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Making a Legal Distinction

April 2008, F&I and Showroom - Feature

by Michael Benoit

Let’s face it; the law is not always the most stimulating topic for those of you who have lives. But knowledge is power, and it’s important to your business. So, this month I’m covering a very basic credit concept that a lot of people don’t get. Don’t feel badly if you’re one of them — the concept is one only a compliance geek like me could love, and it’s kind of subtle.

I recently had the opportunity to speak to a large number of F&I managers. It became apparent to me while moving around the room taking questions that many clearly understood the legal structure of credit transactions. It also became apparent to me that some just did not.

The garden-variety auto finance transaction that takes place in the dealership is an “installment sale” that you document on a retail installment sale contract (RISC). The industry routinely refers to these transactions as “loans,” but that’s a bit like calling a handkerchief a Kleenex. Similar utility but constructed very differently. An installment sale and a loan both achieve the same purpose — financing the sale of a car — but they have vastly different structures governed by entirely different laws. Let’s explore.

A loan involves a borrower and a lender. The lender gives the borrower cash in exchange for the borrower’s promise to pay it back over time at some agreed-upon interest rate. When the loan is used to purchase a vehicle, the borrower takes the loan to the dealership and engages in a cash transaction. The dealer is not a party to the loan.

The parties to a loan transaction are a borrower and a lender, and the latter is usually a bank, credit union or some other entity licensed to lend money. Few dealers, if any, are licensed to lend money. Even if they were, fewer still have the available capital to do so. So, dealers need some other means of financing the cars they sell.

Enter the installment sale transaction. The essence of the RISC is the buyer (your customer) agrees to pay the seller (that’s you) some amount of money over a period of time in exchange for the title to the vehicle. Unlike a loan transaction, there is no lender — just you and your customer. As far as the customer is concerned, that’s the end of the transaction. They are obligated to you, and you are obligated to them under the terms of the RISC.

Well, unless the principal at your dealership is named Buffett or Gates, you’re not going to be able to conduct many installment sale transactions before you run into serious cash flow problems. You need cash to pay off your floorplan so you can finance new inventory. Fortunately, you now have a new asset that you can sell — the RISC.

Enter the finance companies and banks. When you send credit applications to these financing sources to approve installment sale transactions, you are not asking them to lend money to your customer. In fact, they will not be a party to the RISC. You are asking them if they will buy the RISC you and your customer will sign. When one says “yes,” you know you will soon have cold, hard cash you can use to pay off your floorplan and take your profit.

So, here’s how much of your auto finance business works. You negotiate an installment sale transaction with your customer, then send the credit application to a finance company for approval. When you receive an approval, you and the customer execute the RISC. Then the customer can drive away in his or her new vehicle. You then sell the RISC to the finance company, which pays you cash and takes over your obligations under the RISC. You pay off your floorplan (which then makes that capital available so you can acquire more inventory), pay your employees and take your profits.

Like I said, don’t feel badly if you’re just realizing you don’t make loans to your customers. Even the courts and legislatures around the country have difficulty with that distinction. Unfortunately, they of all people should be the ones who get it. Understanding that distinction is critical to determining what laws are applicable to the dealership, and “getting it” will lay the foundation for much more effective compliance in your store.

Welcome to my world!

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 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.

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