On Tuesday, the U.S. Supreme Court heard oral arguments in the appeal of Koons v. Nigh, a lawsuit first decided in 2001. The case concerns a scam that used to be common among less-than-scrupulous used car salesmen, known as a "yo-yo sale." Briefly, it goes like this:
A customer walks into a dealership and finds a car she likes. The customer trades in her current vehicle and signs a contract to buy the new (or "new to her") car with financing. The sale, however, is not completed at that time. Rather, it is made contingent on the dealership being able to find a buyer for the financing. The customer drives home in her new car, confident that this formality will be resolved in a day or so. The dealership, however, has other plans. It arranges for the financing to be rejected, then informs the customer of the rejection and tells the customer to come back in and sign a different contract with different terms -- a larger down payment, for instance, or a higher interest rate. If the customer then asks to just cancel the contract and get her old car back, she is told that the dealership has already resold it, at which time the customer caves in, agrees to worse than the original contract terms and drives the new car home.
Sound illegal? It is, as the federal Truth in Lending Act (TILA) makes clear. The issue that the Supreme Court must now decide is what else TILA says. In Koons v. Nigh, a General Motors (NYSE:GM) Buick-brand dealer reportedly played the part of bad guy, allegedly tricking a customer into paying a lot more than he bargained for to purchase a used Chevy Blazer. The customer sued for what he says TILA entitles him to: double the cost of his finance charges, or about $24,000. The dealer contends that TILA places a cap on the damages a defrauded consumer can recover: $1,000 absent proof of actual financial loss.
Without going into a lot of boring legal details, I've read over the case, and it looks like a better than 50/50 chance that the customer is going to win this one. If that proves to be the case, it will raise the cost of doing business (through increased court awards, insurance premiums to cover the greater risks, and costs to monitor the fairness of transactions) for used car dealers such as AutoNation (NYSE:AN), CarMax (NYSE:KMX), and America's Car-Mart (NASDAQ:CRMT). It will also hurt smaller dealers, for example those who lease car lots from Capital Automotive REIT (NASDAQ:CARS). None of that will materialize right away, however -- a decision on the case in not expected before July 2005.
For more news on wheeling and dealing in the used car industry, read:
- CarMax Stalls Out
- America's Car-Mart Accelerates
- Has CarMax Got a Deal for You?
- Insiders Like CarMax
Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.
