In Iowa, when a dealership sells vehicles “out of trust” (SoT), it may subject the violator to criminal and/or civil litigation, loss of dealer license, and up to 20 years in federal prison (18 U.S.C. § 1963). Let’s follow Dealer X through the following hypothetical:
Perhaps Dealer X has been losing money for months or even longer. Suppose Dealer X has not reduced dealership expenses and/or cannot raise gross profits. Maybe the floor plan financer wants more floor plan reduction or curtailment and there is not sufficient cash flow. Dealer X may either know or later discover that instead of paying off sold vehicles in accordance with the floor plan agreements, the controller has neglected to pay off sold vehicles by using those funds to pay general expenses. Oops, now there are not sufficient funds to make payoff(s). Maybe the dealership is out of trust on one vehicle—maybe ten vehicles. Now what?
Does Selling Out of Trust Lead to Criminal Action?
Well—sometimes. To be found guilty of theft under Iowa Code § 714.1(5), Dealer X must have the specific intent to defraud the floor planner. Here, specific intent means “not only being aware of doing an act and doing it voluntarily, but in addition, doing it with a specific purpose in mind.” This is determined by a jury according to the specific facts of the case. If Dealer X is unaware of the circumstances resulting in the vehicles being sold out of trust, or those sales are accidental, then Dealer X might avoid criminal liability. To be found guilty of theft, it is more likely that Dealer X must personally direct or allow that the our of trust sale occurs with the intent to defraud the lender. This intent to defraud may still be present even if Dealer X intends to pay the lender back at a later date.
To be found guilty of ongoing criminal conduct under Iowa Code § 706A.1(5), Dealer X must have knowledge that the affairs of the dealership were conducted through unlawful activity. If Dealer X is unaware of the out of trust sale, then Dealer X does not have knowledge and would not likely be found guilty. In contrast, if Dealer X is directing or is aware of the unlawful activity, then Dealer X clearly has knowledge of that activity and may be found guilty of ongoing criminal conduct.
The Iowa Court of Appeals dealt with these issues in State v. Friedley, 669 N.W.2d 262 (Iowa Ct. App. 2003). Herald Friedley was charged and found guilty of first degree theft and ongoing criminal activity for selling out of trust and lying to the lender about the location of those vehicles. In Friedley, specific intent for theft was found based on the following findings: 1) Friedley directed that proceeds from the sale of cars not be paid to the bank, 2) Friedley was aware of his obligation to the lender but decided to breach the terms, and 3) Friedley hid this scheme from the lender by telling the lender that the sold vehicles were being “test driven.”
In addition to the criminal charges discussed above, SoT sales leave Dealer X vulnerable to civil litigation with the floor plan lender, customers, and business partners. The floor plan lender can sue Dealer X, as well as any guarantors, under a breach of contract claim. Customers may also bring a cause of action against Dealer X when they realize they lack title to the vehicle sold out of trust.
Advice – In Case of Emergency – Tell the Truth
How could Dealer X avoid this situation?
First, Dealer X could have anticipated that expenses would exceed revenues, then rapidly reduced expenses accordingly.
Suppose that Dealer X encountered a situation where he/she could not take action quickly enough to pay creditors without selling out of trust? As soon as Dealer X became aware that the dealership was in trouble, he/she should have contacted legal counsel to develop a strategy for informing the floor planner about the situation and seeking, e.g., a temporary credit line or perhaps a fixed loan. If Dealer X presents the floor planner with a business plan for increasing profitability, it is more likely that accommodations would be made.
What if Dealer X does not notify the floor planner? If a floor plan lender conducts an audit and asks Dealer X where an out of trust vehicle is located, it is critical for Dealer X to be honest with the floor planner. The worst thing that Dealer X can do is to create a cover-up story about why the vehicle is not on the lot, by claiming, for example, that the vehicle is in an outside body shop, out on a test drive, or at the dealer’s house, etc. If Dealer X lies to its lender, then Dealer X has further opened the door to potential criminal charges.
If you have questions or concerns about out of trust sales, or need help working with your floor plan lender, contact experienced auto dealer counsel today.