Let’s say you want to become a collector-car dealer. First, you need a building large enough to hold a sufficient number of cars for sale, in an appropriate location. That requires significant capital. Next, you need an inventory of marketable collector cars. That requires even more significant capital.
Stephen Phelps thought he had the first part pretty well figured out. He already owned a lush, sprawling, 10-acre property outside Eustis, FL. On it sat a 4,800-square-foot house and several other structures that could be used as showrooms. Phelps formed FSD Hot Rod Ranch LLC (“FSD” standing for “father, son, daughter”) and qualified it as a car dealer specializing in hot rods and classic cars.
The second part of the capital requirement took more creativity. Phelps drew up the “FSD Delayed Payment Agreement.” Under this plan, owners would consign their cars to FSD for a period of six months. If the car was not sold within 30 to 90 days (depending upon the individual contract), the owner would earn a daily fee of between $15 and $60 until the car was sold. If the car had not been sold by the end of the consignment period, FSD would just buy the car. To protect their interests, the owners retained the titles to their cars until they were paid in full.
Finding consignment cars was critical to the plan. Phelps had his purchasing manager scour internet and other listings, looking for cars that weren’t selling quickly. The purchasing manager would contact the often-unsophisticated sellers and persuade them that consigning their cars to FSD would yield quick sales. They also offered rewards for consignment referrals, giving both the referral source and the owner a $500 gift certificate.
The plan worked well, with more than 1,000 cars consigned under the program. FSD claimed to always have at least 60 cars in inventory, describing itself as “America’s Fastest-Growing Classic Car & Hot Rod Dealer.”
The inevitable crash
All was well until people started noticing that FSD wasn’t performing as promised. Sellers complained that their cars had been sold but they hadn’t been paid. Buyers who had paid for and taken possession of their cars complained that they were unable to get a title from FSD. The Florida Department of Highway Safety and Motor Vehicles received at least 58 consumer complaints about FSD.
Lawyers got involved and 15 lawsuits were filed against FSD, Phelps and other company employees; 10 were filed by the same attorney. Two of those cases were later dismissed by the plaintiffs, but the others remain open.
The allegations in the lawsuits are as one would expect:
- Breach of contract
- Fraud
- Conversion (wrongfully taking customers’ cars)
- Violation of Florida’s Deceptive and Unfair Trade Practices Act
- Breach of fiduciary duty
The plaintiffs seek recovery of their losses — the money paid or the value of their car, and insurance premiums paid — plus attorney fees, court costs, and, potentially, punitive damages.
No way out
Phelps apparently saw no good way out of this litigation quagmire and opted to file personal bankruptcy. His bankruptcy petition shows no substantial assets other than his Eustis property, which he valued at approximately $1,000,000. The petition also lists nearly 100 creditors, at least 60 of whom appear to be former customers, and more than $4,000,000 in total liabilities.
Federal authorities have opened an investigation into potential criminal activity that might include fraud and financial crimes. The Eustis Police Department is also investigating potential criminal charges.
Meanwhile, FSD is out of business and the Eustis property is now a wedding and special-events venue.
Consignment woes
The consigned cars create an interesting tug-of-war between innocent parties. The buyers paid for the cars, but the owners didn’t get paid. The buyers have the cars, but the owners still have the titles. The owners no doubt felt secure due to the Deferred Payment Agreement feature that allowed them to hold their titles until they got paid. But the buyers have paid in full and have been driving the cars. Both sides have valid legal claims, but they can’t both own the cars.
The legal reality is that the buyers will get the cars. The owners will be required to transfer their titles to the buyers even though they haven’t been paid. Getting to that result may take some wrangling and significant legal fees for everyone concerned, but that is what the outcome will most likely be.
Under the Uniform Commercial Code, a person who buys a car from a car dealer gets clear legal title to the car even if the dealer doesn’t have it, and even if the dealer is not authorized to sell it. That probably doesn’t sound right, but look at it from the buyer’s point of view. When you buy a refrigerator from an appliance store, you shouldn’t have to worry about some lender or manufacturer later knocking on your door to take it back because the appliance store didn’t pay them for it. It’s the same thing with cars. When the owner voluntarily entrusts their car to a dealer, they create the appearance that the dealer has the authority to sell it, just the same as any other car from the inventory. It may be an illusion, but the owner helped create it, so the innocent buyer is protected.
Many readers might ask, “What about the title?” The unfortunate answer is, “So what?” Certificates of title do not absolutely establish ownership — they are just evidence of ownership that can be rebutted by any number of means. Some states don’t issue titles at all after a car reaches a certain age.
Perhaps more to the point, retail car transactions occur every day without an immediate title transfer. The dealer submits the title with appropriate transfer documents to the buyer’s state DMV, and a new title is later sent to the buyer. That is the typical retail automotive sale procedure, and the law is designed to support such normal trade practices.
Civil claims
Obviously aware that he was going to have a huge liability for judgments entered against him, Phelps filed a Chapter 7 bankruptcy petition. The owners who have not been paid are all listed in the petition as general creditors. Their lawsuits will be dismissed, and their claims will now have to be handled in the bankruptcy proceeding.
In a Chapter 7 bankruptcy, the debtor turns over all assets to the bankruptcy trustee, who liquidates them. Then, after subtracting their fees, the trustee takes care of any secured creditors and divides the residue among all the general creditors in proportion to the amounts of their claims.
In this case, the owners who consigned their cars are not secured creditors. Even though they did not get paid for their cars, they do not have an automatic security interest in their cars under the law. So, as general creditors, they will only receive some fraction of what they are owed.
Meanwhile, the buyers who have not received their titles will file claims in the bankruptcy, but the trustee will likely not assume the burden of getting their titles for them. They will likely each have to sue their respective seller to force the title to be turned over to them. Most sellers can be expected to resist that, which will increase everyone’s legal costs. The buyers’ legal costs can be claims in the bankruptcy, but again, they will ultimately receive only a fraction of their claims.
The Florida twist
There is one huge caveat to all this. Under state law, debtors are entitled to certain specified exemptions from the claims of their creditors, one of them being a homestead exemption. Most states allow an exemption for some specified amount of equity in the debtor’s home, meaning that the creditors — and the bankruptcy trustee — can only lay claim to the equity in excess of the exemption.
Florida is the outlier among the 50 states, as its homestead exemption is unlimited. That means that Phelps’ home — his most significant asset, at a value of $1,000,000 — may be beyond the reach of his creditors. Assuming it meets the minimal Florida homestead requirements, the exemption is established at the time of the filing, and Phelps could now sell the home and put the money in his pocket, with no obligation to pay anyone.
For this reason, the owners’ best hope may be the potential criminal charges. No one seems to know where the money went. It may be gone, but it might be well hidden in an offshore location. If Phelps does have access to the funds, the creditors aren’t going to have an easy time finding them.
The prosecutors, however, are in a better position. In negotiating a plea deal, they can offer more-lenient sentencing in exchange for recovery of the stolen money. They might get it, which could be good news for the owners of the consigned cars. ♦
John Draneas is an attorney in Oregon and has been SCM’s “Legal Files” columnist since 2003. His recently published book The Best of Legal Files can be purchased on our website. John can be contacted at [email protected]. His comments are general in nature and are not intended to substitute for consultation with an attorney.