Guaranteed asset protection (GAP) waivers have always held state regulators’ attention, but as vehicle price increases drive up consumer demand for debt cancellation agreements, regulatory scrutiny into such agreements is also on the rise. From multistate settlements and administrator subpoenas to class action settlements and proposed state regulations, lenders will want to keep an eye on recent developments in the calculation and payment of refunds.
Refunds: Who pays the consumer?
Standard industry practice is for the dealer — rather than the lender or administrator — to issue a consumer refund when a GAP contract is terminated early. In audits, regulators have increasingly questioned lenders on refund calculation and payment practices. However, many states’ consumer finance regulators only have authority to regulate lenders, not dealers and/or administrators. In recent years — legislatively or in practice — regulators have begun requiring the lender to either directly refund the consumer or at least ensure the refund is made.
State regulatory inquiries
Colorado’s attorney general recently subpoenaed records related to calculation and payment of refunds from several administrators. In a consent order, one administrator took a number of deductions in calculating the refund that are not allowed under Colorado’s Rule 8, including pre-totaled condition of the vehicle; excess amount financed; excess mileage driven; prior unrepaired damage; and insurance salvage amounts. After a self-audit, the administrator uncovered nearly 175 consumers who were owed more than $120,000 due to these deductions.
The consent order also outlined escheatment practices, which is the process through which unclaimed assets are turned over to the state if the consumer does not receive a cancelled check within 90 days. Various industry groups are lobbying for allowing some of these deductions so that consumers are not double-compensated, among other reasons. Lenders should keep a watchful eye for the attorney general’s response and review their own escheatment practices.
California’s Department of Justice followed suit in late 2021 by issuing inquiries into how GAP refunds and disclosures were provided to several industry participants. These inquiries, combined with increasing consumer cases and class actions alleging deceptive practices, have added California to the list of states considering GAP legislation in upcoming sessions. Again, industry associations are suggesting amendments to certain provisions, including those which urge the consumer to contact law enforcement if the GAP waiver is not presented as optional; limit the GAP waiver fee to 2% of the amount financed; allow a deduction for claims paid when the agreement is cancelled; and increase the loan-to-value ratio of loans upon which GAP waivers may be placed.
Legal developments impacting business practices
No lender is immune — independent lenders, major banks and captive finance companies have encountered GAP-related legal issues. Recent actions have included everything from multi-hundred-million-dollar class action and attorney general settlements involving violation of consumer protection laws to paying large funds into trust in order to compensate Massachusetts consumers for interest on GAP refunds.
These events have prompted lenders large and small to review or change their business practices, including directly refunding borrowers who pay off their finance agreements early. In fact, consumer advocates hope lenders will recognize this as a preferred business practice rather than relying on the dealer or administrator to make the refund. We can expect that state regulators are closely monitoring any new business practices and may take a more definite position as to who bears responsibility for refunds in their statutes, regulations or practices.
In another notable case currently underway in Virginia, the U.S. Department of Defense, Justice Department, Consumer Financial Protection Bureau and the Attorney General’s Office have submitted documentation to the court espousing the argument that vehicle loans that include GAP are hybrid loans where GAP is “distinct and largely unrelated” to the purchase of the vehicle. Under this premise, GAP would not be subject to the Military Lending Act exemptions and would therefore practically be precluded from financing in the vehicle loan for military borrowers.
Lenders need to fully understand their obligations under each state’s laws. They should also draw on their long-fostered relationships with dealers and administrators to implement sound, tight agreements surrounding:
- Which GAP forms the lender is able to finance;
- How refunds are calculated;
- Which party will be responsible for payment of refunds to the borrower;
- Timing of the refunds; and
- Evidence needed to prove a refund has been paid.
As regulatory scrutiny continues to increase, having these foundations in place may facilitate collaboration among lenders, dealers and administrators to easily pivot as regulations change and to effectively lobby for regulatory improvements.
Kristi Richard is a Member (Partner) at McGlinchey where she advises clients in areas of insurance regulations and compliance. She represents insurance companies and producers in the structuring of credit insurance policies and programs, ancillary products and services.
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