The Supreme Court has confirmed that extended warranties on consumer goods can be "contracts of insurance" falling under the regulation of the Financial Services Authority ("FSA").

In Re Digital Satellite Warranty Cover Limited1, the court found that extended warranties for the repair and replacement of satellite television equipment were regulated insurance contracts for the purposes of the Financial Services and Markets Act 2000 ("FSMA"). It upheld winding-up orders secured by the FSA against the providers of the warranties on the grounds that they did not have the necessary FSA authorisation.

This decision may have regulatory implications for those who sell or perform extended warranties on consumer goods and appliances. A copy of the judgment is available here.

The warranties

Digital Satellite Warranty Cover Limited ("DSWC") and Mr Bernard Freeman and Mr Michael Sullivan, who traded in partnership as Satellite Services ("SS"), entered into agreements to repair and replace customers' satellite television equipment in the event of breakdown, malfunction or certain types of damage caused by external forces (the "Warranties"). Obligations of DSWC and SS (the "providers") under the Warranties were fulfilled by repairing or replacing the equipment (i.e. by the provision of benefits in kind); the providers were not required to pay money in respect of repair or replacement costs incurred by the customer.

The decision

At the High Court in January 2011, Warren J made winding-up orders on the hearing of public interest petitions brought by the FSA2 against the providers and another related entity. Warren J held that the Warranties were "contracts of general insurance" for the purposes of FSMA. Selling the warranties and providing repair and replacement services were, therefore, regulated activities, for which the providers did not have the requisite FSA authorisation.

The Court of Appeal and the Supreme Court have now both upheld Warren J's decision. A copy of our previous briefing on the decision of the Court of Appeal can be found here.

The substance of the appeal – was there a contract of insurance for regulatory purposes?

To be regulated under FSMA, the Warranties needed to be both:

  • a "contract of insurance" (not defined in FSMA) under common law; and
  • a "contract of general insurance" within the definition set out in Article 3(1) of the FSMA (Regulated Activities) Order 2001 ("RAO").

The assumption that the Warranties qualified as contracts of insurance at common law was not challenged by the providers. Instead, it was argued that the Warranties did not fall within Article 3(1) of the RAO on two grounds - that:

  • EU law requires the RAO to be construed as applying only to contracts of insurance that provide for pecuniary benefits (i.e. paying money to the customer, rather than repairing or replacing the equipment); and
  • the business carried on by the providers did not actually fall within any of the classes of general insurance specified by the RAO.

Degree of harmonisation under EU law

UK legislation providing for the authorisation and regulation of insurance companies gives effect to a number of EU directives. The First Non-Life Directive3 ("1NLD") is most relevant to this case; the eighteen classes of general business set out in the RAO essentially correspond to the eighteen classes that are specified in 1NLD. The argument run by the providers was that classes 1-17 in 1NLD4 do not extend beyond contracts of insurance that provide pecuniary benefits and that, in transposing the requirements of the directive, Member States were not entitled to regulate other types of non-life business (including contracts that only provide for benefits in kind).

The question for the court was, therefore, whether the UK was able to regulate more extensive classes of general insurance (in the RAO) beyond those set out in the Annex to 1NLD.

Lord Sumption (delivering the judgment of the Supreme Court) noted that, whilst he was willing to proceed on the basis that classes 1-17 in 1NLD are confined to contracts of insurance providing for pecuniary benefits (not benefits in kind), he had doubts whether that analysis was correct. Deciding the point was a matter for the European Court of Justice and not for the national courts of a Member State.

Even assuming that this narrow interpretation of 1NLD was correct, however, Lord Sumption was in no doubt that the Non-Life Insurance Directives (including 1NLD) were minimum harmonisation measures that did not exclude the right of national governments to extend regulation to a wider class of benefits in kind insurance. 1NLD was never intended to impose a comprehensive scheme of authorisation and the 18 classes of business that were listed were not intended to limit Member States' ability to regulate other categories of business.

Comment

It may be interesting to consider whether the same analysis will apply once the Solvency II Directive comes into force. Solvency II is certainly intended to be a maximum harmonisation measure in the sense that firms covered by the directive should be subject to the same system of supervision irrespective of where they are located in the EU. It does not necessarily follow, though, that Member States cannot also choose to regulate firms that fall outside the scope of the Solvency II Directive; indeed, the FSA clearly proposes to continue regulating a number of smaller insurers that do not qualify as Solvency II firms under relevant directive thresholds.

The Supreme Court's decision also poses the question of whether extended warranty contracts can be sold on an unregulated basis in other European jurisdictions which do not regulate beyond the classes of insurance prescribed by EU law in national legislation.

Classes of insurance under FSMA

Article 3(1) defines a contract of general insurance as "any contract falling within Part I of Schedule 1" to the RAO. The providers argued that the Warranties did not fall within any of the classes of insurance set out in Part I of Schedule 1, so were not contracts of insurance of a type that are regulated under the FSMA regime.

Class 16 (Miscellaneous financial loss)

The main class of business under consideration was class 16 (miscellaneous financial loss):

"Contracts of insurance against any of the following risks, namely –

(a) …

(b) risks of loss to the persons insured attributable to their incurring unforeseen expense (other than loss such as is covered by contracts falling within paragraph 18);

(c) risks which do not fall within sub-paragraph (a) or (b) and which are not of a kind such that contracts of insurance against them fall within any other provision of this Schedule."

The Supreme Court agreed with both Warren J at first instance and the Court of Appeal that the Warranties fell within class 16(b) - risk of loss attributable to the insured incurring unforeseen expense. It agreed with Warren J's analysis that there is no material distinction between a contract which only provides for repair and replacement and one which also provides an indemnity for costs actually incurred by the insured. Both cover the same risk – the possibility of the equipment breaking down or malfunctioning – and a contract that brings about the result which the insured would otherwise have to pay to achieve (i.e. having equipment that works) can properly be categorised as a contract which protects him from financial loss.

Implications of the judgment

The judgment:

  • does not shed any light on what is or is not a "contract of insurance" under common law;
  • does not decide whether general insurance business classes 1 to 17 in 1NLD extend to contracts that only provide for benefits in kind; but
  • does confirm that extended warranty plans providing for the repair or replacement of goods or equipment in the event of breakdown or malfunction can be regulated insurance contracts for the purposes of FSMA (on the basis that without the repair or replacement the consumer would otherwise suffer financial loss); and therefore
  • may have implications for those providing or selling extended warranty plans for various consumer goods and appliances on an unregulated basis.

The FSA has published a press release commenting that:

“The Supreme Court's decision will be of interest to other firms that offer warranties, helping them to understand when they should speak to us about getting authorised."

Unregulated providers and sellers of extended warranties should consider whether they need to be FSA-authorised, either directly or indirectly under the appointed representatives regime. Further FSA guidance on when extended warranties should be regarded as insurance for the purposes of FSMA can be found in Chapter 6 of the FSA's Perimeter Guidance manual.