The UK Court of Appeal has made a significant ruling in favour of car finance customers – and against lenders and dealers – in a case that could have major ramifications for both the current investigation into the car finance sector and lending in general.
You may have heard that the Financial Conduct Authority (FCA) is currently investigating a specific kind of commission agreement found in many car finance contracts. The FCA was originally due to reach a decision on this in September, but has extended the process until May 2025 as it continues to explore the issue.
The current saga revolves around what are called discretionary commission agreements (DCAs), which were banned in UK car finance agreements back in 2021. This is where a broker (which was almost always a car dealer) would be able to push up the interest rate on a car finance contract they were selling in return for increased commission from the lender.
In January this year, the FCA announced it was investigating whether or not the car finance sector had seen widespread, systematic abuse of these DCAs prior to them being banned. This was in response to complaints to both the FCA and the Financial Ombudsman Service, as well as court cases between customers and lenders – egged on by lawyers. Three of these cases were merged into one appeal to the UK Court of Appeal, whose judgement was handed down today.
The Court ruling announced today came down clearly on the side of the consumers, ruling that the lenders and/or brokers had not acted correctly in how these commissions were disclosed to their customers, or whether they were even disclosed at all.
Given that the FCA had already strongly hinted that it anticipates a significant compensation scheme for customers who have had DCAs in their car finance agreements, this judgment makes it even more likely that car finance lenders could be hit with billions of pounds in compensation claims for poor lending practices. But the Court’s ruling has even broader implications than that, which could open the floodgates for many more claims.
Why were discretionary credit agreements bad news?
Most car finance is sold via car dealerships at point of sale. The dealer acts as a broker, sourcing finance for the customer from a lender (or from a panel of lenders, depending on what arrangements they have in place). As an agent for the lender, the dealer earns a commission for the finance policies they sell.
The short version of how the process works is as follows:
- The dealer submits the customer’s finance application to the lender
- The lender approves the finance application at a particular interest rate (for example, 7%) and with any other specific requirements about deposit, contract duration and fees/charges
- The dealer presents a contract with all of this information to the customer to sign
- The finance company pays the dealer for the car, as well as a commission for selling the finance
However, with a DCA there was an extra, hidden, step between steps 2 and 3 above. The lender may have advised the dealer that it had approved the application at 7%, but the dealer could choose to increase the interest rate to, say, 10% or even higher without telling the customer.
So the customer would assume that the finance company had approved the application at 10% without knowing that it had actually been approved at 7%. They had no indication that the dealer had any control over the interest rate (since the dealer is not actually lending the money), so they had no knowledge that it was negotiable.
In some finance software systems, the controls for dealers to jack up the rate were hidden away from the other tools that customers might see while the dealer was completing their applications, further highlighting the fact that this was a pretty shady practice.
With a DCA, the dealer would get a higher level of commission for increasing the customer’s interest rate, as well as separately getting commission for selling the finance in the first place.
A few years ago, the FCA decided that this was not acceptable and so it announced that DCAs would be banned from 2021. Most car finance firms stopped including this provision well ahead of this date, so we are talking about finance agreements from no less than three years ago, but potentially as far back as 2007.
Why were dealers allowed to manipulate the interest rate?
Car finance industry people will tell you that dealers had flexibility to adjust the rate either up or down, so it wasn’t simply a tool for jacking up customer payments. It was simply one of many tools a dealership had to help “structure a deal to meet the customer’s needs”.
For example, if they needed to get the monthly payments down a bit lower to meet a customer’s maximum budget, they could either reduce the price of the car or reduce the interest rate on the finance.
However, the concern was that this hidden ability to manipulate the interest rate wasn’t ever being used to move rates downwards, only upwards. The fact that the dealership would receive more commission for moving the rate upwards meant that the system was inherently open to abuse. This was why DCAs were banned, but it’s not the primary issue in the court case. That was about the lack of disclosure regarding the commissions that the dealers received.
What did the Court of Appeal say?
Interestingly, the Court judgment did not appear to be specifically limited to discretionary credit agreements (although it’s a long read and I’m not a legal expert), so the ramifications could go well beyond the FCA’s current investigation into the car finance sector.
Instead, the judgment referred to non-disclosure of commission payments, which could potentially apply to any type of finance agreement where commissions are paid by the lender to a broker.
Finance agreements are heavily regulated, and it’s a condition of all agreements that consumers need to be presented with all the material facts about a contract that might affect their decision whether or not to go ahead and sign that contract. This includes things like the scheduled loan payments, admin fees payable by the customer, any penalty charges, and commissions payable from the lender to the broker for introducing the customer to the lender.
The Court ruling explained that a dealer is acting as a broker on behalf of the customer, as well as acting as an agent on behalf of the lender, and that therefore they have a duty to act in the customer’s best interests in securing the best terms possible for the loan. That includes disclosing that the dealer would be receiving commission from the lender, as well as how much commission that would be.
The Court ruled that the brokers could not lawfully receive commissions from lenders without receiving “fully informed consent” from the customers. If the customers were not told about the commission payments, they could not give fully informed consent.
What has the industry response been?
The wider ramifications of this ruling have been noted by the finance industry, and we can expect much more to be said in coming days as the details of the judgment are fully digested.
The Finance and Lending Association (FLA), which is the trade body for most of the UK’s car finance lenders, has provided an initial statement that confirms this interpretation, Stephen Haddrill, FLA director general, said: “This is a significant and unexpected judgment, the implications of which stretch far beyond the motor finance sector, making it an issue that demands the immediate attention of the Financial Conduct Authority.”
The FCA has so far simply said: “We note the Court of Appeal judgment on motor finance commission and are carefully considering its decision.”
Shares in Close Brothers Motor Finance, one of the defendants in this case, fell by 15% after today’s judgment was handed down. The company has temporarily stopped offering new finance lending in the car sector while it assesses the implications to its business. It has also indicated that it intends to appeal the decision to the Supreme Court.
How is this likely to affect the car finance sector?
There’s no good news for lenders, who collectively seem certain to end up paying billions of pounds in compensation to customers. While that may sound like good news for consumers, it’s probably more of a small short-term win that will probably drive the cost of borrowing up much further in the long term.
The hypothetical compensation amounts being thrown around in public tend to be anywhere from a few hundred pounds to maybe £1,000 per claim, based on the value of the added interest. So while that might mean millions of customers getting a nice cheque for being overcharged on their last car, it will almost certainly mean that the cost of borrowing is going to go up on their next car, which could easily outweigh any compensation ‘win’.
What will absolutely start to happen almost immediately is that lenders will update their customer documentation on all new agreements to more clearly explain that the dealer is receiving a commission payment for arranging the finance, and how much that payment is – rather than only making that information available on request or allowing dealers to be coy about it in any way.
Any improvements to clarity and transparency are obviously good things for consumers, but they will only really benefit diligent customers who take the time to compare different finance quotes to understand what they’re paying (which should be every customer but it inevitably won’t be most of them).
The FCA will incorporate this week’s Court of Appeal’s decision into its thinking regarding discretionary credit agreement, but it will also need to review its position on commission disclosures more generally as the court ruling sets the bar higher than the FCA’s own guidelines in many ways. Again, this is a good outcome for consumers.
We still won’t know what the FCA will do to address DCAs for another six months, but this decision is another step closer to a widespread compensation scheme for affected car finance customers.
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