If you are in the auto finance business, you cannot possibly have missed the drama percolating around the Department of Defense’s (DoD’s) new interpretation of its own regulation’s purchase-money vehicle finance exclusion, which says transactions with GAP, credit insurance, or other credit-related ancillary products are not within said exclusion. Rather, those products are “consumer credit” transactions subject to the Military Lending Act (MLA). We’ll call this the “GAP problem,” and I’ll explain it in a minute.
The MLA and the DoD regulation provide that if financing for a MLA-covered servicemember is for the express purpose of purchasing a vehicle, the loan isn’t subject to the MLA. We’ll call this the “exclusion.” Until the recent GAP problem, the industry read these provisions as preserving standard new- and used-car financing. The GAP problem arises from the DoD’s recent interpretation of these provisions in a way that knocks purchase-money auto finance transactions out of the exclusion if GAP, credit insurance, or other credit-related ancillary products (credit protection products) are included. And not just going forward, but all the way back to October 2016. Before the DoD published its new interpretation in December 2017, we all thought it was business as usual for auto finance. Now, the DoD has — I think, unwittingly — caused a crisis of epic proportions in the industry.
Let’s get up to speed. Under the MLA, “consumer credit” is a defined term that, until the DoD added it in as of October 2016, didn’t include auto finance. Thus, the need for the contemporaneous exclusion. The DoD published some interpretive Q&A about non-motor vehicle personal property financing that muddied the waters about the extent of the exclusion, and the industry asked for clarification. Under the heading of, “be careful what you wish (ask) for,” we got the clarification that is the GAP problem.
What’s the practical effect of the GAP problem? It means dealers probably shouldn’t sell credit protection products to MLA-covered borrowers (generally, active-duty military and their spouses/dependents) since including them in transactions involving these folks make the transactions “consumer credit” transactions subject to the MLA.
Why is that bad? For many reasons, including the MLA’s constraints on APR, restrictions on contractual terms, and additional disclosure requirements where “consumer credit” is concerned. Among other things, you can’t provide financing to an MLA-covered borrower at a “military” APR (MAPR) greater than 36% (and you must include credit-related ancillary products in the MAPR calculation). You also can’t enforce a pre-dispute mandatory arbitration agreement, and you must provide some disclosures explaining the MLA-covered borrower’s rights. In addition, you cannot use “the title of a vehicle as security for the obligation” you originate unless you are a bank, savings association, or credit union. I don’t know many dealers (the ones that originate the credit) that are themselves banks, savings associations, or credit unions.
The prohibition on taking “the title of a vehicle as security for the obligation” suddenly applies to installment sale contracts that finance credit protection products in a retroactive manner. This narrows the applicability of the exclusion in a way Congress probably never intended (i.e., the interpretation creating the GAP problem is inconsistent with the language of the MLA and the DoD regulation itself) and the industry never expected.
The practical effect is a quash on selling credit protection products to MLA-covered borrowers, yet concerns about being able to adequately identify them are causing some dealers to stop selling credit protection products to any military personnel or dependents. Those concerns are also causing others to go so far as to stop selling credit protection products entirely. Some assignees are refusing to buy paper containing credit protection products for MLA-covered borrowers. Every bank and finance company in the auto finance business is losing sleep over MLA-covered transactions that may be in their portfolios or securitization pools that they can’t identify.
How did this happen? Those of you who are regular readers know that sometimes my friend the cynic shows up to offer alternative and sometimes depressing viewpoints on current events. The other day he mused whether the DoD was used by other agencies to accomplish a long-time consumer advocate goal that they have no jurisdiction or authority to implement. My cynic thinks the DoD will readily admit that it is not skilled at writing financial regulations so the agency had to have reached out to other agencies to help get the job done. Conveniently, the MLA requires the DoD to “consult” with a number of financial regulators — e.g., the Consumer Financial Protection Bureau and Department of Treasury — in creating any rules or interpretations relating to the MLA. So, financial regulators are built in to the process.
My cynic also thinks that the CFPB has spent entirely too much time in bed with consumer advocates in the past five or six years, many of whom have been trying to outlaw credit protection products (such as GAP, credit insurance). Fortunately — or unfortunately, depending on your point of view — the CFPB can’t touch credit insurance. It may have more flexibility to restrict GAP (to the extent it is a waiver product as opposed to an insurance product), but it would first have to find that it harms consumers. There is far too much evidence of the benefits GAP provides — just ask folks who lost their vehicles in recent hurricanes.
So, my cynic says, if your agency has too many constraints on it to outlaw credit protection products, why not take the opportunity to craft an interpretation of another agency’s rule that makes them ridiculously dangerous to sell, and make it that agency’s problem? Clever, right? I hope my cynic is wrong. If he’s right, it means that some agency or agencies disrespected our military by using it to achieve a political goal that they couldn’t, and further disrespected the military by putting auto dealers and their assignees in a position where they have to block their access to products that every other resident of the country (i.e., those they protect) can access.
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. Michael can be reached at 202-327-9705 or firstname.lastname@example.org. Nothing in this article is legal advice and should not be taken as such. Please address all legal questions to your counsel.