Backlash of Backdating

The standard industry practice of backdating contracts may violate federal law. That stems from a Truth in Lending Act case.

It went before the U.S. District Court for the Eastern District of Virginia.

The case involved an auto sale and spot delivery. The first contract signed by the buyer was conditioned on certain financing. When that contract fell through, the buyer signed a second contract about 10 days later. The dealership, as is often done, backdated the second contract to the date of the first contract.

The court addressed whether the disclosures in the second agreement violated the Truth in Lending Act by calculating the annual percentage rate of interest “on the basis of the date on the backdated agreement rather than the date the transaction was consummated.”

The court ruled that the defendant auto dealer in this case violated the Truth in Lending Act.

By its terms, the first retail installment contract became void when the dealership was unable to obtain financing on the terms reflected in the agreement within five days. As noted, the dealership backdated the second retail installment contract by about 10 days.

The court noted that, according to the dealership, “it is industry practice for car dealers to use the date of delivery of the vehicle on subsequent agreements reached in spot delivery transactions, and banks will only accept buyer's orders containing the date of delivery of the vehicle.”

The court reviewed the detailed instructions for calculating the APR as provided in Regulation Z (The Federal Reserve Board regulation that implements the Truth in Lending Act).

The court determined that required disclosures under Regulation Z must be given before consummation of the transaction. According to Regulation Z, consummation occurs not when the consumer takes possession of the product, but at “the time that a consumer becomes contractually obligated on a credit transaction.”

First, the court concluded that the required disclosures were timely. Second, the court concluded that the required disclosures were inaccurate. The APR figure on the second agreement was inaccurate because “Regulation Z does not permit calculation of the APR based on an interest accrual date which is earlier than the consummation date.”

The court did the numbers. The properly calculated APR, using an accrual date of April 13 (the date the second retail installment contract was signed) was 25.35%. Using the improper accrual date (date of vehicle delivery) of April 3 led to the disclosed APR of 24.95%. “This .4% difference is outside the one-eighth of 1%, or .125% tolerance allowed by the statute, resulting in a violation of the Truth in Lending Act.”

The court had a few additional choice comments, including: “The combination of spot delivery contracts and the industry practice of backdating documents to the original delivery date creates a real potential for abuse.”

In fact, the court suggested the following remedy for dealers. If the dealer wants to recover payment from the consumer for the use of the car prior to the second agreement, the dealer “should explicitly provide for some rent to be paid for this time period in the original conditional contract.”

The court awarded the car buyer $1,000 statutory damages, but denied actual damages because the buyer apparently admitted that she failed to read both contracts; therefore, she could not show reliance on the disclosures.

Tom Hudson, Esq., is a law partner with Hudson Cook, editor in chief of CARLAW and publisher of Spot Delivery. Teresa Rohwedder, Esq., is executive editor of Spot Delivery and managing editor of CARLAW, 410-865-5400 and www.creditcompliance.com.