Beware of this Indirect Lending Pitfall

February 24, 2017 at 9:50 am 1 comment

Car Salesman and a Customer --- Image by © Royalty-Free/Corbis


Credit unions understandably look at indirect lending as an attractive means of beefing up their lending portfolios, but NCUA has consistently, and in my ever so humble opinion correctly, emphasized to the industry that these relationships are trickier than they appear.

A recent case out of Arizona demonstrates why it is so important to exercise ongoing oversight over dealerships with which a credit union has an indirect lending relationship and also why it is so important to have an attorney review third party lending contracts.

Since 1975, the FTC’s “ Holder Rule”( 16 C.F.R. § 433.2) has mandated that all consumer credit contracts include provisions making any party assigned such a contract subject to all of the defenses and claims that a debtor could raise against the creditor with whom she contracted. This means that if your credit union purchases car loans from an auto dealership, it is subject to whatever claims the buyer of the car could have against the dealer. Even though the federal regulation already applies to NY lenders, the state has a similar provision N.Y. Pers. Prop. Law § 301 (McKinney).

In Hayward v. Arizona Cent. Credit Union, 241 Ariz. 350, 387 P.3d 1279 (Ct. App. 2017), a woman sued a car dealership over a car purchase gone bad. She traded in her old vehicle and financed a new purchase with a retail installment contract. The agreement obligated the dealership to pay off the balance of the trade, but the dealership neglected to do so. She successfully sued the dealership claiming that it damaged her credit and she was entitled to be reimbursed for the balance of the trade. She won a judgement for both compensatory damages for slightly less than $17,000 and $ 50,000 in punitive damages.

Fortunately for this morning’s blog, but not for Arizona’s Central Credit Union, she won her case but was unable to recover the full amount of her judgement against the subsequently bankrupt dealership. The credit union had a lending relationship with the dealership under which it purchased retail installment contracts, including Hayward’s. Because of the Holder Rule, she brought an action against the credit union seeking to recover the full amount of the judgement.

This brings us to why this case is potentially significant. At the time she brought her suit against the credit union, Hayward had already recovered from the dealership an amount in excess of her compensatory damages. The credit union claimed that, under the Holder Rule, it was not responsible to pay for punitive damages, attorney fees or costs. The court ruled however that, even if the Holder Rule does not require the credit union to pay punitive damages “neither the sales contract nor the judgement specified the order in which those judgements were to be applied.” In other words, Hayward could avoid the prohibition on collecting punitive damages against the credit union simply by claiming that the money she received from the dealership had all been applied to her punitive damage award, leaving the credit union on the hook for the outstanding compensatory damages.

Now don’t panic. If you live outside of Arizona, this case is not binding on you. But the court’s logic could be used as persuasive authority in other jurisdictions, which brings us back to the beginning of this blog. When entering into relationships similar to the one entered into by Arizona Central Credit Union, you may want to specify the order in which a dealership will pay judgements owed to wronged borrowers when reviewing your contract. More generally, the case underscores why well drafted indemnification clauses are particularly important when entering into these types of arrangements.

Last but not least, NCUA has a point. Your credit union should have a good feeling for who it is getting involved with and monitor its practices on an ongoing basis.

So ends our tale. Remember that the advice I give in this blog is not intended as, nor is it a substitute for, legal advice from your counsel.

On that note, I hope to see you all in D.C., please stop by our Let’s Connect NY event on Sunday evening and break bread with your faithful blogger.

Entry filed under: General.

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1 Comment Add your own

  • 1. Richard Wagner  |  February 27, 2017 at 2:49 pm

    Have no fear, if this could effect lenders in NYS , the “banks” will make it nul and void here. The banks will go to the Legislature on Monday and the Governor will be signing the bill on Thursday.


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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association.

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