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Vehicles as Collateral: Lender Beware
July 13, 2011
Even before entering the world of banking, you were most likely familiar with the old adage that a vehicle “loses half its value when it’s driven off the lot” or that a car is “a depreciating asset.” Indeed, the general vehicle depreciation rate is between 15% to 20% per year. All lenders account for this depreciation by scrutinizing the long term value of a vehicle when used as collateral for a commercial loan. However, lenders should also take into consideration certain statutes and situations before allowing motor vehicles to serve as collateral for a loan.

Even after the bank has perfected its interest and the lien is recognized on the front of the vehicle’s title, auto mechanics and towing companies can later assert a superior lien, even for work performed years after the loan transaction is complete. How? Dubbed a “mechanics’ lien,” such statutes broadly entitle any person who tows, alters, repairs, stores, services or improves the vehicle to a statutory lien for payment. The mechanics’ lien is rooted in the idea that the mechanic is in possession of the vehicle with the consent of the owner. Therefore, he has implied authority to contract for repairs and is entitled to a lien for such repairs. The bottom line? A mechanics’ lien is superior to the lender’s lien on the vehicle’s title, even though it arises after the date of the loan.

As the vehicle-collateral ages, and repairs become more frequent, the risk of a mechanic asserting such a lien over the lender increases with time. If the lien remains unsatisfied, the mechanic may sell the vehicle at a public or private sale. Often, mechanics neglect to notify interested parties (including lenders) and the sale occurs without proper notice. At that point, the lender is in an expensive mess and fighting for the return of a depreciated, mobile asset in the hands of an innocent third party.

Be aware. A borrower in default can complicate vehicle repossession by collaborating with a mechanic or towing company to store the vehicle and encumber it with a fabricated mechanics’ lien. Such a tactic is a way to “game the system” and threaten to sell the vehicle if the lender does not pay to have the vehicle removed from storage. In hopes of payment, the mechanic (and borrower) know that the lender will “do whatever it takes” to eliminate the threat of a superior lien and loss of collateral.

Fortunately for lenders, there is one bright spot in that many state statutes require the mechanic or towing company to file a written report with the DMV in order to secure the right to payment while storing the vehicle subject to the lien. Usually, failure to file this report forfeits the mechanic’s right to claim storage charges. More importantly, failure to make the report can often result in civil or criminal penalties, depending on the jurisdiction. Enforcement of the statute requiring such a report is a way to counter any mechanic’s claim for a lien superior to that of the lender. Plus, even if the mechanic or towing company insists that it filed the report, lenders are advised to ask for a copy of the report as well as a certified mail receipt evidencing delivery to the DMV.

All this being considered, even with some statutory safeguards, the remedies available to a lender in a mechanics’ lien situation are less than favorable, especially pertaining to vehicles that have lost a significant amount of their value over the course of a loan. Certainly, spending money pursuing a vehicle that is worth less than $5,000.00 is a “no-win situation.” Therefore, lenders are advised to carefully consider the likelihood of recovery when collateralizing a commercial loan consisting mainly of vehicles as security.
Banking & Finance Law