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Old Wine In A New Bottle

A California appellate court case dealing with negative equity has caused quite a stir. Some automotive trade publications erroneously screamed that the court had ruled that dealers couldn’t finance negative equity (it might have helped if they had actually read the case).

The case stands for the proposition that if a dealer is going to finance negative equity, the dealer must do so in a particular manner. The court’s decision breaks no new ground; it’s mandate for correctly financing negative equity has been the law at the federal level since the Civil War (just kidding, but you get the idea). Old wine, new bottle.

So how does a dealer do it wrong, and how does a dealer do it right? Let’s look at the facts of the California case.

Reta Thompson bought a used motor home from 10,000 Sales RV, Inc. Thompson required financing to buy the used motor home and as part of the sales transaction, agreed to trade in her old motor home. She owed a balance of $46,000 on her old motor home.

Although 10,000 RV appraised Thompson’s old motor home at $30,000, it credited Thompson $54,000 for the trade-in, creating an “over-allowance” of $24,000. The over-allowance permitted 10,000 RV to show on the face of the financing contract a positive net trade-in-value of $8,000 ($54,000 credit minus $46,000 balance owed) to apply to the down payment of the used motor home. However, because Thompson owed $46,000 on her old motor home and 10,000 RV appraised it at $30,000, negative equity of $16,000 existed.

10,000 RV explained that the purpose of including an over-allowance in the cash selling price is to eliminate the appearance of negative equity and increase the prospect of obtaining credit approval for the buyer. The opinion notes that a cash buyer would never be credited an over-allowance because there is no need to obtain financing in a cash transaction (this certainly isn’t true – a dealer paying off a customer’s upside-down trade-in in a cash deal could certainly elect to charge more for the newly-purchased vehicle, but apparently 10,000 RV didn’t make that argument or the court didn’t buy it).

10,000 RV made no disclosure to Thompson about its over-allowance practices. Without Thompson’s knowledge or consent, the $24,000 over-allowance was added to the $69,398 price that a cash purchaser would pay, to show a cash price of $93,398 on the financing contract.

Thompson sued 10,000 RV, claiming that the trade-in vehicle’s value was inflated to hide the negative equity associated with the transaction; the negative equity was included in the cash price of the used motor home; no disclosure was made concerning the negative equity; and that 10,000 RV customarily refuses to disclose the inclusion of negative equity in the cash price listed on its financing contracts.

The trial court ruled for Thompson, finding that 10,000 RV violated various consumer protection statutes, including the California Automobile Sales Finance Act, the Consumers Legal Remedies Act, and California’s Unfair Competition Law. 10,000 RV appealed, challenging the trial court’s injunction that prohibited it from including a trade-in over allowance in the vehicle cash price on a financing contract. The California Court of Appeals affirmed the trial court’s ruling.

The appellate court relied on expert testimony, providing that the practice of including a trade-in over-allowance in the vehicle cash price violates the California ASFA and its corresponding federal regulation, Regulation Z, because the buyer is unaware that she is financing part of the existing obligation on the trade-in (negative equity) in addition to a portion of the purchase price of the new vehicle. Accurate disclosure is also required because the cash price of the vehicle affects sales tax and license and registration fees, which are computed on the cash price.

To the extent the cash price for a financed purchase is inflated above the selling price in a comparable cash transaction, the difference is a finance charge, which must be properly disclosed, the appellate court said. In this case, the cash price of the used motor home should have been $69,398 in both a cash and credit transaction (here again, either 10,000 RV didn’t make the argument or the court didn’t buy it, but if 10,000 RV’s policy had been to increase the cash price of the vehicle in financed and credit transactions alike, the court’s finance charge analysis wouldn’t hold up).

The cash price for the motor home in Thomson’s credit transaction was $93,698 – the $24,000 difference that constituted a finance charge was not properly disclosed to Thompson as a finance charge. Thus, the appellate court found that 10,000 RV violated the ASFA and other California state law by inflating the cash price of the motor home to include the trade-in over-allowance and hide the appearance of negative equity, without full and complete disclosure to its customers.

A correct statement of the court’s ruling in this case is reflected in one sentence: “Although financing properly disclosed negative equity is permissible under the ASFA and Regulation Z, it is not permissible to include the over-allowance in the cash price of a vehicle.” Or, to paraphrase, “if you’re gonna do it, you gotta do it right.”

Thompson v. 10,000 RV Sales, Inc., 2005 WL 1523498 (Cal. App. June 28, 2005)

Vol 2, Issue 9



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