Many in the vehicle finance world were anxiously awaiting a decision of the U.S. Court of Appeals for the Fourth Circuit in the case of Davidson v. United Auto Credit Corporation*. The Davidson case matters to anyone interested in whether GAP coverage can be included in vehicle financing obtained by consumers who are covered by the Military Lending Act, a group that generally includes active-duty military, their spouses, and dependents. If this issue matters to your business, you are aware that there has been a lot of doubt for several years, in part because of some flip-flopping by regulators.

On April 12, 2023, the Fourth Circuit removed this doubt by ruling in favor of United Auto Credit Corporation in a 2-1 split decision. This ruling is cause for celebration in the vehicle finance world. The Davidson case addressed a question of interpretation of a provision in the MLA that exempts credit offered for the express purpose of financing the purchase of a vehicle and secured by the purchased vehicle (the "Purchase-Money Exclusion"). The Purchase-Money Exclusion was created by the MLA and expanded upon in federal regulations promulgated by the Department of Defense to implement the provisions of the MLA.

For many years, the language of the Purchase-Money Exclusion was the subject of a debate about its application to transactions that included financing for amounts other than the purchased vehicle and, in particular, whether the inclusion of certain voluntary products (e.g., GAP coverage) would cause the entire transaction to lose its exempt status. During this period, and thanks to the aforementioned regulatory flip-flopping, the vehicle finance industry found itself in a position to offer GAP to MLA-covered buyers, then have to restrict it, then be able to offer it again.

The Davidson decision reinforces the view that the inclusion of charges for GAP coverage (or other charges directly related to financing the purchase of a vehicle or related products) does not cause the transaction to lose its exempt status. The Purchase-Money Exclusion applies where financing is "for the express purpose" of financing the purchase of a vehicle. The majority opinion framed the legal question very simply—the Purchase-Money Exclusion applies to any "loan procured in the course of purchasing a car, when that loan is offered for the express purpose of financing the purchase and is secured by the car." The court said that this appeal hinged on what Congress meant when it used the phrase "for the express purpose." If that phrase means "for the sole purpose," then no amount other than the price of the vehicle may be financed. If that phrase means "for a specific purpose," then the inclusion of other items in the amount financed is permitted, and the transaction is still exempt.

The court then proceeded to open up its statutory interpretation toolkit (including a review of dictionary definitions of the meaning of "express," some treatises on grammar and logic, and prior court decisions) before reaching the conclusion that, in the context of the MLA, the phrase "for the express purpose" does not mean "for the sole purpose." Based on that analysis, the majority concluded that the inclusion of a $395 GAP coverage charge in Davidson's $14,698.24 motor vehicle finance contract did not disqualify the transaction from the Purchase-Money Exclusion, and, therefore, the transaction was exempt from the MLA.

That's a happy ending to the latest episode, but let's not assume that this is the end of the story. The Davidson case establishes precedent only for the Fourth Circuit, which covers Maryland, North Carolina, South Carolina, Virginia, and West Virginia. Outside of those states, courts are free to reach a different conclusion. Currently, we know of no other cases like Davidson. The result in this case should deter others from bringing a similar claim, but we can't assume that will never happen. Also, there was a dissenting opinion in Davidson, and that judge felt strongly that the majority got it wrong. A copycat case could find its way to a court outside the Fourth Circuit and create a different precedent.

This case is also not necessarily over. Davidson could ask for a rehearing by a larger panel of judges from the Fourth Circuit. Although unlikely, this latest ruling could be appealed to the U.S. Supreme Court. It's even more unlikely that the Supreme Court would reach a different decision from the one reached by the majority in Davidson, but not impossible.

Another potential outcome is that the DoD could try to amend the MLA implementing regulations to specifically state that the inclusion of certain "credit-related" products or services in a vehicle financing will push that transaction outside the Purchase-Money Exclusion. Whether the DoD can undertake such an amendment in light of the Fourth Circuit's majority opinion is unclear. The DoD certainly has the power to amend its MLA regulations, but it can't rewrite the MLA itself. Only Congress can do that. So, it's helpful that the Davidson court focused on an interpretation of the statutory provisions of the MLA and not on the MLA implementing regulations promulgated by the DoD. (By contrast, the trial court decision that was appealed to the Fourth Circuit focused more on the MLA regulations.)

I expect that the majority opinion's focus on the MLA's statutory provisions will make it more difficult for the DoD to promulgate a rule change limiting GAP coverage for transactions with MLA-covered consumers. That said, the DoD filed an amicus brief in the Davidson appeal and took a view contrary to that expressed in the majority opinion. So, there's reason to believe that the DoD might be considering a rule change. If the DoD were to rewrite its MLA regulations to provide that inclusion of GAP coverage or a similar product pushes a vehicle financing outside the Purchase-Money Exclusion, then it would be risky to fund any transaction that includes GAP coverage unless and until a court invalidates that hypothetical DoD rule.

But this is not the time for doom and gloom. The outcome in Davidson is a win for the vehicle finance industry and for a common-sense interpretation of the MLA. If the Fourth Circuit had ruled in favor of Davidson, the result would have been a retroactive change in the law affecting many existing motor vehicle finance transactions. Such a ruling would have spawned countless class action lawsuits against finance companies that had reasonably interpreted the Purchase-Money Exclusion to allow for the inclusion of GAP coverage in transactions with MLA-covered consumers.

If the rules for including GAP coverage and similar products in transactions with MLA-covered consumers are going to change, then that change is best accomplished in an orderly process, either by amendment to the MLA or (possibly) the DoD regulations. Such a process is necessary to avoid a retroactive application of a change in law and ensure that the industry will have sufficient time to revise its funding procedures to avoid violation of the MLA. 

*Davidson v. United Auto Credit Corporation, 2023 U.S. App. LEXIS 8747 (4th Cir. (E.D. Va.) April 12, 2023).

*Robert F. Gage is a partner in the Michigan office of Hudson Cook, LLP. 

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