Written by our Chief Counsel, E. L. Eversman, a premier legal authority in the automotive arena, these articles address the most important legal issues affecting the automotive industry today.

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Diminished Value And Leased Vehicles:<br>Do Leased Cars Really Suffer Less from Collision Damage? - 02/12/2003


A separate category of interest in the diminished value debate is the ability of parties to a lease arrangement to successfully claim and recover for diminished value. To me, it seems to be a straightforward proposition.

Leases are simply arrangements by which an owner allows someone else to have legal possession and use of property for a price - and usually for a set period of time. Most car leases are for a time period longer than a year and involve a cost greater than $500. Therefore, for those jurisdictions following or adopting some form of the seventeenth century English statute, known commonly as the Statute of Frauds, automobile lease contracts must be in writing to be valid.

Lease contracts are governed by the same principles as other contracts and operate according to their individual terms, provided that the terms do not violate statutes or public policy. That being said, what makes a leased car any different than one financed through a bank or owned outright for the purpose of claiming diminished value? Simply put, nothing. So, why are banks, leasing companies, and the people leasing those cars told that diminished value is not recoverable when a leased vehicle has been damaged? Good question, because it is recoverable.

Owners v. Lessees

A damaged vehicle suffers diminished value, irrespective of the relationship or ownership in which it is held. The only issue to be addressed is, who is entitled to claim and recover for the diminished value? This question is easily answered when a vehicle is owned outright. Obviously, the owner is entitled to the diminished value.

Even when the automobile is financed through a bank or other lender, the answer is straightforward. The owner is still the party entitled to the diminished value. The finance company may be in possession of the vehicle's title, but it only has a security interest in the vehicle, not an ownership interest. In other words, the lender retains the vehicle's title, thereby preventing any transfer of ownership, as collateral against default and to ensure repayment of the money it has lent. This arrangement gets slightly more complicated if the vehicle's owner is in default and the vehicle is repossessed.

As an example, imagine the situation in which John owns a car and is hit by another driver who is at-fault. The car is taken to a bodyshop for repair. However, John has not paid his car loan for several months, and the bank has authorized repossession of the vehicle. When the bank discovers the car's whereabouts, it takes possession of the vehicle upon completion of the repair and makes a claim for inherent diminished value against the at-fault driver. Because the bank is, typically, legally entitled to sell the vehicle and transfer "good" or "clean" title to a subsequent buyer to satisfy John's outstanding debt, the bank is entitled to apply the diminished value payment to the outstanding loan, as well. This occurs because the diminished value payment represents a monetary value taken from the collateral by the at-fault driver that would, otherwise, have been sold with the car and applied to John's debt.

The lease arrangement has similarities to the financed vehicle scenario but has some key differences. With a vehicle lease, the bank or leasing company is the owner of the vehicle, and the individual merely has the right of possession and use for a specific period of time and for a price. These leases are a species of common law bailment. The primary difference between a lease and an ordinary bailment is the fact that the parties understand that the property will be used during the time it is out of the owner's control. Because a car is a depreciating asset by its very nature, which is increased by use, the leasing price is set to account for the natural depreciation associated with age, mileage, and "ordinary wear and tear". The anticipated value of a car at the end of the lease is known as the "residual value".

What has not been taken in to account in the leasing process is the effect of accelerated depreciation on the vehicle's value resulting from damage to it. While lease contracts control exactly how many miles can be driven during the lease term and how much each additional mile over that allotted number will cost, they do not address how diminished value issues will be handled. Yet, failure to adequately address diminished value in car leases is likely responsible for a large portion of the losses suffered by banks, and is a significant cause why many banks are withdrawing from the consumer auto-leasing arena.

Many leasing agencies grapple with the issue of how to accurately determine residual values. Simply determining what a car with specific equipment and certain mileage will be worth in five years is easy. The problem arises with the variables and the underlying assumptions about the property being leased - primarily that the vehicle will return at lease-end in the same condition as lease- inception, less ordinary wear and tear and mileage allowed. Unfortunately, many vehicles are not returned in the assumed condition. Many of them return, with no fault attributable to the leasing party, having suffered thousands of dollars worth of inherent diminished value, despite being properly repaired. In that situation, which party should bear the brunt of the economic loss, despite neither being proximately responsible for creating that loss? Legally and equitably, neither of them should. If the vehicle had not been leased, there would have been little question about the owner's entitlement to payment for the vehicle's diminished value or that the at-fault driver was responsible for the payment. The situation is not any different with a lease.

One argument asserted for refusing to pay diminished value on a lease vehicle is that banks and lease companies can actuarially compensate for any anticipated diminished value in the use calculation and can simply increase the amount of the lease. That solution unfairly places the economic burden for an at-fault driver's negligence on third parties and creates a financial disincentive to lease a vehicle, which inequitably affects banks and leasing companies. One might just as readily argue that insurers can alleviate the problem simply by raising their rates.

Another frequently voiced argument is that only the actual owner is entitled to diminished value payment and the individual leasing the car cannot claim or receive such payment. That argument is not legally sound. Even in ordinary bailment situations at common law, the person in possession is charged with the responsibility to protect and preserve the property to allow it to be returned to the owner in the originally-bailed condition. As the person in possession is responsible for compensating the owner for any damage to the property, that person is entitled to seek payment from any third party actually causing the damage. If someone is uncomfortable paying anyone but the actual owner, that is easily remedied -- send the diminished value check directly to the owner.

Furthermore, vehicle leases typically state that when the vehicle is returned at lease-end, there will be additional charges for any excessive wear and use and the excessive wear clause includes payment for any damage to the body, lights, trim, paint, interior, glass, and for any missing equipment, parts and accessories. These clauses do not restrict charges to only unrepaired
damage or allow for aftermarket parts to be substituted for original ones. Accordingly, the person turning in a car at lease-end, which was severely damaged in a collision caused by another party, can still find him/herself liable to the bank or leasing company for thousands of dollars in diminished value.

Public Policy and the Vehicle Lease

There is no identifiable reason why diminished value is not being paid on damaged, leased vehicles, but leased vehicles have been expressly excluded from the settlement terms of the successful first party class actions, like State Farm Mutual Automobile Insurance Company v. Mabry , 274 Ga. 498, 556 S.E.2d 114, 2001 LEXIS 910 (Ga. 2001). However, the fact that the parties to the lawsuit agreed to exclude leased vehicles does not mean that the courts feel diminished value is inapplicable to those situations. In its Mabry decision, the Georgia Supreme Court recognized that an insurer's obligation to its insured under the policy included payment for both lost utility and value, which encompassed diminished value. There is nothing to indicate that Georgia's high court would interpret the law differently for insureds who leased their vehicles.

Perhaps the most troubling issue with the disparate treatment of diminished value payments between owned and leased vehicles is the economic disincentive it creates. This economic disincentive is twofold: If banks and financing companies cannot recover for diminished value in the same way that a private owner can, those companies will not be able to be made whole, will suffer significant losses, and will not be able to offer competitive leases. Additionally, those who can afford to purchase a vehicle will likely choose to purchase over lease because of the safeguards ownership offers regarding diminished value recovery. The long term result will be that some banks will no longer offer consumer auto leases (many already have stopped), leasing companies will dramatically increase lease rates (many already have), and consumers will be left with far fewer options than they previously enjoyed.