A Way for Dealers to Sell GAP to MLA-covered Borrowers

On December 14, 2017, the Department of Defense (“DOD”) issued a regulation concerning the exemption from the Military Lending Act (“MLA”) for purchase money auto financing credit secured by the vehicle. The MLA is a law passed in 2006 protecting service members and their families by requiring extensive disclosures and prohibiting certain contract provisions.  Purchase money vehicle financing is exempt and it was believed that this exemption included all aftermarket products sold with the vehicle in the transaction as well.

DOD’s new interpretation said that a transaction is exempt from the MLA “that finances the [vehicle] itself and any costs expressly related to that [vehicle]. . . provided it does not also finance any credit-related product or service.”  This means if the auto financing transaction includes GAP or credit insurance, the whole transaction is arguably outside of the exemption and subject to the MLA. 

As a result, auto dealers cannot sell and finance GAP in indirect auto finance without running afoul of MLA penalties which include the inability to take a security interest in the vehicle.  Other penalties can include voiding of contracts from inception; civil liability of actual damages or $500 statutory damages recoverable in class actions; punitive damages; costs and attorney’s fees, along with possible criminal liability. 

Possible Actions in Response to the DOD's December 2017 Interpretation
Trade associations and dealer groups have been lobbying the DOD to revoke the December 2017 interpretation.  They were apparently close to doing so in June 2018 but a change in DOD and other agency personnel delayed and politicized the issue.  The timing of the revocation of the DOD interpretation is now uncertain.

The main result is dealers should not offer credit insurance or GAP to MLA-covered borrowers in indirect auto finance transactions.  This means you will have to check every customer to see if they are an MLA-covered borrower using one of the "safe harbors" for doing so --these being either a DOD MLA website or a credit report indicating the person's MLA status-- before selling them GAP or credit insurance.  Do this at the time the consumer submits a credit application or within 30 days earlier if, for example, you are doing a pre-screen mailing.  Document your doing so in the deal jacket.

But it’s not so easy.  At least 11 states have military anti-discrimination statutes.  Each state interprets its law differently.  In response to a claim of military discrimination for not selling GAP to MLA covered borrowers, the dealer could argue that the federal MLA and DOD interpretation preempts their state’s anti-discrimination law  Consult your local attorney or compliance professional on the law in your state to get a sense of whether a the courts will recognize federal pre-emption as a defense to an alleged credit discrimination against protected military members under your state's law.

A Solution for Dealers to Enable MLA Borrowers to Finance GAP
There is another solution making its way around the industry.  The prohibition on taking a security interest in a vehicle on a compliant MLA contract does not apply to banks, credit unions, or savings associations (collectively “banks”).  A number of banks—principally credit unions--are preparing compliant MLA loan agreements (not an easy task with all the disclosures and computing an alternative MLA APR) that permit a vehicle security interest.  Reportedly, several large banks are also exploring this alternative.

If an MLA-covered borrower wants to purchase GAP, the solution for dealers is to contract to become an agent of one of these banks and engage in “direct” or “two-party” financing where you act as an agent of the bank in contracting for a direct loan from the bank to the consumer instead of the more-familiar three-party indirect credit sale of the vehicle.   The proceeds of the loan are directed to the dealer and the bank is named as the original creditor on the loan agreement.  The dealer gets a service fee for handling the paperwork for the bank.  For MLA-covered borrowers who want GAP or credit insurance, this solution should work.
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Most industry experts believe the DOD December, 2017 regulation will be revoked or repealed at some point, probably later this year.  But there is no guarantee.  Trade associations are also working the legislative front with the Congress.  But until one of these approaches leads to a repeal, contract with a bank that offers compliant MLA loan agreements to establish a two-party lending relationship so your MLA-covered borrowers can finance GAP like everyone else.