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Negative Equity in Lemon Law Cases

Negative Equity

Lemon Law Buyback Information

When you owe more in finance (whether for a purchase or lease) than your vehicle is worth, you are said to be “upside down.” Another way to describe this surplus debt is “negative equity.”

Sometimes, negative equity is created at the time the new car is purchased or leased. This generally happens when you trade in a car you are upside down on for a new one. The surplus debt is rolled into the finance of the new car.

For instance, let’s say you have a car that’s worth $15K but still has a remaining loan of $20K. You are $5K upside down. Then, let’s say you trade the car in on a new car you are purchasing for $25K. The $5K negative equity will be added to the purchase, so you are effectively securing a $30K loan with a $25K asset.

Negative equity is controversial because cars are depreciating assets by themselves. Starting upside down in a transaction is a good way to stay upside down for a long time, while you are making payments.

The significance of negative equity on a lemon law buyback

If you have a qualifying California lemon law claim, the manufacturer must repurchase or replace your vehicle (minus a value offset for miles driven before the problems started).

In the case of a lemon law repurchase, the amount of the refund is equal to the “actual price paid or payable by the buyer,” which includes the down payment and monthly payments, along with registration charges and other costs listed on the purchase or lease agreement.

Whether the negative equity counts as part of the price “paid or payable” for the car is a heated topic of debate between consumer lawyers and manufacturer defense attorneys. The consumer lawyers argue the debt is part of the price paid to purchase the vehicle. After all, there is no way for the consumer to get the trade-in vehicle back, and it’s not his or her fault that the car is a lemon and may end up on the receiving end of a lemon law buyback.

The defense attorneys argue that there should be a deduction for the debt carried over from the previously traded-in car, because paying off two cars due to one lemon would be a “windfall” — an unearned reward.

Which way is more ethical?

This answer to this question is important. If a deduction is taken for negative equity, the amount of reimbursement for payments made by the consumer will be reduced, eliminated, or — in extreme cases — reversed, so that the consumer actually owes the manufacturer money after the car is “bought back” in a lemon law repurchase.

Taking our example of the $30K debt owed on a $25k car, if the consumer has made $1,000 in payments at the time of a lemon law buyback, he or she will actually have to pay the manufacturer $4,000 to take back the car. For many cash strapped consumers, this outcome is not feasible. The lemon law repurchase itself becomes prohibitive.

This issue can be very confusing. Goldsmith West has found that many consumers are not even aware that they have financed negative equity, let alone that they may be asked to pay the manufacturer money for it, despite having a strong lemon law claim may end in a lemon law buyback.

What the Law Says About Negative Equity

At the time of this writing, there is no California case law that is controlling on this subject. Case law is generally created when a case is appealed, and it is likely that neither the consumer attorneys nor the defense attorneys have found the right case, or want to put the issue before the court at the risk of creating unfavorable law.

However, the California Department of Consumer Affairs (DCA) has a longstanding rule that no deduction should be taken by the manufacturer for negative equity. While this may not control courts, the rule should be enforced in lemon law arbitrations, as DCA audits them for compliance. In one of its recent “Lemon Law Aid for Consumers” pamphlets, DCA described this rule’s effect in no uncertain terms:

  • If the arbitrator decision awards you a replacement or refund of your vehicle, the manufacturer is prohibited from deducting for negative equity. Negative equity is not an allowable deduction in State-certified arbitration programs. When an award is made, it is the responsibility of both the State-certified arbitration program and the manufacturer to ensure the consumer is made whole.
  • Negative equity is also referred to as being “upside-down” in your car loan. In other words, if you owe more money on your car loan than the car is worth, the manufacturer may not deduct that amount. Therefore, when the arbitration program receives and reviews the repurchase and replacement amounts (calculation worksheets) provided by the manufacturer, it is the program’s duty to notify the manufacturer of unallowable deductions, such as negative equity. This deduction must be corrected and returned to the consumer.

Negative Equity Solutions

While the question of how to treat negative equity in the case of a lemon law buyback is difficult, there may be an easier answer in the case of a replacement. It is possible to do a trade by “collateral swap.” In a collateral swap, the loan schedule, current balance, and payment amount stays the same. The only thing that changes is one car (the lemon) is removed as collateral to secure the loan, and is replaced by another car (the replacement vehicle). The consumer is arguably returned to the position that he or she bargained for, with a new car and the same loan terms.

Many lemon law settlements that involve negative equity result in some kind of compromise on the issue. Converting the value of the settlement into a “cash-and-keep” deal is one way to do this; unfortunately, it often leaves the consumer to continue driving the lemon. It also avoids the manufacturer’s requirement to title brand the vehicle as a lemon.

Another solution is to pursue arbitration instead of litigation, because the DCA rule should be controlling in arbitration. We’ve already detailed how arbitration appears to be biased against the consumer, but this may in fact be the best reason to choose to arbitrate a lemon law case.

However, despite the clear DCA rule prohibiting negative equity deductions, our experience is that the two major private arbitration providers — the Better Business Bureau (BBB) Auto Line Program and the California Dispute Settlement Program (CSDP) — may be passive aggressive when it comes to negative equity. By failing to adequately explain the rule to their arbitrators or in published rules for consumers, they create a situation that may confuse consumers or their own individual arbitrators. Indeed, DCA audits of arbitration providers have found this to be the case in the past, with respect to certain manufacturers.

Conclusion

Negative equity can be confusing, and where it exists, it is often a central issue to a lemon law case. It must be considered in the overall strategy of how to proceed in a case. Be sure you understand this issue — or have experienced lemon law counsel who understands it — before you decide how to approach your lemon law claim. For more information on negative equity in lemon law buyback cases, contact Goldsmith West today for a free consultation.

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