It is the sort of legal ruling that normally would not even merit a glance from most in the Square Mile.
Yet this week, City analysts who usually spend their days scrutinising British banks were instead scouring a 38-page judgment on a little-known dispute between a Coventry-based tool manufacturer called Expert Tooling and an electricity supplier, hunting for clues about the outcome of a separate, but analogous, court case that could have multibillion-pound ramifications for the car loans industry.
Such is the uncertainty caused by the motor finance affair which is set to come to a head next Tuesday when the Supreme Court begins a three-day hearing into issues at the heart of the car loans controversy.
Depending on the decision by the country’s highest court, some analysts believe that lenders ranging from the finance arms of car manufacturers to banks could be on the hook for customer compensation totalling as much as £44 billion. That would put the scandal on a par with the payment protection insurance (PPI) debacle, which fuelled a boom among ambulance-chasing claims-management firms and left lenders footing a redress bill of about £50 billion.
Claims companies and law firms are already swarming over the car loans controversy, with a flood of complaints against brokers and lenders pending.
“For the motor finance industry it’s hugely important,” Benjamin Toms, an analyst at RBC Capital Markets, a stockbroker, said of the forthcoming Supreme Court hearing.
Given the high stakes, some enterprising analysts such as Toms, who has a law degree, have turned into amateur lawyers as they try to predict the outcome of next week’s crunch hearing by scrutinising other rulings, including the recent Court of Appeal judgment in Expert Tooling and Automation Limited v Engie Power Limited.
Like the motor finance affair, the Expert Tooling dispute concerns the appropriate disclosure of commissions paid to brokers. However, analysts are split on the ruling’s relevance to the forthcoming car loans hearing and even the Court of Appeal said during the Expert Tooling case: “This is clearly a complex area of the law and clarification from the Supreme Court is much needed.”
The origins of the car loans scandal stretch back years.
Driven by the rise of personal contract purchase (PCP) arrangements that were first introduced into Britain by Ford in the early 1990s, the motor finance industry has exploded in recent decades. According to estimates last December by regulator the Financial Conduct Authority, about 80 per cent of new car deals and a “substantial minority” of used sales involve finance, and nearly 99 per cent of the 31.7 million car loan arrangements since 2007 involved a commission paid to a broker — which is usually the motor dealer — by a lender.
In April 2017 worries about the opacity of motor finance lending, as well as possible conflicts of interest, prompted the authority to examine the industry. This culminated in the regulator imposing a ban on so-called discretionary commission arrangements in car loans that took effect in January 2021.
Discretionary commissions are those that are tied to the interest rate paid by the borrower. The authority concluded that “the widespread use of this type of commission creates an incentive for brokers to act against customers’ interests” by encouraging dealers to charge higher interest rates.
Some lawyers believe the Supreme Court’s ruling potentially applies beyond motor finance to other areas of finance that involve commissions
ALAMY
This was not the end of the matter, however. In January last year the authority revealed it would conduct a review into discretionary motor finance commissions paid between April 2007 and January 2021, a bombshell move that shocked the industry because of the inquiry’s wide-ranging nature, which immediately fuelled speculation that lenders might have to pay billions in compensation.
The regulator said it was embarking on the inquiry because of a rise in complaints about pre-ban discretionary commissions to the Financial Ombudsman Service, which is an independent organisation that resolves disputes between the public and financial firms. It highlighted two particular decisions in which the ombudsman had found in favour of the complainants, and against Barclays and Lloyds Banking Group, in cases involving broker commissions that had not been disclosed to consumers.
Within weeks of the authority’s announcement, Lloyds, one of Britain’s biggest motor finance providers, had set aside £450 million to cover the cost of possibly compensating customers. Shares in Close Brothers, a merchant bank where motor finance accounts for a relatively high proportion of its loan book, also fell sharply amid investor fears the business could be crippled by the cost of paying redress.
The crisis escalated further last October when the Court of Appeal ruled against lenders Close Brothers and Firstrand in three motor finance cases brought by consumers. This judgment widened the scope of the scandal because it applies to all types of commissions, not just discretionary arrangements, and concluded they were unlawful if they were not properly disclosed to, and consented to, by customers.
This meant common law was going beyond what regulation had previously required. Shock at the judgment caused swathes of the motor finance industry to temporarily freeze over while lenders overhauled their documents and processes to ensure they met the new standards.
• https://www.thetimes.com/article/treasury-to-launch-review-of-financial-ombudsman-service-z5j3gs9lj Treasury to launch review of Financial Ombudsman Service
It also prompted Lloyds to lift its compensation provision to £1.15 billion, while a number of other lenders also decided to set aside sums for possible redress in the light of the ruling. They include Santander UK, which has earmarked £295 million, and Close Brothers, which has made a £165 million provision.
“I don’t think I can recall a case where there’s been such a level of disconnect between what the law and regulation requires,” said Stephen Haddrill, the director general of the Finance & Leasing Association, which represents car loan providers, who also previously led the Financial Reporting Council, the accountancy industry regulator.
It is this Court of Appeal ruling that has now been referred to the Supreme Court which will have a final say in the matter.
Beyond the immediate impact on motor finance, the saga has wider ramifications for Britain, something that Charlie Nunn, the Lloyds boss, recently hinted at when he said the affair had raised “a broader investability question” about the UK.
This was underscored by an attempt by the government to intervene in the forthcoming hearing in support of lenders. It emerged in January that concerns about the potential implications of the October judgment for Britain’s wider regulatory landscape had prompted the Treasury to apply to the Supreme Court to have a say at the hearing, although its application was ultimately rejected by judges. The City regulator has been given permission to intervene, however.
While it is unclear when the court will issue its ruling, the authority has committed to deciding within six weeks of the judgment whether an industry-wide redress scheme is required.
It said that “firms would be responsible for determining whether customers have lost out due to the firm’s failings” under any scheme, which would cut out the claims companies that are seeking to profit from the scandal.
The City also hopes the Supreme Court clears up some of the wider ambiguity caused by the Court of Appeal judgment. Some lawyers believe the ruling potentially applies beyond motor finance to other areas of finance that involve commissions, including premium finance — a widely used credit product that allows consumers to spread out the cost of insurance — and asset finance. Even phone contracts could potentially be caught by the ruling. Depending on the Supreme Court’s decision, compensation payouts could be even bigger than currently feared by lenders.
“A judgment which encapsulates commissions in all finance arrangements where there’s non-disclosure … will take you beyond motor finance,” Toms said. “Premium finance shares a scary number of similarities.”
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