Mendoza v. Lithia Motors, Inc.: Revisiting Dealer Retention and Disclosure Obligations

An automobile dealer’s retail installment sales contract (“RISC”) is a heavily regulated piece of paper, and rightly so, because a car is one of the most significant investments made by a consumer. A large part of that regulation governs financing and the sale of additional services and products, a portion of which often is retained by the dealer to compensate it for arranging financing and reselling various products. There is nothing wrong with a dealer retaining a portion of the buyer’s payment as long as that retention is adequately disclosed.

Although federal and state disclosure requirements are well settled, case law addressing these rules is often not precise, leaving room for enterprising lawyers to test the law. The game goes like this: a lawyer threatens a class action unless the dealer pays up to head off potential liability. That is exactly the position in which Lithia Motors, Inc., and a number of affiliated companies, found themselves in Mendoza v. Lithia Motors, Inc., Case No. 6:16-CV-01264-AA (D. Or.), a putative class action. After a series of motions to dismiss and a motion for summary judgment, the District of Oregon entered orders in favor of the defendants and produced critical opinions directly reinforcing key aspects of the disclosure regime upon which dealers nationwide can rely in the future.

The Plaintiffs’ Claims

The representative plaintiffs, who purchased automobiles from dealerships that were affiliated with Lithia Motors, made a number of claims. The common theme among these claims is that the defendants were required to disclose the amount of profit they made from the sale of certain items. If plaintiffs were correct, then dealerships across the country would be subject to a disclosure requirement that applied to no other type of market transaction.

First, the plaintiffs alleged that the defendants failed to properly disclose under the federal Truth-in-Lending Act (“TILA”) the existence and amount of compensation the dealerships received for arranging financing for a consumer. More specifically, they asserted that the dealerships had an affirmative obligation under federal law to disclose the difference between: (1) the rate of the loan obtained by the dealership for the consumer at the consumer’s request; and (2) the rate of the loan ultimately offered to the consumer by the dealership. The difference between those rates is known as the dealer reserve (or yield spread premium), and it is used to compensate the dealership for obtaining financing for the buyer. Additionally, in some instances, certain lenders offered a flat fee to a dealer instead of a dealer reserve. The plaintiffs asserted that the dealers’ failure to disclose the existence or the amount of the dealer reserve or the flat fee violated the law, as did the dealerships’ alleged failure to disclose the profit they earned on their sale of products supplied by third parties (such as GAP insurance, service contracts, lifetime oil, etc.).

Second, the representative plaintiffs alleged that Lithia’s disclosure practices constituted common law fraud and violated various provisions of the Unfair Trade Practices Act (“UTPA”) and its regulations, including the Oregon bird-dog rule. They again alleged that the dealers did not sufficiently disclose that they were retaining a portion of the purchase price of various third-party products.

The Defendants’ Response

The plaintiffs’ complaint had two problems: (1) it was wrong on the law; and (2) it was wrong on the facts. From the defendants’ perspective, it was hard to see how the RISC and the related sales and disclosure documents could give rise to these claims, particularly because the RISC they used was very similar — and in some cases, identical — to the Oregon Auto Dealers Association’s form. In other words, if the defendants’ RISC disclosures were problematic under state and federal law, then every dealer in Oregon using this form might have similar issues. There was no question that the stakes were high or that the defendants had little choice but to fight.

Moreover, both the TILA and the UTPA issues — particularly the bird-dog rule — seemed as if they were well settled. This was especially true of the TILA claims, where courts in other jurisdictions had weighed in on similar claims and where the Federal Reserve itself offered clear guidance, Regulation Z, on what needed to be disclosed to consumers. The defendants thought they were following that guidance to the letter. The plaintiffs, however, rejected that defense and sought to create new law that would result in a significant new disclosure regime for the industry — and, not coincidentally, a huge damage award were a class to be certified in the case.

Many of the Oregon UTPA claims, too, challenged settled law, though some were so fact intensive that they would require fact development in order for them to be resolved at summary judgment. The bird-dog claim was one of those, because there was no Oregon case law explaining exactly what the bird-dog regulation meant. Automobile industry members know exactly what the bird-dog rule was designed to do — stop kickbacks over a certain amount from being paid for the referral of a potential consumer. However, Oregon’s bird-dog regulation could be read by aggressive plaintiffs’ lawyers to apply to any payment to a third party, not just to payments for a customer referral. And, if the regulation applied to any third-party payment, arguably it applied to a host of third-party products sold by dealers across the state.

Resolution of the TILA Claims

The TILA cause of action was resolved against the plaintiffs on one of the defendants’ motions to dismiss. The claim encompassed two courses of conduct — the arrangement of financing and the sale of third-party products.

The court quickly disposed of the third-party products issue. Not only did plaintiffs allege that the defendants failed to disclose that the dealerships retained certain amounts identified in the RISC as “amounts paid to others,” but also that the defendants failed to itemize each amount that was paid to third parties by the creditor on the consumer’s behalf — that is, the defendants did not break out how much profit they retained from the sale of the third-party products. In their briefing, the defendants pointed out that TILA did not require a dealership to disclose the amount of profit that it made but only that the dealer may be retaining some portion of the sales price. And that is exactly what the defendants’ RISC stated. The court agreed. The following Reg Z passage was critical to the court: “For example, the creditor could add to the category ‘amount paid to others’ language such as ‘(we may be retaining a portion of this amount)’.” Based on this plain language, and the many state and federal cases that considered the issue previously, the court declined the plaintiffs’ demand to require disclosure under TILA of the exact amount retained. The court also found that the defendants satisfied TILA’s requirement with regard to the sale of third-party products, because the RISCs in question each contained the required disclosure. (They each provided: “*Seller may be retaining a portion of this amount.”)

The plaintiffs made a similar argument with respect to the dealer reserve or flat fee, claiming that TILA required disclosure of that amount retained by the dealerships related to the arrangement of financing. The court again rejected the plaintiffs’ attempt to add language to the statute. TILA and Reg Z require disclosure of the “finance charge” which is “the cost of consumer credit as a dollar amount.” The “finance charge” includes "any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.” 12 C.F.R. § 226.4(a). In other words, the “finance charge” that must be disclosed is the total cost to the consumer, and the use of the term “any charge” in Reg Z recognizes the fact that the total charge may include components. TILA, however, does not require itemization of those components. In fact, the statute says that the finance charge disclosure is not itemized, 15 U.S.C. § 1638(a)(3), and courts have held uniformly that TILA does not require the lender to identify the components of the finance charge, including the existence of a dealer reserve. The court found that because the RISCs at issue disclosed the finance charge, they satisfied the TILA requirement. The court dismissed this portion of the TILA claim, as well as the Oregon UTPA claims predicated on the alleged TILA violations.

Resolution of the UTPA Claims and Common Law Fraud

The court dispatched a series of UTPA claims on the defendants’ motion to dismiss, all of which were based in whole or in part on the plaintiffs’ allegations that the defendants did not disclose their profits or the fact that they would retain part of the price of third-party products. Among other things, these included claims for passing off services, causing confusion as to source of services, causing confusion as to affiliation or connection, making false or misleading representations of fact concerning price reductions, and making a false or misleading representation of fact concerning the offering price. Each of these claims failed at the pleading stage. As these statutes are specific to Oregon, we will not go into granular detail on each, but the court’s reasoning was similar to that discussed above — the pleadings simply misread the language of the statute, and the defendants met their disclosure requirements.

One of the plaintiffs’ UTPA arguments deserves some scrutiny. The RISC’s itemized payment disclosure included the following headline language before listing each product individually: “Charges other than Finance Charge, including Amounts Paid to Others on My Behalf: (*Seller may be retaining a portion of this amount).” The plaintiffs asserted that this statement violated certain UTPA sections because, they argued, it insinuated that all amounts listed included sums paid to others (and not to defendants or an affiliate) on the consumer’s behalf and because the UTPA provisions at issue required disclosure of the exact amounts retained. The court rejected this argument: Nowhere did the UTPA require the amount of the profit to be disclosed, and the language at issue meant that the goods or services may be — but are not necessarily — purchased from a third party. Thus, for example, the fact that a lifetime oil product was sold by a defendant affiliate (which was fully disclosed in the RISC) did not support plaintiffs’ various UTPA claims. Each entry for which a defendant dealership may have retained a portion of the fee was identified and was marked clearly with an asterisk, referencing the disclosure in the heading; that was all the defendants needed to do.

The plaintiffs supported their common law fraud argument with the same textual reading of the RISC. They argued that the language stated or implied that all service products were supplied by third parties, which was contrary to the facts, because a defendant affiliate supplied the lifetime oil product. The court again found that the headline disclosure said all that was necessary and that the RISC was not fraudulent: Although some amounts may be paid to third parties, the document did not falsely state that all amounts would be paid to third parties, and the defendants disclosed in the RISC exactly who was being paid.

The court’s handling of the bird-dog regulation under the UTPA is perhaps more important, because bird-dog rules exist in jurisdictions nationwide and some are not clearly written. Our research did not uncover any reported decision explaining how they function or why they exist.

The Oregon bird-dog regulation, issued pursuant to the state UTPA, is found at OAR 137-020-0020(3)(k), entitled “Undisclosed Fee Payments”:

[a] dealer who sells or leases a motor vehicle to a consumer and makes any payment to any non-employee third-party in conjunction with the sale or lease, other than a referral fee of $100 or less (also known as a “bird-dog” payment), must specifically itemize such payment on the consumer’s purchase order, lease agreement and retail installment contract.

According to the plaintiffs, this rule required a dealer to itemize every payment made to a third party, other than a $100 referral fee. In other words, the plaintiffs alleged that the defendants serially violated the bird-dog rule when they did not itemize the fees paid to third parties for the sale of their products.

The court rejected the plaintiffs’ argument at summary judgment. It considered declarations from a witness who served on the advisory committee drafting the rule as well as the official commentary and other relevant documents. The witness was adamant that the rule was adopted to regulate only the disclosure of bird-dog fees. Moreover, the official commentary on its face addresses only payments for referral of a consumer to a dealership. The court further found that the plaintiffs’ expansive reading of the regulation would “impose an expansive itemization requirement upon dealers,” who “would be required to itemize a litany of payments on the customer’s documents, thus volunteering the profits made on any third-party product associated with the sale. The dealer’s personal cost of the very vehicle itself, being a third-party payment, would presumably fall under this expansive disclosure requirement.” That sort of burdensome disclosure had never been discussed by the rule’s drafters, was not addressed by the rule’s text, and made no sense given the history of the regulation.

In the same order, the court dispatched two final claims. First, it rejected a UTPA argument under OAR 137-020-0020(3)(u), “Yield Spread Premium Disclosure.” The plaintiffs asserted that the dealers did not clearly and conspicuously disclose that it may receive compensation for arranging financing. The court disagreed. It reviewed the entire deal packet for the sale at issue and found abundant evidence of significant, clear, and conspicuous disclosure of the required information. The court also cited the deposition transcript of the consumer, who agreed that the disclosure language in the documents disclosed what was required by law. Then, having dismissed all of the underlying claims in the case, the court rejected the elder financial abuse claim pursued by two senior citizen plaintiffs. Without a predicate UTPA violation, the claim for abuse could not stand.

Takeaways

• Although the plaintiffs have signaled their intention to appeal the District Court’s ruling, there are some key lessons that bear reviewing:
• TILA: The District of Oregon fully endorsed what was the common understanding of the disclosure requirements and it adopted the Reg Z commentary in full. These rulings can be used to bolster a TILA defense involving similar facts. TILA does not require disclosure of a dealer’s profits.
• Bird-Dog Rule: With the District Court’s summary judgment ruling, there is now a decision addressing exactly what the bird-dog rule was intended to cover. This development is critical, because prior to this case there was no decision with a clear discussion of the scope and intent of the bird-dog rule.
• The Litigation Process: It can take a long time. Be persistent and patient, read the statutes and regulations, and do your homework. Not all claims will be resolved on a motion to dismiss, and the court may grant leave to replead. Develop the record and do all you can to resolve the case prior to class certification. Be well prepared for depositions, and walk the putative class plaintiffs through all of the written disclosures; you never know what people will say.
• Facts Matter: Make certain your dealership clients have updated forms that make all the disclosures required under state and federal law. Also make certain the disclosures are clear and conspicuous (as defined in your jurisdiction). At the end of the day, the defendants prevailed in this matter at District Court because they cared about compliance and got ahead of any potential problem. You will do your clients a tremendous service if you help them do the same.

Originally published in the Defender, The National Association of Dealer Counsel Newsletter, May 2019. Reprinted with permission.