Maybe I should have explained it better. Its not illegal, and most dealers were requiring this. From CFC website:

A dealer has included in the purchase agreement a requirement that I return the new car or pay the dealer the amount of the CARS program credit if the CARS program credit application is rejected. Do I have to sign this in order to participate in the CARS Program?

NO. You are not required to sign an agreement like this to participate in the CARS Program. However, you may agree to such a term, but your choice to agree is between you and the dealer.

My parents paid fully, the dealer is holding on to a check and won't cash it until they have a response from the program. Technically the dealer still owns the car until it gets paid, its all in a contract. Have a temporary tag so gotta carry all the paperwork in the car.

The only party taking a risk here is the dealer, for if we decide to return the car we basically used it for a few weeks for free. We only have to pay if we damage something, not for regular wear and tear or mileage.