At the end of September, California enacted Assembly Bill No. 2111 (“AB 2111”), which makes several helpful changes to various California statutes regulating service contracts. AB 2111 takes effect on January 1, 2011. Several of the changes made by AB 2111 are discussed below.
A. Many Service Contracts No Longer Need to Be Sold Through a Person in the Product’s Chain of Distribution
In California, service contracts on electronic equipment, appliances, telephone equipment, furniture, jewelry and certain other products are regulated by California’s Bureau of Electronic and Appliance Repair, Home Furnishings and Thermal Insulation (“BEARHFTI”). An “obligor” (i.e., the person financially and legally obligated) under such service contracts must be registered with BEARHFTI as a “service contract seller.” However, current California law allows an obligor who is not within the covered product’s chain of distribution to be registered as a service contract seller only if the service contracts are “sold by the seller, manufacturer, or repairer of the product covered by the service contract.”1 This restriction prohibits obligors/ service contract sellers who are not in a product’s chain of distribution from selling service contracts directly to consumers.
AB 2111 removes the chain of distribution restriction. As amended by AB 2111, the definition of a service contract seller now expressly includes “a third party, including an obligor, who is not the seller, manufacturer or repairer of the product.” However, a thirdparty obligor will be required to obtain a service contract reimbursement policy.2 Currently, third-party obligors (although prohibited from direct sales) may obtain a reimbursement policy or elect one of several other options permitted under applicable California law for service contract sellers to demonstrate financial responsibility (e.g., based on net worth). After AB 2111 takes effect, third-party obligors will have more marketing flexibility, but their only option to demonstrate financial responsibility will be to obtain a reimbursement policy.3
Please note, that the requirement that service contracts be sold through a person in a product’s chain of distribution remains for “vehicle service contracts,” which are regulated by the California Department of Insurance.4
B. Service Contract Administrators May Now be Obligors/Service Contract Sellers
Currently, for a service contract regulated by BEARHFTI, California requires that a person acting as a “service contract administrator” (e.g., a person who disburses money for service contract claims and also participates in the adjustment of such claims) register with BEARHFTI. However, a service contract administrator is not permitted to also be the obligor/service contract seller.5 This has required persons wanting to act as obligor and administrator under BEARHFTI regulated service contracts to use two separate entities — one to act as the registered obligor/service contract seller and one to act as the registered service contract administrator.
AB 2111 deletes the restriction in the service contract administrator definition that prevented an administrator from also acting as an obligor/service contract seller. In addition, AB 2111 expressly states that a registered service contract administrator who is the obligor under a service contract may act as a service contract seller without a separate registration. Where a service contract administrator elects to act as obligor, all service contracts under which the administrator is obligor must be insured by a service contract reimbursement policy. Similar to the discussion in part A above with respect to third-party obligors/service contract sellers, an administrator acting as obligor will not have the option of using any other means (i.e., other than obtaining a reimbursement policy) of complying with the financial responsibility requirements for BEARHFTI registration.6
C. Limit on Incidental Indemnity Payments Under Service Contracts Removed
Currently, service contracts regulated by BEARHFTI may include incidental indemnity payments, such as for power surges, food spoilage or accidental damage from handling, not to exceed a retail value of $250 per year. AB 2111 removes the dollar limitation on incidental indemnity payments under such service contracts.7
D. Change in Permitted Refund Methodology Where Purchaser Cancels a Vehicle Service Contract
California law specifies the methodology for calculating the refund owed to a vehicle service contract purchaser when the purchaser cancels the service contract. When a vehicle service contract is cancelled by the purchaser either: (1) within the freelook/ full refund period (i.e., within 60 days of the purchaser’s receipt of the contract or within 30 days of the purchaser’s receipt of the contract in the case of a used motor vehicle without a manufacturer’s warranty) but after there has been a claim under the contract; or (2) after such free-look/full refund period, the purchaser must receive a prorata refund “based on either elapsed time or an objective measure of use, such as mileage or the retail value of any service performed.” While the obligor has the option of determining which the objective measure will be used to calculate such pro-rata refund, the method must be specified in the contract.8
AB 2111 amends the current law by allowing the obligor under a vehicle service contract to determine the objective measure to be used to calculate the pro-rata refund at the time the contract is cancelled. 9 It remains to be seen how much information, if any, the California Department of Insurance will require obligors to disclose in the vehicle service contract about the possible methods to be used for calculating such refund.
E. Express Exemption from the Insurance Code Added for BEARHFTI Regulated Service Contracts
AB 2111 adds an express exemption from all provisions of the California Insurance Code for service contract sellers and service contract administrators registered with BEARHFTI. However, consistent with other provisions discussed in parts A and B above, AB 2111 adds a new statutory provision stating that a service contract administrator or third-party service contract seller acting as obligor without having a service contract reimbursement policy covering all service contracts under which such entity is obligor shall be deemed to be unlawfully transacting the business of insurance and subject to specified enforcement and penalty provisions under the California Insurance Code (including imprisonment for willful violations).10
AB 2111 makes several helpful changes to California’s service contract laws. For service contracts regulated by BEARHFTI, certain of the changes, such as removing the requirement that third-party obligors sell service contracts through a person in the product’s chain of distribution, help to better align California’s service contract law with the service contract laws found in many other states.