The Calculus of Adverse Action

January 2007, F&I and Showroom - Feature

by Michael Benoit

You’ll notice that, from time to time, I’ll devote a column to those pesky adverse action notice requirements. For those of you who may be thinking that I do this because it’s all the law I know, let me assure you that I have other talents as well. This just happens to be one area of compliance I see as important and evolving, and one that I am more and more convinced is not well understood by the dealer community. Dealers would be well served to address in their rigorous (and enterprise-wide) compliance programs their adverse action notice obligations and policies and procedures to mitigate risk.

Spot deliveries gone awry pose a specific adverse action issue for dealers, particularly where nonprime customers are involved. Take the case of Thelma Robertson from Virginia. After seeing a commercial for a well-known lead-generating company on television, she called the lead generator and completed a loan application over the phone. Within 10 minutes of speaking to the representative, Thelma received a call back instructing her to go to her local dealership to buy a car with her approved loan. At the dealership, Thelma executed a retail installment sale contract and drove off in her (new) used car.

A month later, Thelma contacted the dealership to check on the status of her permanent tags. She was told that her contract had been denied and that the dealer had to repossess the car. As you might imagine, Thelma was a bit miffed. She sued the dealer, alleging, among other claims, that the dealership violated the Equal Credit Opportunity Act (ECOA) and the Fair Credit Reporting Act (FCRA) when it failed to provide her with an adverse action notice. The dealer moved to dismiss her claims, primarily on the grounds that it was not a “creditor” in the transaction, and therefore was not required to give an adverse action notice.

The U.S. District Court’s Western District of Virginia denied the dealer’s motion to dismiss. Citing the ECOA, it noted that a “creditor” includes “any person who … regularly arranges for the extension, renewal or continuation of credit …”The court found that Thelma pleaded facts sufficient to support her claim that the dealer acted as the creditor (presumably by working with finance sources to arrange financing), had taken adverse action against her and failed in its obligation to provide her with an adverse action notice required under the ECOA.

The court also found that Thelma had pleaded facts sufficient to support her claim that the dealer took adverse action against her based on either “information contained in consumer reports” or “information obtained from third parties other than consumer reporting agencies (the standard for adverse action under the FCRA),”and that the dealer failed to notify her of the adverse action altogether or failed to notify her properly as required under the FCRA.

For both ECOA and FCRA purposes, “adverse action” means “a denial or revocation of credit, a change in the terms of an existing credit arrangement, or a refusal to grant credit in substantially the amount or on substantially the terms requested.” I expect the dealer will be able to prove facts that allow it to overcome Thelma’s adverse action challenge under the ECOA, but not because the dealer isn’t a creditor or because the adverse action didn’t occur. The dealer’s best defense will be to show that the third-party finance company involved in the transaction provided adequate notice.

Dealers routinely rely on third-party finance sources to provide adverse action notices when credit is denied. As we’ve noted before, the ECOA expressly allows dealers to do so. But dealers need to remember that doing so does not relieve the dealer of liability for the notice obligation. In other words, you better hope the third-party finance company you rely on to send out adverse action notices gets it right.

Thelma’s FCRA allegation is more troubling. The court could find that the act of taking the car back was the adverse action — an action solely in the control of the dealer. Remember, in a retail installment sales transaction, the contract is between the dealer and the buyer (the finance source merely steps into the dealer’s shoes when the contract is assigned). In Thelma’s case, the dealer will not be able to point to the finance source as the entity responsible for repossessing the car because the contract was never assigned (and the dealer admits that it took the car).

Don’t be too cavalier regarding your obligations to send adverse action notices. A good internal compliance program can help you organize your business to limit the number of notices you need to send and, more importantly, identify those times when you do. Put yourselves in the shoes of Thelma’s dealer — would you rather spend 39 cents on a stamp or $39,000 (or more) contributing to your lawyers’ disposable income fund?

You do the math.

Michael Benoit is a partner in the Washington, D.C., office of Hudson Cook LLP. He is a frequent speaker and writer on a variety of consumer credit topics. He can be reached at michael.benoit@bobit.com. Nothing in this article is intended to be legal advice and should not be taken as such. All legal questions should be addressed to competent counsel.