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This article originally featured in Insurance Day, January 2025, authored by partner Jenny Boldon and trainee solicitor William Hanwell.
In a landmark ruling on October 25, 2024 on three combined appeals (Johnson v FirstRand Bank Ltd, Wrench v FirstRand Bank Ltd and Hopcroft v Close Brothers (2024)), the UK’s Court of Appeal held lenders and intermediary car dealers had breached their duty to inform unsophisticated car buyers about commission earned on car finance loans.
This decision could result in a flood of new compensation claims. It might also have ramifications for brokered finance arrangements more broadly. The lenders have been granted permission to appeal by the Supreme Court.
In all three cases, the claimant customers entered into credit agreements arranged by motor dealerships to purchase vehicles, with finance provided by lenders. In each case, the dealer (acting as a credit broker) received a commission from the lender, which was not or was only partially disclosed to the customers.
The customers brought proceedings against the lenders, arguing the dealers were receiving “secret commissions” from them without the customers’ knowledge and they were not in a position to give fully informed consent.
They argued this was in breach of the dealers’ “disinterested” duty to provide them with information, advice or recommendation on an impartial basis, as well as a breach of a fiduciary duty arising as a result of their broker status, acting for and on behalf of customers.
Fiduciary duties
The Court of Appeal held the dealers owed their customers fiduciary duties and they could not receive commission from lenders unless fully informed consent had been given to such payments. To have given informed consent, the consumers should have been informed about the exact commission paid by the lenders and how it was calculated – reference to commissions in “the small print” was insufficient.
The commissions the lenders paid to the dealerships were therefore held as unfair and unlawful, with lenders held personally liable or alternatively liable as an accessory to the dealer’s breaches of duty. Lenders will need to satisfy themselves full disclosure has been given to customers, if necessary providing such to customers directly.
Car finance deals have been on the regulatory radar for some time. Between 2007 and 2020, 14.6 million car finance deals were brokered using discretionary commission arrangements (DCAs) , in which the commission paid to dealers was linked to the interest rate on the loans, allowing dealers to charge customers more.
The Financial Conduct Authority (FCA) banned DCAs in early 2021, resulting in a stream of complaints to the Financial Ombudsman Service by consumers who said they were not properly told about commissions and large numbers of County Court claims.
The FCA announced in January 2024 it was investigating the historic mis-selling of DCAs and using its information-gathering powers under the Financial Services & Markets Act 2000 before deciding how it will respond. In the meantime, it has extended deadlines it had set for dealers to respond to customer complaints.
The FCA issued a short statement to confirm it was “carefully considering” the decision of the Court of Appeal and it may seek to intervene and make submissions to the Supreme Court. Any Supreme Court ruling is likely to influence the FCA’s considerations on whether to implement a consumer redress scheme.
Full disclosure
It appears the level of disclosure required in relation to commission is now greater than that specified by the relevant legislation and FCA rules. As matters stand, brokers and lenders cannot assume a generic statement about potential commission payments meets disclosure obligations.
For disclosure to be “sufficient”, it must be clear and complete, providing full detail on commission calculations and the lender/broker relationship. In the short term as a “fix” it seems dealers will ask customers to countersign a document containing this information as evidence the customer is fully informed.
The Court of Appeal decision applies not only to DCAs but to almost all car finance deals and means another 11 million buyers could be eligible to bring claims against their dealer and lender.
Estimates of the total compensation bill range from £13bn ($15.9bn) to £21bn, with potential for these claims to be the most costly since the mis-selling of payment protection insurance.
Close Brothers, understood to be the most exposed lender to car finance, initially paused providing new car loans in light of the Court of Appeal judgment and the share prices of both Close Brothers and FirstRand were negatively affected.
Lloyds Banking Group had already set aside £450m earlier in 2024 to cover operational and legal costs associated with possible motor finance claims and most lenders have now made provisions.
However, significant claims may be even more costly to smaller car finance firms, who may not have significant resources or sufficient insurance to pay claims. The FCA is mindful this might reduce the availability of car finance for consumers, thereby potentially increasing prices and harming consumers further.
The impact of this judgment is also expected to be felt beyond the motor finance market. The principles outlined in the judgment may apply more broadly to any goods and services purchased via credit brokers. This might include, for example, a range of household goods, holidays, mortgages and insurance products. In any arrangement where commission is paid, it must be fully disclosed.
The judgment appears limited to “unsophisticated consumers” but whether it is limited to individual customers, rather than, for example, small and medium-sized enterprises or sole traders, is unclear.
Pending clarity from the Supreme Court, lenders and brokers should implement clear disclosure practices while insurers will be keen to understand what steps are being taken to mitigate risks of claims.
Insurance and reinsurance