War of the Words

No, it isn't Tom Cruise doing battle with the aliens with the future of mankind hanging in the balance.

Instead, the good guys are car dealers and sales finance companies, and they are doing battle with the bad guys — plaintiffs' lawyers, state Attorneys General, legislatures, regulatory agencies, the courts and public opinion.

And the battle isn't one that involves death rays or light swords. Instead, the weapons are words. How can that be, you ask?

In law school, a wizened old professor said, “If you let me pick the vocabulary, I'll win the debate.” Well, in the battle between car dealers and their various adversaries, the adversaries are trying to pick the vocabulary. By picking the vocabulary, they hope to win the battle.

In a typical dealership financing arrangement, there is no “loan” and there is no “lender.” The document signed by the customer is called something like a “retail installment contract.” When the dealer has completed the retail installment contract and the customer has driven away in his or her newly-purchased car, the dealer assigns the contract not to a “lender” but to a bank, credit union or sales finance company.

I have been told that the terms “loan” and “lender” are so deeply imbedded in the lexicon of dealers that they cannot be dislodged. I beg to differ. I believe that if dealers understand that using, and permitting others to use, these incorrect terms will increase their legal risk, they will begin to use more accurate terms.

Why Does It Matter?

Why on earth does it make a difference what terms we use to describe these paper documents and those who buy them? Several reasons, in my view.

First, people in the business ought to understand the business. People who don't understand the correct language applicable to their business can make mistakes, and sometimes those mistakes can be costly.

More than once, we have seen companies that plan to buy retail installment contracts in a state call up the regulatory authorities in a state and tell those authorities that they plan to “lend” in the state and would like to know if a “lending license” is required. Unless the state authorities delve into the nature of the company's business, they are likely to take the caller at his or her word, and send an application to engage in the lending business. The hapless company will apply for and get the incorrect license, and start buying contracts without having the correct license. And no, I'm not making this up — I have seen it happen on several occasions.

Another problem can arise when a dealer or finance company trying to determine the maximum finance charge rate that it can impose consults the state usury law — applicable to loans — rather that the state installment sales law, to find the answer. The rates that can be charged under these laws frequently differ. The consequences of charging a rate higher than permitted can be dire, while the consequences of charging less than the maximum rate can simply be expensive.

But it's in the lawsuit and legislative arenas where the big risks exist. As an example, consider the rash of class action lawsuits alleging credit discrimination on the part of dealers and finance companies. The plaintiffs' lawyers in these cases have incorrectly described the business of indirect auto finance in an effort to bolster the various legal theories that they rely on.

They try to convince the courts that dealers are agents for companies that make loans, so that they can use that “agency” relationship to get to GMAC, NMAC and other deep pocket “lender” defendants. They rail about “dealer mark-ups,” and “street rates,” and use these loaded terms to frame the debate. Hint — the wizened professor ought to come to mind about now.

Out With Theirs, In With Ours

We need to reject this loaded vocabulary in the strongest terms, and substitute our own vocabulary instead. Insisting on “retail installment contract” and “sales finance company” instead of “loan” and “lender” is just a start.

Let's also reject the term “dealer markup.” Why? The rate that appears in a retail installment contract is determined by the dealer and the customer as part of the bargaining process. When the contract is signed, the dealer has several options with respect to it. The dealer can simply keep the contract and collect the payments, as some dealers do. That means the dealer collects the entire unpaid balance, including the entire finance charge. What happens to the concept of “dealer markup” when this happens?

Even when the dealer sells the contract, it isn't unusual that several sales finance companies and banks have approved the buyer's credit and have offered to buy the contract. Each of these potential buyers of the contract may demand a different minimum rate (or, “street rate,” in the vocabulary of the consumer activists). How do you measure a so-called markup when it might be computed from different bases?

So, out with “dealer markup.” In with “contract rate.”

And don't get me started on “street rates.” The consumer advocates have twisted this term to mean an alternative rate that the car buyer could get “on the street,” i.e., by going directly to GMAC or FMCC or Americredit and getting a loan. There's only one teeny problem with the activist's theory on this point — GMAC and the other sales finance companies do not make loans directly to car buyers (except in Ohio and in some few scattered programs).

The “street rates” published to dealers by these companies are not alternative rates at which consumers can borrow money directly. Even companies such as banks that buy contracts from dealers and actually also make direct loans to car buyers often don't offer car buyers rates that are as low as the so-called “street rate” offered to dealers.

What sales finance companies really mean by “street rate” is “this is the lowest contract rate that we will buy from you, Mr. Dealer.” If that's what it is, why don't we call it the “minimum acceptable contract rate?” (we could even abbreviate it to the cool-sounding term, “MAC Rate.”)

So, out with “street rate,” in with MAC rate.”

Conclusion

Words matter. They aren't loans, they are retail installment contracts. They aren't lenders, they are sales finance companies or banks. Dealers cannot “mark up” a rate if they are entitled by the terms of the retail installment contract to keep all amounts the buyer pays. And finance companies don't have street rates, they set a minimum acceptable rate, or MAC rate, for the contracts they are willing to buy. Repeat each one of these sentences a thousand times.