A quick summary of the law: Adverse action notices are required under the federal Equal Credit Opportunity Act ("ECOA") and its implementing Regulation B, and the Fair Credit Reporting Act ("FCRA") when a "creditor" takes "adverse action" against a consumer. ECOA prohibits discrimination in credit practices and requires giving customers notices of the reasons credit was denied or counter-offered. FCRA deals with credit reports and requires notices to consumers when a credit report is used in taking an adverse action. Both laws have specific required language you must include in the adverse action notice, but one notice can meet the requirements of both laws.
The definitions of "creditor" and "adverse action" are critical in knowing when you have to send notices.
Generally, if a dealer takes any action in setting the terms of credit for its customer (such as by marking up a buy rate or rehashing a credit offer from a lender), the dealer is a "creditor." While there is an old Federal Reserve Board interpretation that says a dealer who merely refers credit applications to a lender but does not participate in the credit decision does not have to send an adverse action notice. It’s not recommended to rely on that exception even if you were relatively passive in the process. In this day and age, almost any dealer who is involved in obtaining credit for consumers will be considered a "creditor" who is obligated to send an adverse action notice if one is required by ECOA or FCRA.
"Adverse action" is defined under ECOA as "a denial or revocation of credit . . . or a refusal to grant credit in substantially the amount or on substantially the terms requested." However, under ECOA and Regulation B, there is no "adverse action" if the consumer accepts a counteroffer of credit. FCRA adopts the ECOA definition of adverse action (no adverse action if the consumer accepts the credit offer) but adds a catch-all provision alternatively defining "adverse action" as any action or determination that is "adverse to the interests of the consumer." Some recent cases have held that the consumer's acceptance of a credit offer doesn't negate this catch-all definition of "adverse action" under FCRA. So it is possible to have no adverse action under ECOA but adverse action under FCRA if the consumer accepts a credit offer that is considered adverse to their interests.
If there is "adverse action," the creditor is obligated to send the consumer an adverse action notice giving the reasons (ECOA) and identifying the credit bureau whose report the creditor relied on in taking the adverse action (FCRA). The adverse action notice needs to go out within 30 days after the creditor receives a completed credit application.
In one case that came down a while ago, a dealer obtained a credit approval for a customer conditioned on the customer providing proof of income. When the customer failed to provide the proof of income, the lender revoked its approval and the dealer repossessed the car. The court held that under the FCRA "catch-all" of any action adverse to the consumer, the dealer was required to send an adverse action notice to the consumer even though it was the lender that took the real "adverse action" by withdrawing its credit offer.
Historically, many dealers have relied on adverse action notices from lenders to satisfy any obligations the dealer may have to send such notices to their customers. Regulation B permits a third party (the lender) to provide an adverse action notice on behalf of a creditor (the dealer) but, in that case, the adverse action notice needs to state the name and address of the dealer. Most lender adverse action notices don't do this and a dealer should not rely on a lender to send the adverse action notice on its behalf. This is something you have to do for yourself. But when should you send adverse action notices? The cases are in conflict and you should check with your local attorney for what the law and trends are in your area. But here is a suggested procedure that attempts to reasonably reconcile the majority of cases and the realities of business.
A dealer should send an adverse action notice to a customer in at least the following three circumstances:
1. When you take a credit application but don't send it to any lender and don't provide any financing to the customer such as a buy-here-pay-here dealer. This is a no-brainer. By not sending the credit application to any lender, you make yourself the creditor and you have made a decision not to extend credit. Classic adverse action. The cases are uniform in this scenario. The dealer is a creditor by reason of accepting a credit application and neither financing the customer nor sending the application to a lender. In doing so, the dealer has taken adverse action with respect to the customer.
2. When no lender approves credit for the customer or when the customer declines all offers of credit that are made by the lenders. Remember it said that a customer accepting a counteroffer of credit, no matter how unfavorable, negates "adverse action" under the ECOA definition? If that doesn't happen, either because no lender approved the customer or the customer refused all credit offered, you are stuck with an adverse action situation. Send your own adverse action notice to the customer in this situation.
3. When you "unwind" a spot deal. Failed spot deals cause more dealer litigation than any other circumstance. Under both the general definition of "adverse action" (failure to provide credit on the terms requested) and under the "catch-all" prong of the FCRA (action adverse to the interests of the consumer), unwinding a spot deal is probably adverse action.
Since a contract was already signed and is now being cancelled, it is difficult to claim that the customer's acceptance of a counteroffer (another contract that you can sell to a financing source) negates adverse action. Unwinding a spot deal would also seem to fit squarely under the "catch-all" definition in the FCRA of "any action adverse to the customer." Perhaps most importantly, it is also the situation where you are most likely to have an unhappy customer. Sending an adverse action notice in this situation is a good way to ensure compliance and is thus a recommended course of action.
As noted above, a case held that marking up a buy rate can be adverse action under the FCRA. An insurance case ruled that just picking where you send the credit application (to a prime or non-prime lender, for example) can be adverse action. But if these cases represent the law, almost every transaction will require an adverse action notice. That would be an absurd result and doesn't comport with the spirit of the law. It would also make adverse action notices essentially meaningless (since almost everyone would get one) and that was not the intention of Congress nor the Federal Reserve Board. It would also place an unreasonable compliance burden on dealers to send adverse action notices when customers walk away happy with their auto purchase and financing.
Again, check with your local attorney, but be aware that you are probably not sending adverse action notices in many situations where you may be required to do so or where doing so is a best practice. Don't wait for a plaintiff's lawyer or a regulator to be the first to let you know.