Murky Military Lending Act requirements leave industry scrambling

The Department of Defense's latest interpretation of the Military Lending Act, published last month, includes a murky set of rules that could retroactively put dealers and lenders in regulatory jeopardy, attorneys, compliance experts and industry trade associations say.

For now, industry leaders suggest that dealers consult their legal counsels, but sources are hopeful that the Defense Department soon will adjust the guidance.

The Military Lending Act was designed to protect active duty service members and their dependents in credit transactions. The protections include certain disclosures, arbitration provisions and a 36 percent interest rate cap on a finance agreement combined with ancillary and credit products.

Until now, motor vehicle finance transactions were believed to be exempt from the act. Only auto title loans had to comply with it.

Under the latest interpretation, if a vehicle finance contract for active military members or their dependents includes financing for credit-related products or services, such as guaranteed asset protection or other types of credit insurance, or provides cash-out financing, the creditor, which would be the dealership or lender, must comply with the act. Although the interpretation was published in December, the Defense Department says it has been in effect since the rule was amended Oct. 3, 2016. (Through cash-out financing, an uncommon practice at franchised dealerships, a customer can finance a product plus an amount in cash. For example, a customer could finance a $10,000 item plus $2,000 in cash. The customer would pay interest and other finance charges on the $12,000 principal.)

The latest interpretation of the Military Lending Act says that because products and services such as leather seats or extended warranties are related to the vehicle, they are exempt from the rule. Credit-related products and services, such as GAP and credit life insurance, are related to the finance transaction, not the vehicle, so they are included under the act.

Under the new interpretation, all retail installment contracts and consumer-protection product contracts must be updated to remove arbitration provisions or disclose that an arbitration clause is not applicable to borrowers covered under the act. Dealerships also are required to make a number of oral disclosures to covered borrowers at the point of sale.

"So under [the Department of Defense's] premise, we should have been already doing this, and that's where the real rub is," said Steve Roennau, vice president of compliance at EFG Cos.

If the rule was set to take effect after Dec. 14, dealers and lenders may have an easier time adopting it, Roennau said. But because the Defense Department said the industry should have been abiding by this rule since October 2016, dealers are unsure of how to address transactions that took place from Oct. 3, 2016, to Dec. 14, 2017. During that time frame, most likely were not checking the military status of their customers because they were unaware of the requirement.

Now, in some cases, dealers and lenders are challenged with identifying active duty service members and their dependents more than a year after they purchased GAP or another credit insurance product.

"You need to give people time to comply," said Tim Meenan, executive director of the Guaranteed Asset Protection Alliance. "All of those disclaimers and disclosures could have been developed in advance, and we wouldn't find ourselves in this position."

Now, the covered transactions that were completed between Oct. 3, 2016, and Dec. 14, 2017, could be considered void, some sources say.

"The challenge here is, according to the regulation, those contracts are void. Dealers and finance companies have been arguably unjustly enriched by money paid, but service members have been unjustly enriched by virtue of the fact that they've had a vehicle in their possession that they can use as they like," said Michael Benoit, partner at Hudson Cook, who has been working with the trade associations on the issue. "I would like to think this is a Scrivener's error."

The Defense Department may not be totally at fault, he said. "It's out of their wheelhouse. They may have not received the best advice" from some financial agencies, he said.

"What's the old thing they say about legislation? You never want to watch the sausage being made. It works in the regulatory world as well. Both legislatively and regulatorily, I think there was some really bad sausage-making that went on," he said.

Lender and dealer reactions to the latest interpretation are scattered, Benoit said. Until the rule is clarified, some dealers no longer will sell GAP to active duty military members and their dependents or have stopped selling GAP altogether. Some lenders are refusing to buy a contract with GAP if the buyer is an active duty military member or a dependent, or they will not fund GAP contracts for any customers. And some dealers and lenders are going through business as usual, ignoring the latest interpretation, Benoit said.

"I don't know if there is a best way" to handle the requirements, Benoit said. "All you're really doing is balancing risk."

Many dealers' course of action will be driven by the lenders, he said.

Ford Motor Credit Co. said in a letter to dealers that it will continue to purchase retail installment contracts with active duty military members and their dependents, but "until clarity can be reached on this matter, please do not include GAP, credit life or credit disability insurance. If Ford Credit determines the applicant is a Covered Borrower with GAP or credit insurance on the contract, the contract will be returned."

A Ford Credit spokeswoman told Automotive News the captive is unable to finance those products with military members and their dependents until it has had time to implement full compliance procedures in accordance with the Military Lending Act.

Mercedes-Benz Financial Services, Toyota Financial Services and Ally Financial each said it still is reviewing and evaluating the latest interpretation of the act. Other lenders declined to comment.

Some legal counsels have recommended that dealerships avoid transactions with military members and their dependents for now because of the interpretation's murkiness and because they may not yet have compliant forms. But that could lead to another problem, EFG's Roennau said. Denying the military could result in discrimination issues, he said.

Trade associations are urging the Defense Department to reconsider this interpretation and re-evaluate its effect on active duty military members and the auto finance industry.

The department issued the guidance without a notice or comment period, which sources said they believed may have been because it was an interpretation of a regulation, not a new regulation. But that left industry groups unable to explain how the interpretation could harm military members and affect dealerships and lenders before it was published. The National Automobile Dealers Association, the American Financial Services Association and the Guaranteed Asset Protection Alliance have contacted the Defense Department to address the issue.

"We met with the Department of Defense, explained to them how very concerned we are, particularly with the retroactive nature of this interpretive regulation," Bill Himpler, executive vice president of AFSA, told Automotive News.

AFSA is hopeful that the department "will revisit this issue in relatively short order and will make some sort of accommodations that either restore the overall exemption for vehicle finance or at a minimum retract part of the rule and put it out for notice and comment," Himpler said. "It's a much more complex issue than they first believed."

NADA spokesman Jared Allen said the dealer group is working with multiple federal agencies and members of Congress to address the issue and encouraging dealers to be diligent. "NADA is urging all dealers who sell to members of the military to immediately review this new DOD interpretation of federal law and consult with their legal counsel to determine whether to continue offering certain credit related products, such as GAP insurance, to military customers," he said.

Meenan, of the GAP Alliance, said that if the Department of Defense had gone through a rule-making process that included a notice and comment period, he doubts it would have issued the interpretation in the same form. "We're still hopeful that we can convince the Department of Defense that this is the wrong approach," he said. "We think it's unconstitutional to create a penalty retroactively. The Constitution allows businesses to know what is prescribed conduct. To be told after the fact that what you were doing" was illegal is unfair, he said.