How the Military Lending Act Plagues the Finance Industry
The Military Lending Act (MLA), enacted in 2006 and implemented by the Department of Defense (DOD), protects active duty members of the military, their spouses and their dependents from certain lending practices. In December 2017, the DOD issued an amended interpretive rule to clarify whether personal property and auto finance purchase money credit transactions were eligible for a stated exclusion under the MLA. Unfortunately, the “clarification” only caused further confusion.
with co-author Erica A.N. Kramer
In December 2017, the DOD issued an amended interpretive rule (“December Interpretive Rule”) to clarify whether personal property and auto finance purchase money credit transactions were eligible for a stated exclusion under the MLA. Unfortunately, the “clarification” only caused further confusion. Even worse, it took away an important option from covered borrowers.
Before the December Interpretive Rule, most in the auto finance industry believed that the MLA excluded purchase money auto credit transactions. However, the December Interpretive Rule FAQ #2 states that if a transaction also finances “credit-related costs,” it will be disqualified from the exclusion. The term “credit-related costs” is not defined; however, examples are provided — namely, GAP and credit insurance.
Adding to the confusion is the fact that the MLA prohibits creditors from securing credit transactions with covered borrowers with a motor vehicle title. This destroys the practicality and economics of financing the purchase of a vehicle with a credit-related product. No finance source in its right mind will make an unsecured loan or purchase a retail installment sale contract without obtaining a security interest in the vehicle as collateral. This effectively takes away a covered borrower’s opportunity to purchase GAP.
Could the covered borrower purchase the GAP for cash? Well, for most GAP products, no, because GAP waiver products are agreements creditors enter into waiving their right to collect deficiencies in the event the vehicle is a total loss. In other words, the legal structure of this product is that it’s a part of the financing document. There are third-party GAP insurance products, but they are not as prevalent, and covered borrowers usually don’t have the spare cash to buy these products after making their down payments.
Note that there is a carve-out in the MLA to the vehicle title prohibition, but it only applies to banks, savings associations and credit unions. And that carve-out isn’t broad enough to help most auto finance deals, even if a bank, savings association or credit union ultimately takes assignment of the retail installment sale contract.
Dealers are thrust into a Catch-22 situation: Most sell GAP waivers and historically have offered them to all customers, but they are now effectively prohibited from offering them to covered borrowers because the GAP waiver cannot be financed (since no finance source will make a loan or buy a retail installment sale contract that is not secured by the vehicle being purchased).
So, what’s a dealer to do? The choices are limited and unpalatable. The outcome is even worse for a covered borrower, who can no longer purchase a legitimate product that would protect him or her from liability in the event the vehicle is subject to a total loss. This is particularly unfortunate, given the hurricanes and fires the U.S. has experienced in the last couple of years.
Some dealers and finance sources have chosen to completely stop selling and financing GAP and other types of credit insurance products. Why a complete stop to the sale of GAP waiver? Because many states have laws prohibiting creditors from discriminating against servicemembers. In these states, dealers may be challenged as discriminating if they do not offer servicemembers the same products they offer non-servicemembers. Why take such a conservative approach? Easy answer: The MLA’s penalties for not complying are draconian. Nonconforming transactions are void from inception, and the MLA provides both criminal and civil penalties, along with a private right of action. Moreover, offering products and services only to certain consumers but not to covered borrowers could result in allegations of a UDAAP violation.
The other option is to offer and sell GAP waiver and credit products only to non-covered borrowers. Some creditors have chosen this path. This requires the creditor to check the covered borrower status of every applicant. If a covered borrower is involved, GAP and other credit-related products are not offered or financed. This approach may work for creditors in a state with no servicemember anti-discrimination laws or where creditors have undergone a careful analysis and concluded that no programs are available to covered borrowers.
Creditors who take this second approach should document their analysis and have a formal policy in place consistent with such analysis. Note that this path is not without risk! It does not mitigate all state discrimination or UDAAP claims that may arise from offering certain products only to non-covered borrowers. Creditors should also take advantage of the MLA’s safe harbor for determining covered borrower status. To obtain the safe harbor, creditors must verify the consumer’s covered borrower status, either through the MLA database or by using a consumer report obtained from a nationwide consumer reporting agency, and they must keep a record of their findings.
Will the DOD reconsider?
Industry trade groups continue to appeal to the DOD, as well as to Congress. Covered borrowers have enjoyed the benefits of the GAP waiver for years. Now, they’ll have no option but to get stuck with paying the deficiency in a total loss situation, in the midst of being without transportation and needing to a buy and finance a new car. Hopefully, the DOD will reconsider how it’s chosen to protect covered borrowers.
This article is provided for informational purposes and is not intended, nor should it be taken as, legal advice. The views and opinions expressed in this article are those of the authors in their individual capacities and do not reflect the official policy or position of their partners, entities, or clients they represent.
Patricia Covington is a partner in Hudson Cook’s Richmond, Virginia office and can be reached at 
