity into the price of new vehicles and inflate the trade-in amount to hide negative equity. These dealers run the risk of getting sued, he says.
Case in point
In the Arizona case, Christina Slover-Becker bought a 2000 Mercedes-Benz ML320 from Pitre Chrysler-Plymouth-Jeep of Scottsdale Inc. in 2003. She traded in a 2001 Jeep Grand Cherokee and provided a down payment of $4,400, according to court documents.
She had negative equity of $10,800 from the Grand Cherokee, which the dealership did not disclose in the loan contract for the Mercedes, the documents say.
Slover-Becker complained that the dealership violated the federal Truth In Lending Act by rolling the negative equity into the price of the Mercedes and failing to disclose the amount as a separate item.
But in November, the U.S. District Court for the District of Arizona ruled the dealer's actions were legal. The decision was published last month.
The court ruled that the negative equity was not a finance charge, requiring disclosure under the federal Truth In Lending Act. It also concluded that federal rules allow dealers to include the negative equity in the purchase price.
The court said disclosure would not have helped the plaintiff understand the credit terms any better.
"While the retail installment sales contract in this case may not have disclosed all the details of the contract between the parties, it did disclose that which the Truth In Lending Act requires: the cost of the credit transaction," the decision says.
Not the last word
The Arizona ruling contradicts other decisions, such as the Reta Thompson vs. 10,000 RV Sales Inc. case last year. In that case, the California Court of Appeal, Fourth District, Division 1, ruled that a motor-home dealer that failed to disclose negative equity violated state law.
Two other cases last year in Texas and Florida also favored disclosure.
In the Florida case, the U.S. District Court for the Middle District of Florida wrote that when a Hyundai dealership rolled the debt into the vehicle price, it was "making it appear that they were not including debt in the financing for the new vehicle."
"By balancing the trade-in in this way," the court said, "the defendant disguised the fact that the trade-in was actually a negative down payment."
Industry attorneys say the Arizona case is not the final word on disclosure. Says Hudson: "The recent cases have called attention to the issue of negative equity, and I expect we will see a small flurry of cases."
You may e-mail Donna Harris at [email protected]