The car finance industry was thrown into confusion following a Court of Appeal judgment delivered on 25 October 2024.[1] The judgment, examining three historic cases, concluded that it would be illegal for a broker (e.g., the car dealer) to receive a commission payment from a lender without the informed consent of the car buyer. Furthermore, the judgment ruled that the finance companies were liable for the actions of the intermediaries. The ruling which, in effect, conflicted with the guidance issued by the Financial Conduct Authority (“FCA”) in 2019, may have damaging long term implications for the car industry and other sectors that rely on finance.[2] An appeal to this decision will now be heard by the Supreme Court in April this year.[3] This Martello view explores the background to the issue and the potential consequences for the car finance industry as well as other consumer finance sectors should the judgment be upheld.
Press coverage has labelled the judgment “the car finance mis-selling scandal” and speculated on the cost to banks with comparisons being made to the Payment Protection Insurance (“PPI”) scandal. Prior to the 25 October 2024 judgment, several banks had already made significant provisions to account for potential future remediation costs following the decision by the FCA in January 2024 to launch a review of lenders’ discretionary commission arrangements (“DCAs”), going back as far as 2007.[4] However, in the opinion of this author, both the press commentary and the FCA’s approach ignores the fundamental differences between car finance and PPI.
Essentially, the PPI issue involved hidden commissions on an opaque insurance product that many consumers were unaware they had agreed to, and in some cases, would never be able to benefit from. Every buyer of a financed car, however, is fully aware that they are purchasing a vehicle, and that the purchase will comprise multiple elements, all of which may contain a dealer margin and could be subject to negotiation:
All of the above will require a viable vendor to source the product or service at one price and then sell to the buyer at a higher price, routinely adjusting specific margins in the sale negotiation. The purchase price of a car will ultimately be calculated by ‘bundling’ these products and services and, assuming the purchase is subject to financing, allows the acquisition of the car for a known and agreed monthly price. The consumer makes a value judgement based on this monthly price, unrelated to the margin a dealer has earned on each element of the purchase.
The majority of car purchases are financed through some form of loan, lease or hire purchase agreement.[7] The critical factor is whether the customer obtained the vehicle at a monthly cost considered acceptable. The act of buying a car is a highly subjective and emotive decision, with colour, engine size, transmission type, wheel design and other options all being considerations in the final choice and cost. The calculation of monthly instalments is also highly sensitive to the amount of deposit agreed, and the size of any final ‘balloon’ payment at the end of the financing term.
The FCA has focussed on one element of the bundled product, the finance cost and margin, and in January 2021 banned DCAs that allowed brokers and dealers to opaquely increase interest rates to boost commissions earned. The FCA found that arrangements that led to consumers paying more for their finance, were unfair and lacking in transparency, ignoring the fact that the finance margin often cross subsidises reduced margin elsewhere. In summary, consideration of one element of the bundled product in isolation (i.e., interest cost), misunderstands and misrepresents the nature of a car purchase in which finance cost is only one element.
A dealer may offer a discount on the purchase price, a higher trade-in price for an existing vehicle or a discounted extended warranty and partially offset the cost with a higher interest margin, culminating in a monthly cost for a bundled product and service which the buyer is happy to pay. The buyer is generally uninterested in the margin the dealer earns on the sale of the new car, whether the dealer manages to sell the trade-in at a profit, the margin earned on GAP insurance or any other element of the transaction.
The decision to single out the finance cost for transparency on margins, while leaving other components unaffected, creates an inconsistency that could have significant implications for the car sector, as well as other vendor and consumer finance activities.
Take, as one example, the common practice of retailers offering (in conjunction with their finance partners) interest-free loans for say sofas and kitchens. The lender will still make a lending margin on the loan to the consumer, but the interest rate earned (regardless of the “0%” headline) is in effect paid by the retailer as a subsidy, of which the customer is unaware. For a sustainable business, this cost to the retailer will be passed on to the customer via pricing of the sofa or kitchen in question. Another example is where price-comparison websites receive a fee or commission from the lender for the successful referral of a loan or credit card to a customer, an essential but invisible element of the sites’ revenue models. It is easy to see the that a deconstructive approach to commissions, margins and sources of income and profit could disrupt other sectors functioning well today.
The Supreme Court will examine the issues around car finance commissions and duty of disclosure. In this author’s view, it is critical that all the elements of a bundled car finance transaction are considered to fully reflect the practical realities of vehicle financing.
While the Court of Appeal’s conclusions were of course welcomed by the claims management sector, the approach is likely to inflict significant costs and change upon the car industry and has the potential for contagion to other sectors relying on vendor finance.
If not overturned by the Supreme Court in 2025, this approach introduces additional layers of cost and bureaucracy to lenders. Faced with the prospect of reviewing a back book stretching back 15 years or more in response to the demands of claims management companies’, there is likely to be a reduction in lenders’ appetite to extend credit to the automotive retail industry. This in turn could increase the cost of car finance and other forms of consumer finance in the UK and might well negatively impact UK economic activity as well as the current government’s
[1] Johnson v FirstRand Bank, Wrench v FirstRand Bank and Hopcraft v Close Brothers Limited [2024] EWCA Civ 1282.
[2] FCA CP19/28, Motor finance discretionary commission models and consumer credit commission disclosure, dated October 2019.
[3] Announcement from the UK Supreme Court on 11 December 2024. [https://www.supremecourt.uk/news/uksc-announcement-1]
[4] These banks include Lloyds (£450m), Santander UK (£295m), Barclays (£400m) and Close Brothers (£320m). As stated in the Guardian’s article, ‘Santander puts aside £295m for car loan mis-selling’, dated 20 November 2024. [https://www.theguardian.com/business/2024/nov/20/santander-puts-aside-295m-payouts-car-loan-customers]
[5] The advertised cost of a car, whether new or second-hand, is likely to be subject to negotiation, resulting in potential discounts that reduce the vendor’s profit margin.
[6] The price that a dealer agrees to pay for a part-exchange is set at a level which will also generate a profit, against which the dealer assumes the risk of subsequent retail price volatility, the length of time the car is going to be held in stock, and the cost of potential repairs or servicing to secure a re-sale.
[7] Around 80% of new cars are subject to motor finance, and a substantial minority of used car sales funded through finance. As stated in paragraph 8 of the FCA’s letter to the Supreme Court, dated 2 December 2024.
