Court of Appeal decides that extended warranties are regulated contracts of insurance

10/01/2012

The Court of Appeal in Re Digital Satellite Warranty Cover Limited has held that extended warranties covering satellite television equipment were contracts of insurance and the businesses selling them were carrying out regulated activity that fell under the regulation of the Financial Services Authority (“FSA”).

 

Facts

 

The businesses involved in this action sold extended warranties relating to satellite television dishes, digital boxes and associated equipment. They targeted people who had bought satellite systems and whose warranties were about to run out.

 

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 not only breakdown or malfunction but also accidental damage (“the Warranties”).

 

DSWC and SS’ contractual obligations under the Warranties were to repair or replace the faulty or damaged equipment. There was no obligation to pay money in respect of the repair or replacement costs incurred by the customers under the Warranties.

 

The FSA brought an action against DSWC and SS on the basis that they were selling and carrying out insurance contracts without proper authorisation required under the Financial Services and Markets Act 2000 (“FSMA”).

 

In the High Court Warren J held that the Warranties were “contracts of general insurance” for the purposes of FSMA and therefore were a regulated activity, for which DSWC and SS did not have the requisite FSA authorisation. This decision was upheld by the Court of Appeal.

 

The Legislation

 

Section 19 of FSMA prohibits anyone carrying out regulated activity in the UK unless they are an authorised person or exempt. Article 3(1) of the Regulated Activities Order 2001 (“RAO”) defines contracts of general insurance as “any contract falling within Part I of Schedule I”. This sets out specific classes of risk and the main class that was under consideration in this case was Class 16 that sets out “miscellaneous financial loss”, namely

 

“Contracts of insurance against any of the following risks,

(a)     risks of loss to the persons insured attributable to interruptions of the carrying on of business carried on by them or to reduction of the scope of business so carried on;

(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 court had to decide whether the Warranties were contracts of insurance and, if so, whether their activities fell within Schedule I of the RAO.

 

The Court of Appeal Judgment

 

The Court of Appeal upheld the decision of Warren J that the Warranties fell within Class 16(b) – risk of loss attributable to the insured incurring unforeseen expense. The risk covered by an agreement that provides for the repair and replacement of equipment and an agreement that provides an indemnity for the costs involved are essentially the same. They both contain the risk of the breakdown of equipment that will lead to an unforeseen expense on behalf of the insured.

 

Patten LJ said that although the Warranties provided for the risk of malfunction to be dealt with by way of repair or replacement it was essentially a financial one.

 

The judgment also addressed whether there could be “contracts of insurance” at common law which are not caught under Part 1 of Schedule 1 of the RAO and are therefore unregulated. The FSA submitted that Class 16(c) was a catch all sub class and Patten LJ was inclined to agree:

 

“Their [FSA's] first submission is that the RAO provides a complete code for the regulation of non-life business which encompasses every contract of insurance. As a corollary to this they also contend that class 16(c) is a catch-all provision which is intended to apply to any contracts of general insurance which do not fall within one of the other classes or within classes 16(a) or (b) … my own view is that this is probably right and that class 16… (was intended to be the catch-all which the FSA contends for and is not limited to residual cases of financial loss.”

 

Comment

 

Extended warranties are extremely common in the retail market and are often called “service contracts” as they provide an extended period of repair and maintenance for a product that a customer would otherwise be required to pay for themselves. They are widely marketed and sold by many major retailers. The Warranties under consideration in this case are very similar to service contracts and this decision raises questions in relation to the legality of such extended warranties.

 

Therefore, this case may have direct implications for those selling or providing extended warranties for various consumer goods and appliances on an unregulated basis. Unregulated providers and sellers of such extended warranties will need to consider whether they need to be FSA regulated.

 

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