U.S. scrutiny of dispute provisions in loan contracts threatens dealerships

U.S. dealerships, which increasingly ask car buyers to sign binding arbitration agreements in the finance and insurance office, soon could be barred from using that dispute-resolution provision.

The Consumer Financial Protection Bureau is nearly a year into its public inquiry into how such arbitration clauses affect consumers and financial services companies. Congress required the study as part of the Dodd-Frank Act and gave the bureau power to make regulations to protect consumers.

The scrutiny has some prominent dealership legal and compliance experts warning that today's widespread use of the agreements in vehicle sales is likely to end. Nearly 40 percent of dealers responding to a recent unscientific Automotive News survey also expressed concern that they soon will lose the arbitration option.

"I think arbitration is on its last legs," said Tom Hudson, a partner in the Hudson Cook law firm in Hanover, Md., who predicts the bureau could issue such a ruling before year end.

For dealers, the end of arbitration would mean the loss of a tool they say speeds up dispute resolution, cuts costs, helps keep them out of court and minimizes the risk of class-action lawsuits. Consumer advocates say the end of arbitration would put dealers and consumers on a more level playing field in a court of law.

The potential change is causing concern among dealer principals, dealership compliance directors and finance directors. Dealerships typically ask consumers to agree to arbitration in a stand-alone agreement or as part of the retail installment sales contract signed in the F&I office.

The industry's use of arbitration agreements has increased substantially in the past 10 to 15 years, Hudson and other experts say.

"Dealers are probably inclined to use arbitration now more than ever," says Terry O'Loughlin, director of compliance for Reynolds and Reynolds, the dealership services giant that provides documents to retailers. "You're talking about a tremendous potential liability that dealers will now face."

O'Loughlin also is betting the bureau will prohibit binding arbitration agreements, though he predicts it might take two years. As a lawyer, O'Loughlin investigated and prosecuted dealerships and finance companies for the Florida attorney general for 16 years before moving to Reynolds and Reynolds seven years ago.

The use of arbitration agreements can vary widely from state to state, and national data aren't available, according to Reynolds.

In some states -- California, Florida and Virginia, for example -- arbitration agreements are used in the majority of deals. In California, considered one of the most active states with regard to litigation, O'Loughlin estimates that at least 70 percent of retail installment sales contracts include arbitration provisions.

In the Automotive News survey, 59 percent of respondents said they ask customers to agree to arbitration as a standard practice.

For its part, the Consumer Financial Protection Bureau says it has no pending or proposed rules that would impact the vehicle loan process directly, and a bureau spokeswoman declined to comment "on potential actions that the bureau would take."

But although franchised dealerships generally are exempt from the Consumer Financial Protection Bureau's oversight, the agency has purview over arbitration. It could limit dealerships' use of arbitration agreements by issuing a rule or engaging in enforcement action against the lenders that buy paper from dealerships, says Hudson, the dealership lawyer who specializes in F&I matters.

If the bureau deems it an unfair or deceptive act to buy contracts that include mandatory arbitration agreements, dealerships effectively will be blocked from using them, Hudson says.

The agreements theoretically could still be used in cash deals, he says.

Hudson says he predicts the bureau will block predispute arbitration agreements largely because "consumer advocates in the country have been screaming and yelling that arbitration is unfair to consumers for years."

One consumer advocate seeking the end of arbitration agreements says the bureau's inquiry gives her more optimism about the issue than she has ever had.

"That's because the agency is so independent," says Rosemary Shahan, president of Consumers for Auto Reliability and Safety, which is based in California. Shahan contrasted the bureau with Congress, where previous attempts to rewrite arbitration laws have faltered and where she says car dealers hold much more sway.

Shahan and other consumer groups have submitted testimony and arbitration case studies to the bureau to consider.

In some cases, car buyers have been unable to get problems solved or to get an arbitration proceeding scheduled for years after a dispute began, Shahan says. She also contends that arbitrators are biased in favor of dealerships, which typically pick up the bill for arbitration.

"Mandatory predispute binding arbitration is really bad for consumers," Shahan said. "So we are hoping that the Consumer Financial Protection Bureau will prohibit it."

Many dealers, on the other hand, contend that arbitration agreements benefit consumers as well as dealers.

"It gives each party a lot of legal rights, but it controls some legal expenses and controls the process," said Scott Smith, president of Sonic Automotive Inc., the nation's third-largest retailer. "It still provides protection for the consumer, and it provides protection for the dealer."

Minimizing the risk of a costly class action is the key benefit, many dealers and industry experts agree.

Though the agreements are used widely, arbitration rarely happens. Only three of 79 respondents to the recent Automotive News survey said they've participated in arbitration with a customer in the past two years.

Smith said Sonic tries to resolve consumer complaints before a problem gets to arbitration. A very small number of complaints reach that point. "It might not even be a single-digit" percentage, he says.

As with many retailers, signing an arbitration agreement is mandatory at Sonic. Almost half of the respondents to the Automotive News survey said they won't complete a sale if the customer refuses to sign an arbitration agreement.

"A customer doesn't have to buy a car from us, but if they want to buy a car from us, they have to agree to the arbitration agreement," Smith says.

Asbury Automotive Group Inc., the nation's seventh-largest dealership group, also asks customers to sign arbitration agreements.

"We take compliance very seriously," says Asbury CEO Craig Monaghan, stressing the training and oversight that goes on in Asbury's F&I offices. "One of the advantages of the arbitration agreements is they help defend against frivolous lawsuits."

Monaghan said he will watch the scrutiny of arbitration closely.

Skip Davenport, dealer principal at D&D Ford in Greer, S.C., has been using arbitration agreements for at least 10 years and says it's important for dealerships to preserve the option. He aims to satisfy customers without involving lawyers.

"At the end of the day, if our customer isn't satisfied and happy and telling their friends in the community that we did a good job for them, it doesn't benefit us in any way," Davenport says.

His dealership is one of about 300 in South Carolina embroiled in class-action claims that the stores collected millions of dollars in illegal administrative fees from customers. Some of the claims are still active, and they show why dealers need the legal protections arbitration agreements can provide, Davenport says.

Whether dealerships ultimately will keep the option will come down to the Consumer Financial Protection Bureau.

Says O'Loughlin of Reynolds and Reynolds: "Is the deck stacked against dealers and other organizations that prefer arbitration? It may be. I hope there's still some small sliver of hope there, but we'll see."

Eric Freedman contributed to this report