Dealers report an increase in chargebacks from finance and lease sources related to cancellations of voluntary protection products like extended warranties and GAP. Some finance and lease sources are going back three to five years and imposing chargebacks claiming VPPs should have been cancelled because of the early termination of retail installment or lease obligations.
What is going on?
Contractual Obligations
The responsibility for refunds on cancellation relate to contractual requirements of the VPP agreements between the product administrator and the customer, and the dealer obligations are contained in indirect finance and lease agreements between dealers and finance and lease sources.
The obligation to provide a refund upon cancellation of a VPP is contained in the VPP documentation. That agreement should follow state law and provide for the calculation of, and payment for, the refund amount upon cancellation. Cancellation generally comes because the customer pays off the retail installment or lease obligation early, defaults, or the vehicle becomes a total loss. When the customer no longer has a finance obligation, finance protections such as GAP should be cancelled, and when the customer no longer has the vehicle, extended service or maintenance agreements should be cancelled.
Between the dealer and the finance or lease source, the obligation to provide a refund is contained in the indirect finance or lease agreement which governs the assignment of retail installment sale contracts by the dealer to the finance or lease source. Generally, these agreements provide that upon termination of the financing, or lease obligation, the dealer will be responsible for the refund. Here is an example from a typical indirect finance agreement:
(b) Refund of Unearned Charges. Dealer agrees that upon prepayment, repossession, or total loss, Dealer shall refund any unearned charges for aftermarket products to the Buyer or finance source, as appropriate. In the case of prepayment, unless applicable law requires finance source to process such refunds, this is accomplished either by notifying the customer to make application to Dealer for the refund, or by Dealer authorizing finance source to make the refund on Dealer’s behalf. When there is repossession, total loss, or in those jurisdictions where applicable law requires finance source to process such refunds, Dealer authorizes finance source to debit Dealer’s DFI Account for the unearned charges.
When dealers assign the retail installment sales contracts or leases to the finance or lease source, the dealer is no longer involved in servicing the accounts. Dealers will not necessarily know if the financing or lease obligation has terminated early.
A major exception to this is an early trade in at the dealership. For example, if a customer with sixty month financing trades in the vehicle at 42 months to the dealer from which he or she bought it and buys a replacement vehicle, the dealer should know that any VPP should be cancelled on the trade. Dealers should have in place a process to cancel the products, providing for refunds that may even be included as a downpayment in the new deal.
In all other cases, where a finance or lease obligation is terminated, a dealer may not know to process a VPP cancellation. Finance sources may contend that reports to dealers regarding reserve should have given them a heads up, but finance and lease sources have not always had a practice of notifying dealers of finance or lease obligation terminations, and reserve reports may not provide this information on so-called “split reserve” relationships where the dealer earns only a portion (e.g. 70%) of the reserve with the balance of the reserve being kept by the finance source to fund what used to be chargebacks to reserve accounts for those early finance or base obligation terminations.
Importance of Dealer Knowledge of the Termination of the Obligation
Dealers should know of the termination of a customer’s finance or lease obligation. Dealers do not service their own VPPs. Most dealers do business with VPP suppliers. Even where dealers may have their own reinsurance companies, the actual servicing of the VPPs is done by the supplier.
Suppliers must calculate and provide refunds upon notification of cancellation. Where there is no notification of the cancellation, the VPP continues in effect until it runs out naturally. If the VPP supplier is notified months or even years later that the policy should have been cancelled, its response may be that it did not know of the cancellation of the VPP, and it continued in full force and effect with the VPP supplier earning the premium on the VPP. Remember that where the VPP was sold to the customer at a retail price but the wholesale price was funded to the VPP supplier, the dealer may be responsible for its portion of the refund.
What Changed?
Apparently, there have been threats of class actions against finance and lease sources for failure to credit customers with refunds upon early terminations of their finance or lease obligations. Besides resolving those, finance and lease sources are taking two steps. First, they are putting in place processes to notify dealers of early terminations of finance or lease obligations that should lead to VPP cancellations. Second, they are charging back dealers, as much as three to five years later, for VPP refunds when customer finance or lease obligations terminated early.
How It Should Work
The process being put in place to notify dealers of the cancellations of the customers’ finance or lease obligations is the way the process should work. When a dealer is notified, the dealer can contact its supplier. The supplier can then process the refund and provide some funding for refunds for which the dealer is obligated under the indirect finance or lease agreements.
The Way it Should NOT Be Done
Some finance and lease sources are now billing dealers for refunds on VPPs for customers’ terminated finance and lease obligations when they never notified dealers of those terminations contemporaneously. Dealers understandably object that if they did not know of the cancellation, how can they be responsible for the refund?
The finance sources contend that under the indirect finance or lease agreements a dealer is responsible to process the refund, sort of a strict liability argument. However, dealers say that does not seem right, and the dealers have a point. Where the finance source never made the dealer aware of the termination of the finance or lease obligation when it occurred, the dealer likely did not know to cancel the VPP. Dealers can contend that finance or lease sources interfered in the proper operation of the contractual provision requiring the dealer to refund the unearned VPP balance. A finance source should not benefit from its own inattention, especially when a dealer is damaged by that inattention. That is what lawyers call estoppel which is a bar or impediment which precludes a person from asserting a fact or a right when the hindrance is due to that person's actions, conduct, statements, or failure to act.
What a Dealer Should Do
Given the new found energy of finance and lease sources, dealers should institute processes for identifying the need to cancel VPPs, appropriately cancel them, and arrange refunds.
- If a customer trades a vehicle previously sold by the dealership before the end of the finance or lease period, the dealer should have in place a policy to process the VPP refunds which may even include a process whereby the customer is given credit for the refund in the new deal.
- If a finance or lease source notifies that a customer’s finance or lease obligation has been terminated, the dealership should check to determine what VPPs may be outstanding and process any necessary refunds.
- When notification by some other means comes to the dealership of the termination of the finance or lease obligation, have a process to determine whether there are VPPs in effect and process the refunds.
- In the event of threatened chargebacks to the dealership for cancellations where the dealership says that it never knew of the termination of the finance or lease obligations, the dealer should marshal its facts. Was it a deal where the early termination resulted from a replacement deal by the dealership? Were there notifications from the finance source? Was there other information from which the dealership should have determined the early termination of the finance or lease obligation?
A dealer facing a chargeback demand from a finance or lease source it considers improper should seek advice from legal counsel to determine whether there is overreaching because the source should be estopped by its inattention to its obligations to keep the dealer aware of the termination of the customer’s obligation.