We’ve talked a lot about “process and procedure” in these columns, particularly as it relates to compliance. The operative word here is good, because procedures that conform to a lesser standard can really put a dent in your retirement plan.

Case in point is Danny Dealer in California, who is being sued for allegedly disclosing negative equity (the amount a buyer is upside down on their trade) incorrectly. This is an ongoing case (unless it settled before the issue’s publication) and the names are changed to protect the innocent.

Paul Plaintiff sued Danny for violating the disclosure requirements of California’s Automobile Sales Finance Act (ASFA), as well as other state laws. Specifically, Paul is alleging that Danny disclosed some or all of the over-allowance from his trade in the cash price disclosure for his new car on his retail installment sale contract (RISC).

Paul contends that his RISC is unenforceable as a matter of law, basing his charge on two points:

1. By including Paul’s negative equity in the cash price, including the over-allowance for a trade-in (as opposed to disclosing it separately), Danny disclosed the cash price in the RISC incorrectly (thus violating ASFA, among other things).

2. Paul may have paid a higher sales tax and registration fee because of an artificially inflated cash price.

Paul hired Larry Lawyer to pursue his claims. Larry knows a dollar sign and a lot of zeroes when he sees them, and he figured that if he can prove that Danny did this to Paul, he can probably prove that there were other victim’s of Danny’s alleged business dealership. More plaintiffs means a bigger potential award (and of course, more attorney fees). So he filed the claim as a class action on behalf of Paul and “all persons who, since Dec. 28, 2000, purchased a vehicle from Danny Dealer. He’d charge that the customers entered into a RISC and had the cash price of the vehicle purchased increased on line 1.A.1 of the RISC. He alleged Danny did this to cover some or all of the overallowance. Larry Lawyer also claimed that Danny Dealer failed to properly disclose the prior credit or lease balance owing.”

Danny is a franchise dealer, and it doesn’t take a genius to figure out that the number of folks who bought a car on credit with a trade over the last seven years is probably pretty high.

In order to sustain a class action, the court first has to agree that the claims are of the type for which class treatment makes sense, and that the class is adequately defined (the rules are actually more complicated — we’re lawyers, after all — but that’s the gist of how it works). Although the trial court refused to certify the class, the California Court of Appeal reversed that decision. It found that Larry’s proposed class had common issues of fact and law. The core factual issue was whether the cash price of the vehicles being bought included an over-allowance for trade-ins without adequate written disclosures. The core legal issue was whether this failure to disclose negative equity on the RISC violates the ASFA. From a proof perspective, the court noted that the parties would be able to tell from Danny’s customer records whether the ASFA had been violated.

Now, it is entirely within the realm of reason that, at worst, Paul’s complaint is nothing more than an aberration, (i.e., a mistake by a new finance employee, or a programming error). At best, it just didn’t happen. That’s probably not the case since Larry is unlikely to have filed the class-action claim unless he was pretty sure that Paul had been injured in the same way he expects the class to be.

The real worst-case scenario is that Larry is right in thinking that Danny’s F&I shop routinely rolls negative equity into the cash price. This would technically be “compliance” in that folks are all following “procedures,” but it certainly is not the kind of “good” compliance we talk about. A good compliance training and monitoring program goes a long way toward spotting these things before they become a problem.

Lawsuits are, unfortunately, a cost of doing business. Lawsuits like the one Danny faces are a plaintiff’s lawyer’s dream, because they involve a simple systemic error that has the potential for a windfall in attorney fees. For Danny, it’s a nightmare. Win or lose, he has to defend himself, and that’s almost never cheap. Still, an effective F&I compliance program can go a long way toward scuttling Paul’s class-action claim. It will also save Danny a boatload of legal fees. If not, let’s hope Larry Lawyer is in a settling mood.

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 [email protected]. 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.