IN THE MATTER OF: REQUEST BY RODNEY D. MARTIN ON BEHALF OF NATIONAL CITY BANK FOR A DECLARATORY RULING ON THE APPLICABILITY OF THE MOTOR VEHICLE SALES FINANCE ACT TO CERTAIN TRANSACTIONS

DECISION

I. AUTHORITY

You have requested on behalf of National City Bank ("National City"), a national banking association, a declaratory ruling regarding the applicability of the Motor Vehicle Sales Finance Act ("Act")¹ to National City's proposed "direct lending program."

Section 63² of the Administrative Procedures Act of 1969 allows an agency to issue a declaratory ruling, upon request by an interested person, as to how a statute administered by the agency would be applied to an actual state of facts. Section 2(17)³ of the Act defines the administrator of the Act as the "commissioner of the financial institutions bureau." Thus, the Commissioner has authority to issue a declaratory ruling regarding the applicability of the Act to an actual state of facts. Your request letter of July 27, 1999, coupled with your letters of February 17, 1999, and March 8, 1999, set forth a statement of facts sufficient to enable the Bureau to issue a declaratory ruling regarding the applicability of the Act to the stated facts.

II. FACTS

National City is a national banking association with its principal office in Cleveland, Ohio. National City proposes to lend money to Michigan consumers for the purchase of motor vehicles. According to your request letter, National City "would enter into an agreement with a motor vehicle dealer in Michigan under which the dealer would serve as National City's limited agent for the purpose of soliciting loans to finance motor vehicles, taking applications for the vehicle loans, preparing the loan documentation, and closing the loans by obtaining the buyers' signatures on all required documents."

Your request letter stated that "National City would prescribe the terms of the loan, including the minimum interest rate. The dealer would be given no authority to bind National City regarding the terms of loans, except that the dealer could, within a range established by National City, negotiate a higher interest rate. National City would pay a commission to the dealer on each loan closed, which would include any yield-spread differential." The yield-spread differential may range from zero to six percentage points over the minimum interest rate (par rate) of the contract.

Finally, your request clarified that the proposed transaction would be non-recourse, meaning that National City would not have express recourse against a dealer under which National City could require the dealer to "buy back" previously executed installment sale contracts. Your request letter indicates that National City would only have recourse against the dealer in the form of a cause of action "for breach of its agency responsibilities."

III. STATUTES

The Act is Michigan's regulatory pronouncement regarding the financing of motor vehicles sold through installment sale contracts. The Act states in section 3 that:

". . . a person shall not engage in this state as a principal, employee, agent, or broker in either of the following unless that person is licensed as provided in this act:
     (a) The business of an installment seller of motor vehicles under installment sale contracts.
     (b) The business of a sales finance company."⁴

"4. 'Installment seller' or 'seller' means a person engaged in the business of selling, offering for sale, hiring, or leasing motor vehicles under installment sale contracts or a legal successor in interest to that person. As used in this subdivision, "business" does not include an isolated sale." * * * "6. 'Sales finance company' means a person engaged as principal, agent, or broker in the business of financing or soliciting the financing of installment sale contracts made between other parties, and includes the business of acquiring, investing in, or lending money or credit on the security of the retail seller's interest in such contracts whether by discount, purchase, or assignment of those contracts, or otherwise. . ."⁵

"9. 'Installment sale contract' or 'contract' means a contract for the retail sale of a motor vehicle, or which has a similar purpose or effect, under which part or all of the price is payable in 2 or more scheduled payments subsequent to the making of the contract, or as to which the obligor undertakes to make 2 or more scheduled payments or deposits that can be used to pay part or all of the purchase price, whether or not the seller has retained a security interest in the motor vehicle or has taken collateral security for the buyer's obligation, and includes a loan, mortgage, conditional sale contract, purchase-money chattel mortgage, hire-purchase agreement, or contract for the bailment or leasing of a motor vehicle under which the hire-purchaser, the bailee, or the lessee contracts to pay as compensation a sum substantially equivalent to or in excess of the value of the motor vehicle, and any other form of contract that has a similar purpose or effect. The terms do not include a sale or contract for sale upon an open book account in which the seller has not retained or taken a security interest in the motor vehicle sold or collateral security for the buyer's obligation, the buyer is not required to pay any sum other than the cash price of the motor vehicle sold in connection with the sale or extension of credit, and the buyer is obligated to pay for the motor vehicle in full within 90 days after the time the sale or contract for sale was made. These terms also mean and apply to any extension, deferment, renewal, or other revision of an installment sale contract."⁶

Generally, dealers that provide financing options at the dealership for the purchase of motor vehicles do so through the installment sale contract process. This process involves the dealer establishing relationships with banks and finance companies to prearrange various financing options that combine the sale of a motor vehicle with the installment financing of the sale. The process used to establish the relationships are contracts commonly referred to as dealer reserve, dealer participation, or dealer agency agreements. The contracts outline the rights and duties of the dealer and the bank or finance company and the method of calculating fees paid by the bank or finance company to the dealer. The contracts establishing the relationships do not cover any duty or obligation of the installment buyer owed pursuant to an installment sale contract - they simply structure a relationship between the dealer and the bank or finance company.

Consumers that arrange their own financing outside of the dealership negotiate loans with banks and other finance companies directly. In such direct lending arrangements the sale and the financing activity are entirely separate and openly negotiated. Direct lending transactions are not predicated on the dealer having a preexisting contractual relationship with the lender. It is this distinct separation of the contract of sale from the financing of the sale that validates the long held position that the Act does not govern direct loan transactions that provide funds to consumers for the purchase motor vehicles. However, this position may have been misinterpreted by some to mean that any transaction financing the sale of a motor vehicle and labeled by the lender to be a "direct loan" is not an installment sale contract subject to the Act.

Pursuant to section 2 of the Act, in order for a particular document to be an "installment sale contract," it must be a contract for the retail sale of a motor vehicle in which part or all of the price is payable in 2 or more scheduled payments, or be any other form of contract that has a similar purpose or effect. Whether the seller (dealer) has taken a security or collateral interest in the motor vehicle is irrelevant to the finding of an installment sale contract.

Under section 2 of the Act, if the sale or contract was an open book account and the seller did not take or retain a security interest in the motor vehicle, and the buyer paid for the motor vehicle in full within 90 days, no installment sale contract will be found to exist for purposes of the Act. This is the only express exemption from the Act's definition of an installment sale contract.

It is my conclusion that the National City "direct lending program" does not involve an "open book account" and therefore is not excluded under section 2 of the Act.

Because the National City transaction does not qualify for the Act's sole express exemption, I must determine whether the transaction is a contract that has a purpose or effect similar to a contract for the retail sale of a motor vehicle. In short, is the National City transaction a direct loan and not within the meaning of the Act's definition of "installment sale contract," or is the transaction an "installment sale contract" subject to the Act?

The Bureau must "look through a transaction so as to avoid the betrayal of justice"⁷ and "look squarely at the real nature of the transaction, thus avoiding . . . the contrivances of form, or the paper tigers of the crafty."⁸ The label given to the agreement by itself is not determinative of the agreement's provisions and "all circumstances accompanying the transaction must be taken into consideration."⁹ This is important not only for uniform administration of the Act, but to further Michigan's public policy of encouraging the sale of retail goods on credit while placing strict usury limits on outright loans of money. The technical distinctions between credit sales (installment sale contracts) and loans of money must be maintained.¹⁰ Where the substance of a loan, labeled to be direct or otherwise, does not differ in any significant aspect from a transaction subject to the Act, the transaction will be found to be an installment sale contract subject to the Act.¹¹

While few cases have addressed the issue of whether a loan is direct and not subject to the Act, the Michigan Court of Appeals opinion in the Barnes v. Michigan National Bank¹² is illustrative of the analysis that should be conducted in deciding whether a particular transaction is a direct loan not subject to the Act or an installment sale contract subject to the Act.

The Barnes case involved a financing agreement between the purchaser of a motor vehicle and a national bank. The court found that the bank was not a regulated party under the Act because the agreement ". . . was a direct loan from the bank to the consumer plaintiffs." The court explained that:

"The overriding consideration in this case is the true relationship between the bank and the plaintiffs, and the lack of any relationship between the dealer and the bank. The crux of the transaction was that of a personal loan by the bank to the plaintiffs, not dealer- or bank-induced financing of the sale of the motor vehicle. As the trial court correctly recognized, even if the bank was found to be within the scope of the MVSFA and subject to the defenses plaintiffs had against the dealer, the bank is without recourse against the dealer. Where, as here, the bank is an unrelated third party which has made a separate transaction with plaintiffs to extend them credit, we cannot conclude that the Legislature intended the bank to be left 'holding the empty bag.'"¹³

Because the Court in Barnes stated that the subject transaction was not an installment sale contract subject to the Act, it is helpful to compare that transaction to a transaction executed under National City's "direct lending program." In order to represent efficiently such a comparison, I have developed a matrix (Appendix A) which is based upon the declaratory ruling request letter of July 27, 1999, your letters of February 17, 1999, and March 8, 1999, and our previous discussions regarding the features of a Barnes-style "direct loan", the National City transaction, and a typical installment sale contract.

The comparisons made in Appendix A clearly indicate that what the Court of Appeals found to be a direct loan not subject to the Act is not what is contemplated in National City's "direct lending program." In fact, the substance of National City's transaction is much more similar to the typical installment sale contract than the Barnes transaction.

The consumer in both the National City transaction and the typical installment sale contract chooses to finance the purchase at the dealership by utilizing one of the installment sale financing options offered at the dealership. As is the common practice of banks and finance companies that finance installment sale contracts at dealerships, National City will require that dealers have a preexisting contractual relationship with the bank before it will finance any installment sale contract.

In both the National City transaction and the typical installment sale contract transaction the dealer supplies and forwards the credit application to the bank or finance company. In the National City transaction, the dealer negotiates the interest rate term of the contract directly with the consumer, which may result in an increase in the interest rate of up to six percentage points over and above National City's par rate¹⁵. Dealers in installment sale transactions have similar authority to increase the interest rate term of the installment sale contract. The dealer prepares all contract documents, obtains the necessary consumer acknowledgments, transmits the executed loan documents to the lender, and is paid the proceeds of the loan for the purchase price and a yield-spread differential in each transaction.

The main difference between the National City transaction and other installment sale contract transactions is that in the typical latter transaction the dealer assigns its interests in the contract to the lender, while National City's transaction does not require an assignment. In the typical installment sale contract transaction, the dealer assigns its interests in an installment sale contract to the predetermined lender for a fee (yield-spread differential).¹⁶ In effect, the lender compensates the dealer for participating in the lender's contract-making process. In the National City "direct lending program," the dealer is compensated in a similar fashion for its involvement in National City's transaction. For each installment sale processed by the dealer on National City's behalf, National City pays the dealer a fee (yield-spread differential). This fee is a payment that in no significant aspect differs from the fee received by the dealer in the assignment of an installment sale contract. In fact, National City's "Auto Rates" sheet (yield-spread pricing schedule) does not differ from those customarily used in the installment sale market. Therefore, the outcome of assigning an installment sale contract - dealer receipt of a payment from the lender of assignment - is effectively no different from the dealer receiving a "dealer commission fee" from National City. Thus, the true relationship between National City and the dealer is one based on an installment sale transaction, underpinned by an elaborate fiduciary relationship created by the preexisting "Dealer Documentation Agreement." It is a preexisting contractually based relationship that allows Dealers to selectively induce consumers to finance their installment purchases through the National City. It is a transaction that is much more complex and comprised of a great many more duties and obligations than any direct loan program.

Review of the proposed transaction and potential relationship between National City and installment sellers licensed under the Act reinforces the conclusion that the National City "direct lending program" does not differ materially from a transaction subject to the Act. In order to participate in the "direct lending program," a dealer must enter into a "Dealer Documentation Agreement" with National City. This agreement in elaborate detail outlines the rights and duties of National City and the dealer.

As stated in your request letter of July 27, 1999, National City has modified its "Dealer Documentation Agreement" to remove the express contractual recourse provisions that would have required dealers to repurchase contracts from National City for breach of the Dealer Documentation Agreement. Nonetheless, your request letter indicates that National City would have an agency agreement with the dealer. The agency agreement protects National City in a manner that no true direct lender would ever be protected.

If the dealer in any respect breaches its duties owed to National City under the agency agreement in completing any installment sale transaction and that breach causes National City to incur a loss or any other liability, National City may take recourse against the dealer by bringing an action against "the dealer for breach of its agency responsibilities." In short, National City will not be left "holding an empty bag,"¹⁷ it will have recourse against the dealer in the form of an action based in the law of agency.

Further, as you correctly note in your request letter, the Act "was enacted to limit the rate and terms under which a motor vehicle dealer could sell an automobile…" In the National City transaction, the dealer is permitted to increase the interest rate term by as much as six percentage points. Arguably, if the National City transaction was found not to be subject to the Act, the dealer and National City could agree to allow the dealer to set all of the terms of the installment sale regardless of the Act. Clearly, this is not what the legislature intended, and perhaps the very reason section 2(9) was enacted to broadly define "installment sale contract" to include "any other form of contract that has a similar purpose or effect."

Therefore, I must conclude that the proposed transaction of National City, as outlined and described in your request letter of July 27, 1999, your letters of February 17, 1999, and March 8, 1999, and during our previous conversations regarding this matter, to be an "installment sale contract" as defined in section 2 of the Act.

National City's standing as a national bank does not mean that all entities entering into an agency engagement with the bank to facilitate the making of installment sale contracts may do so with impunity towards the licensure provisions of the MVSFA.

Section 15(a) of the Act states, in pertinent part, that:

"No installment sales contract shall be sold to any person doing business in this state who is not licensed under the provisions of this act."¹⁸

Where a bank licensed under the Act has engaged a licensed installment seller as an agent to facilitate the making of installment sale contracts, the agent must not only maintain licensure under the Act, but must ensure that the installment sale transaction that it is facilitating is conducted in full compliance with the Act.²¹ Where such agent has facilitated the making of an installment sale contract and that transaction does not comply with the Act, that agent may be subject to an administrative enforcement action as well as any applicable criminal sanction.²²

Lenders and their licensed dealer agents are not allowed to evade or circumvent the Act by artificially labeling installment sale contracts as direct loans. Where the substance of a transaction is clearly within the purview of the Act, consumers should be able to rely on the consumer protection provisions of the Act. If transactions that in substance are installment sale contracts are not made subject to the Act, the public interest of consumer protection embodied in the Act is defeated. To allow otherwise is to exalt the form of the transaction over its substance and diminish the important public policy of preserving the distinction between installment sale contracts and contracts for the lending of money.

V. CONCLUSION

IT IS MY RULING, based upon the facts presented, that the proposed transaction of National City, as outlined and described in your request letter of July 27, 1999, your letters of February 17, 1999, and March 8, 1999, is an "installment sale contract" as defined in section 2 of the Act, and is therefore subject to the Act.

IT IS ALSO MY RULING that where an entity has engaged an agent to facilitate the making of an installment sale contract, the agent must not only be licensed under the Act, but must ensure that the transaction is conducted in full compliance with all terms of the Act.²³ Where such agent has either facilitated the making of an installment sale contract on behalf of an unlicensed entity, or, regardless of whether the entity is licensed, if the transaction does not comply with the Act, that agent will be subject to an administrative enforcement action as well as any applicable criminal sanction.²⁴

_______________________________________
Gary K. Mielock, Acting Commissioner
Financial Institutions Bureau
Department of Consumer and Industry Services

Dated January 1, 2000

FOOTNOTES:

1. Act No. 27 of the Public Acts of the Extra Session of 1950, MCL 492.101 et seq; MSA 23.628(1) et seq.
2. MCL 24.263; MSA 3.560(163).
3. MCL 492.102(17); MSA 23.628(2)(17).
4. MCL 492.103(a) and (b); MSA 23.628(3)(a) and (b) (emphasis supplied).
5. MCL 492.102; MSA 23.628(2) (emphasis supplied).
6. MCL 492.102(9); MSA 23.628(2)(9) (emphasis supplied).
7. People v Lee, 447 Mich 552, 561, 526 NW2d 882 (1994).
8. Wilcox v Moore, 354 Mich 499, 504, 93 NW2d 288 (1958). Cf., McQueen v Williams, 177 F3d 523 (1999).
9. Seaboard Surety Co. v Bachinger, 313 Mich 174, 178 and 179 - 180, 20 NW2d 854 (1945) (cited with approval in, Kimmel v Hammond, 352 Mich 625, 630, 90 NW2d 681 (1958)). See also, Foster v Ypsilanti Savings Bank, 299 Mich 258, 268 - 269, 300 NW 78 (1941) (quoting Hess v Haas, 230 Mich 646, 652, 203 NW 471 (1925)).
10. See, Griggs v Robinson Furniture Company, 78 Mich App 712, 724-725, 260 NW2d 898 (1977).
11. OAG 1956, No 2,784, p 768, 770 (Dec 19, 1956).
12. 159 Mich App 433, 439, 407 NW 2d 23 (1987).
13. 159 Mich App at 439 (emphasis supplied).
14. Brief for Appellee at 2 - 5, 159 Mich App 433, (1987) (No 90650).
15. For instance, according to the National City Bank Auto Rates sheet (effective February 16, 1999), a "Tier A3" purchaser buying a vehicle priced between $5,000.00 and $12,499.00 would be charged an interest rate of 13.50% by National City. However, because of the three-party (installment sale) nature of the National City Transaction, the dealer may negotiate with the purchaser and increase the contract term by 6% to the rate of 19.50%.
16. Lenders normally refer to such payments as "dealer participation fees."
17. See, 159 Mich App at 439.
18. MCL 492.115(a); MSA 23.628(15)(a).
19. MCL 492.115(a); MSA 23.628(15)(a).
20. MCL 492.115(b); MSA 23.628(15)(b) and MCL 492.137; MSA 23.628(37). See, OAG 1956, No 2784, p 768 (Dec 19, 1956). See also, Restatement (Second), Agency, Section 19 comt d (1958) ("An act may be criminal or tortious if performed by the agent although not if performed by the principal.") and Dodge v Blood, 299 Mich 364, 376, 300 NW 121 (1941).
21. MCL 492.112 - 492.134; MSA 23.628(12) - MSA 23.628(34).
22. MCL 492.109; MSA 23.628(9) and MCL 492.137; MSA 23.628(37).
23. MCL 492.112 - 492.134; MSA 23.628(12) - 23.628(34).
24. MCL 492.109; MSA 23.628(9) and MCL 492.137; MSA 23.628(37).

Appendix A

I. Transaction Comparison: Barnes, National City, and Installment Sale Contracts

Barnes "Direct Loan"	National City Transaction	Installment Sale Contract
Customer goes to dealer to look for vehicle	Customer goes to dealer to look for vehicle	Customer goes to dealer to look for vehicle
Customer decides on vehicle to purchase	Customer decides on vehicle to purchase	Customer decides on vehicle to purchas
Customer obtains direct financing	Customer decides to obtain financing for vehicle through those available at dealer	Customer decides to obtain financing for vehicle through those available at dealer
No contract between the Dealer and Bank	Dealer and Bank must have a preexisting relationship before engaging in the transaction	Dealer and Lender must have a preexisting relationship before engaging in the transaction
Dealer does not take the credit application	Dealer takes credit application on behalf of Bank	Dealer takes credit application on behalf of dealer, for assignment to Lender
Dealer does not impact loan rate or terms	Dealer negotiates an interest rate above National City's par rate to create a yield-spread differential	Dealer negotiates an interest rate above National City's par rate to create a yield-spread differential
Dealer does not transmit application	Dealer faxes or otherwise transmits application to Bank	Dealer faxes or otherwise transmits application to Lender
Bank approves or denies the application	Bank approves or denies the application	Lender approves or denies the application
Bank prepared its own loan documents, all of which were signed at the Bank	On behalf of Bank, Dealer completes Bank's contract in Bank's name with transaction specifics and obtains Borrower's signature - document is a combined promissory note, disclosure statement and security agreement that requires only the Borrower's signature	Dealer prepares the installment sale contract in Dealer's name with specifics of the transaction, and Dealer and customer execute the installment sale contract, which is a combination installment sale contract, disclosure statement and security agreement
Assignment not required - true direct loan	Assignment not needed since the contract is a direct promissory note from the Borrower to the Bank	Dealer assigns the installment contract
No fee paid; loan did not involve dealer	Dealer receives a fee Dealer Commission Fee (yield-spread differential) for processing the contract	Dealer receives a dealer participation fee (yield-spread differential) for processing and assigning the contract
Check payable to consumer and dealer	Bank pays dealer for the sale by permitting the dealer to draw a draft on the Bank or paying proceeds to a "dealer commission account"	Assignee pays dealer for the contract by sending dealer a check, dealer coming to Assignee to pick up a check, dealer drawing a draft on the Assignee, or paying proceeds to a "dealer reserve account"
No loan documents are sent	Dealer sends contract documents to the Bank	Dealer sends contract documents to the Assignee
Dealer owes no duty to Bank *	Dealer owes various duties associated with being engaged as the Bank's agent	Dealer owes various duties associated with the dealer participation agreement
Bank is not liable for UCC or FTC claims	Bank is liable to consumers for warranty claims under the UCC and FTC "Holder Rule"	Assignee is liable to consumers for warranty claims under the UCC and FTC "Holder Rule"

* The only duty owed by the dealer to the bank in this transaction is the titling requirement under the Motor Vehicle Code, MCL 257.217(2), (4), and (5); MSA 9.1917(2), (4), and (5), and certain provisions of the Uniform Commercial Code.