Managing dealer risks when a customer doesn’t pay
All dealers rely on retail financing companies to extend credit to customers so the customers can buy equipment. Because you play a role in that financing process, you also understand that the finance companies have a lot of rules that must be followed before a loan is made to your customer. These rules and procedures aren’t just there to protect the lender before the loan is made… the point of many of these rules is to make sure the lender has the right to grab the equipment/collateral from your customer if the customer doesn’t pay.
The problem dealers and finance companies face is that a failure to follow all of the rules correctly doesn’t come to light until a customer can’t pay the bill (perhaps even four-five years down the road) and the customer’s creditors or a bankruptcy trustee start fighting over who has the rights to the equipment. In these situations, if a finance company can’t recover the equipment (or get enough value from the recovered equipment), they will often be knocking on your door to recover the loss – a chargeback – by pointing a finger at you as the source of the information or action that caused the problem.
Chargebacks represent significant and unexpected costs. Because they can appear several years after your role in the transaction, it is also nearly impossible to manage risk by simply making an assessment about whether or not the customer will be able to pay at the time the loan is made. The only answer is to implement clear direction with your dealership employees on compliance with the required rules established by your retail finance providers.
The Importance of Compliance
To illustrate the importance of compliance, I want to share with you four issues that lead to chargebacks against dealers and represent the most likely grounds for a chargeback relating to a UCC security interest issue:
1. Wrong Customer Name. One of the harshest results under the UCC filing system occurs when there are minor errors in a customer’s name. This applies to both individual and corporate customers. A misspelling or missing middle initial on a name can be enough to screw up the finance company’s claim to the equipment and justify a chargeback. For corporate customers, putting a space in the wrong place (e.g., NetWork Solutions instead of Network Solutions) or using a d/b/a can have the same impact. The best way for dealers to limit risk in this area is to be sure to follow the names reflected on the official documents of the customer (e.g., driver’s license or articles of incorporation) and not to rely on auto-fill features in business systems that can perpetuate mistakes many times over.
2. Filing in the Wrong Place. This is related to the “wrong name” issue. Your customer’s “location” is important because it determines where a UCC filing should be made. For individuals this would be tied to their state of residency so obtaining current address information is important. For most of your customers who have entities, “location” is based on the state where the entity was formed. Because this can be different than the state(s) in which the customer operates, obtaining current corporate documents and verifying incorporation on a state’s Secretary of State website are important steps to managing risk in this area.
3. Mistakes in Collateral Descriptions. Unlike issues with names, a problem with a collateral description occurs when the description is too specific and includes mistakes. For example, a collateral description on a UCC filing that says “combine” will not cause problems. But if the description is more specific and the wrong brand, model number or serial number are used, there is a risk that the UCC filing will be considered defective as it could be viewed as misleading other creditors as to what collateral might be available to them. Even though most dealers won’t be making the UCC filings and therefore don’t control how much specificity goes into the collateral description, instituting procedures to double-check the accuracy of collateral information submitted to the finance company is important.
4. Delivering Equipment Too Early. One of the most difficult issues from a risk management standpoint relates to the timing of delivery to a customer and the related timing deadline for filing a UCC financing statement. The issue comes up because the finance company only has 20 days after your customer “receives possession” of the equipment to file the UCC financing statement. The problem is there is no definition of “possession” in the UCC and there are many circumstances in which a customer gets to use the equipment (e.g., potentially “taking possession”) before the financing paperwork is given to the finance company. In these situations, issues can occur with the 20-day deadline. This area is further complicated because courts in different states have made varying rulings in this area and there is not always a bright line as to how dealers and finance companies should approach this. Despite these issues, dealers still need to educate both their financing personnel and sales staff on the risks and implement some best practices. To minimize risks to your dealership in this situation, I recommend implementing the following:
- Always use a written rental agreement or demonstration agreement with a customer to document clearly that you are retaining ownership of the equipment in these situations.
- If a customer has signed a binding purchase order for the equipment, do not give the customer a short-term trial period before the equipment is financed or paid for without communicating this in advance to the finance company and confirming that a UCC filing is being timely filed.
- If a customer exercises a purchase option under a rental-purchase option transaction, proactively work to identify the finance company that will be used and inform them of the option exercise date.
Even though the situations mentioned here can easily cause problems with UCC filings and chargebacks, they are not the only issues. Be sure to follow all of your finance company’s procedures and make sure someone in your organization is given the responsibility to stay on top of changes in procedures and the authority to implement and roll out changes to procedures as needed.
The reality is that UCC-based chargebacks pose a risk to your bottom line and dealers need to be vigilant about compliance in this area and implementing procedures to manage the related risks.
Article Written By Lance Forwalt
LANCE FORMWALT is the leader of the Equipment Dealer Group at Seigfreid Bingham, P.C. The firm also serves as legal counsel to the Western Equipment Dealers Association (WEDA). Lance may be contacted at email@example.com or 816-265-4106. Also see www.sb-kc.com. This article is intended to provide general recommendations and is not intended to be legal advice. You should always consult your attorney for advice unique to you and your business.