By Michael G. Charapp
Charapp & Weiss LLP
We have talked repeatedly about how the compliance world for dealers changed dramatically with the result of the federal election in November 2020. We have warned about the need for a Fair Lending Program and for a program for pricing voluntary protection products like extended warranties and GAP. Now we will remind you of your dealership’s obligations to be sure you are calculating and paying VPP refunds if cancellation for any reason occurs.
The Obligation to Make Refunds for VPP Cancellations
We have written about dealer refund obligations. A provider of VPP products should not expect to keep the money if a VPP is cancelled. A VPP certificate generally addresses the responsibility for refunds on cancellation of the VPP agreements.
The VPP documentation 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.
Several years ago, there were class actions against finance and lease sources for failure to credit customers with refunds upon early terminations of their finance or lease obligations. This shined a light on VPP refund practices. With increased regulatory oversight, expect that dealers will be challenged to justify their processes for tracking and paying refunds for VPP cancellations.
How It Should Work
The indirect finance or lease source should have a process to notify dealers of cancellations of the customers’ finance or lease obligations. When a dealer is notified, the dealer can determine whether the customer has the right to a VPP refund and 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.
What a Dealer Should Do
Dealers should institute processes for identifying the need to cancel VPPs, appropriately cancel them, and arrange refunds.
1. 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.
2. 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.
3. 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.
4. 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. However, just because there may be improper chargeback demands does not mean dealers can relax their vigilance about VPP refunds. Emphasis on refunds for cancelled VPP obligations will be a priority under the new compliance atmosphere.