Recent Developments In The Law Affecting Vehicle Service Contracts

In 2010, we saw many changes to federal and state laws affecting various segments of the financial services and insurance industries. These changes took the form of legislative enactments, or revisions to existing legislation, and a number of note worthy court decisions affecting vehicle service contracts. While some of these recent developments in the law expressly targeted vehicle service contracts, other changes tangentially affect the vehicle service contract industry, as a whole.

Either way, as outlined below, some of these changes will inevitably affect the way vehicle service contract providers currently conduct business, as they respond to these changes to existing laws and new regulatory requirements.

Newly Enacted Federal Legislation

Any service contract provider involved in the financial services, insurance or related industries should understand how, if at all, The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”) may affect its business.

Enacted in law on July 21, 2010, Dodd Frank is primarily a banking and investment business oriented piece of legislation; however, it also affects certain aspects of the insurance industry and could impact the vehicle service contracts business particularly to the extent this business is not considered to be the business of insurance.

Consumer Financial Protection Act of 2010

Title X of Dodd Frank, also known as the Consumer Financial Protection Act of 2010 (“CFPA”), establishes a new federal agency called the Bureau of Consumer Financial Protection (the “Bureau”). Many of the consumer protection powers of the Federal Reserve, Federal Deposit Insurance Corporation, Office of Comptroller of the Currency and Office of Thrift Supervision will be transferred to the Bureau, which has broad rule-making authority and regulatory oversight for a wide range of consumer oriented financial products and services.

The Bureau will supervise persons who offer or provide a consumer financial product or service. A consumer “financial product or service” means certain financial products or services that are offered for use by consumers primarily for personal, family, or household purposes.

In addition to the laundry list of what could be deemed as “traditional” financial products and services included within the purview of the CFPA, the Bureau is also permitted to expand its regulatory oversight to “other products or services as may be defined by the Bureau by regulation, if the Bureau finds that the product or service (a) has the purpose of evading any Federal consumer financial law, or (b) is permissible for a bank or BHC to offer to or provide under Federal law or a regulation that has, or is likely to have, a material impact on consumers.

Currently, the business of insurance is not included within the definition of a financial product or service, which reflects the maintenance of the states’ purview of the regulation of insurance under the McCarran-Ferguson Act.

For purposes of the CFPA, the “business of insurance” means writing insurance or reinsuring of insurance risk. Thus, to the extent that a particular aspect of the vehicle service contracts business is the business of insurance, the CFPA does not apply; however, for any part of the vehicle service contracts business that is not considered to be the business of insurance, the CFPA could be applicable.

Most states in which vehicle service contracts are regulated subject these contracts to regulation in their insurance codes but do not treat vehicle service contracts as insurance; although there are some key differences in how states do this. Some states’ vehicle service contracts laws provide that vehicle service contracts are not insurance in any respect, and while they are regulated within state insurance codes, they are wholesale exempted from all other provisions of the insurance code.

In contrast, other states exempt vehicle service contracts only from certain, but not all, provisions of the insurance code, leaving open the question of whether they are the business of insurance even though they are not fully regulated as an insurance product.

Thus, for purposes of the CFPA to the extent that vehicle service contracts are exempted in their entirety from a state’s insurance code, they could become subject to the jurisdiction of the Bureau of Consumer Financial Protection if it were to determine that these contracts have a material impact on consumers.

Federal Insurance Office Act of 2010

Title V of Dodd Frank, also known as the “Federal Insurance Office Act of 2010” (“FIOA”), created a new Federal Insurance Office (the “FIO”) within the Treasury Department, the first, true federal agency related to the insurance industry. The FIO’s authority extends to all lines of insurance, other than crop, health and long-term care insurance, and it can collect data from insurers and their affiliates.

Similar to the question of whether the CFPA has jurisdiction over vehicle service contract market participants, the FIO’s regulatory reach turns on whether vehicle service contracts are considered “the business of insurance.” While the FIO clearly has authority over insurance companies that issue contractual liability insurance policies that insure the obligations of obligors under vehicle service contracts, the FIO could wade into seeking data from obligors and administrators as well.

Furthermore, the FIO is required to conduct a study and issue a report to Congress within eighteen months on ways in which insurance regulation can be modernized and improved, which could include recommendations for changes in how the vehicle service contracts industry is regulated.

NonAdmitted and Reinsurance Reform Act of 2010

Title IX of Dodd Frank, also called the "Nonadmitted and Reinsurance Reform Act of 2010” (the “NARRA”), prohibits a state from denying credit for reinsurance for the ceding insurer's ceded risk, if the domiciliary state of the ceding insurer recognizes such credit and is either (a) an NAIC-accredited state; or (b) has financial solvency requirements substantially similar to NAIC accreditation requirements.

According to the legislative summary, the NARRA also “preempts the extraterritorial application of a non-domiciliary state's laws, regulations, or other actions (except those related to taxes and assessments on insurance companies or insurance income) to the extent that they:

1. restrict or eliminate the rights of the ceding insurer or the assuming insurer to resolve disputes pursuant to contractual arbitration that is not inconsistent with federal law;
2. require that a certain state's law shall govern the reinsurance contract, its requirements, or any disputes arising from it; or
3. attempt to enforce a reinsurance contract on terms different than those set forth in it, if those terms are not inconsistent with this subtitle.”

Thus, essentially, the NARRA eliminates any barriers that previously existed for insurance carriers issuing contractual liability insurance polices that indemnify or reimburse vehicle service contract providers (“Service Contract Liability Policies”) from getting credit for reinsuring the risk on such policies in numerous states, by subjecting such carriers only to the laws of their home state.

The NARRA also establishes new rules with respect to the assessment of premium tax payments for nonadmitted insurance. Specifically, under the NARRA “no State other than the home State of an insured may require any premium tax payment for nonadmitted insurance.”

However, the new law also allows States to enter into a “compact or otherwise establish procedures to allocate among the States the premium taxes paid to an insured’s home State;” and also requires that in order for States to impose eligibility requirements on nonadmitted insurers, that the State adopt “nationwide uniform requirements, forms, and procedures, such as an interstate compact.”

Further changes include, but are not limited to, (i) a limitation that only the statutory and regulatory requirements of the insured’s home State are applicable to nonadmitted insurance issued in such state and (ii) that only an insured’s home State “may require a surplus lines broker to be licensed in order to sell, solicit, or negotiate nonadmitted insurance with respect to such insured.”

Despite the foregoing, the nonadmitted insurance aspect of the NARRA may not be of particular importance to the vehicle service contract industry as a whole, since those insurance carriers which provide Service Contract Liability Policies usually do so as a licensed/admitted insurer, rather than on a surplus lines insurance basis.

However, like the FOIA, the NARRA represents for the first time a significant intrusion by the federal government into what has been historically limited to state regulation of the insurance industry and the insurance industry’s increasingly diminished tolerance for non-uniformity of state insurance laws.

Newly Enacted State Legislation

California

On September 29, 2010, California Governor Arnold Schwarzenegger signed into law California Assembly Bill 2111 (“A.B. 2111”), which amended various California statutes regulating service contracts.

One of the major changes that A.B. 2111 does to existing law is that it removes the exclusion for service contract sellers or insurers from the definition of “service contract administrator” making the California Service Contractors law applicable (including the registration requirements of Sections 9855.1 9855.3) to any insurer that “who performs or arranges the collection, maintenance, or disbursement of moneys to compensate any party for claims or repairs pursuant to a service contract, and who also performs or arranges any of the following activities on behalf of service contract sellers:

1. providing service contract sellers with service contract forms;
2. participating in the adjustment of claims arising from service contracts; or
3. arranging on behalf of service contract sellers the insurance required by Section 9855.2.”

The portion of A.B. 2111 specifically applicable to vehicle service contracts, eliminates the requirement that a vehicle service contract obligor provide in the written contract, itself, the methodology for calculating the pro-rata refund amount due when the purchaser prematurely cancels the vehicle service contract.

Instead, the new law allows the service contract obligor to determine the objective measure to be used to calculate the pro-rata refund at the time the contract is cancelled. A.B. 2111 also adds an exemption from the requirements governing a vehicle service contract for a warranty provided by a vehicle “glass sealant manufacturer.”

Florida

Florida Governor Charlie Crist signed into law Florida Senate Bill 2176 (“S.B. 2176”) on June 1, 2010, which substantially revises laws governing motor vehicle service agreement companies. Specifically, S.B. 2176 exempts commercial motor vehicle service contracts from regulation by amending the definition of “motor vehicle service agreement” to exclude “service agreements that are solely to persons other than consumers and that cover motor vehicles used for commercial purposes.”

S.B. 2176 also provides for misdemeanor penalties for service agreement companies that fail to be licensed as required under existing law; and increases the list of prohibited practices under current law (for example, making a false, deceptive or misleading advertisement “with respect to the service agreement company’s affiliation with a motor vehicle manufacturer” or “its possession of information regarding a motor vehicle owner’s current motor vehicle manufacturer’s original equipment warranty”).

S.B. 2176 eliminates the requirement that all service agreement forms and related documents must first be submitted and approved by the Florida Office of Insurance Regulation. Instead, a service agreement company can now use forms that do not have to be pre-approved, as long as such forms contain certain statutorily-required information and/or disclosures.

The new law also makes it clear that the Florida Office of Insurance Regulation no longer regulates rates charged by service agreement companies and requires that each service agreement sold in the state on or after July 1, 2011 “be accompanied by a written disclosure to the consumer that the rate charged for the service agreement is not subject to regulation by the office” which disclosure may be part of the service agreement, itself, or in a separate written statement.

Louisiana

Louisiana House Bill 519 (“H.B. 519”) went into effect on August 15, 2010 and added new Sections 969.24.1 and 696.24.2 to the Louisiana Motor Vehicle Sales Finance Act, aimed at eliminating anti-competitive behavior among motor vehicle sales finance companies. H.B. 519 could impact the way some vehicle service contract providers do business.

Specifically, Section 969.24.1 makes it unlawful for any person subject to the requirements of the act to take any actions “that the intended or actual effect of which is to coerce or attempt to coerce any seller to sell or offer to sell any extended service contract, extended maintenance plan . . .

offered, sold, backed, or sponsored by a particular entity, including but not limited to any manufacturer or distributor of motor vehicles or affiliates thereof . . .

by setting limits for the amount financed in regard to the financing of premium or other charges for any insurance coverage, product, or service financed on the retail installment contract, when the discrimination in the amount financed limits is based, in whole or in part, upon whether or not the product, insurance, or service is provided by [such] person or affiliates thereof . . . .”

Section 969.24.2 makes it unlawful for any person “to require a seller to sell any insurance coverage, product, or service, which is provided, administered, or sold by a person or any affiliates thereof, subject to the provisions of [the Motor Vehicle Sales Finance Act], in order to secure preferential financing or preferential limits on the amounts financed rates for the dealership or its customers.”

Washington

Effective on June 10, 2010, Washington House Bill 3032 added to the definition of “service contract” “a contract or agreement sold for separately stated consideration for a specific duration to perform the repair or replacement of tires and/or wheels damaged as a result of coming into contact with road hazards;” but excluded service contracts provided by tire, wheel or motor vehicle manufacturers.

Recent Court Decisions of Interest

In Sawyers v. Herrin-Gear Chevrolet Company, 26 So. 3d 1026 (Miss. 2010), plaintiff Andria Sawyers sued Herrin-Gear Chevrolet Company, Inc., alleging fraud, breach of contract and bad faith, emanating from the plaintiff’s purchase of a “Gap Asset Protection Deficiency Waiver Addendum” in connection with her purchase of a 2002 Ford Explorer.

In response to the lawsuit, defendant Herrin-Gear Chevrolet Company, Inc. filed a motion to compel arbitration based on an arbitration provision contained in the agreement. In granting the defendant’s motion, the court disregarded the plaintiff’s claim that the arbitration provision was invalid because the GAP waiver was an insurance policy subject to regulation and the defendant was not registered with the Mississippi Department of Insurance; and held that GAP waiver products were not insurance.

In Midwest Agency Servs., Inc. v. JP Morgan Chase Bank, 2010 U.S. Dist. LEXIS 22457 (E.D. Ky. March 11, 2010), the plaintiff sued JP Morgan Chase and its affiliated entities, Chase Auto Finance Corporation (“CAF”) and Chase Insurance Agency, Inc. (“CIA”), alleging anti-competitive practices stemming from CAF’s policy requiring automobile dealers that use CAF financing only to use “approved” GAP insurance products, which list did not include plaintiff but did include CIA, among other GAP insurance providers.

In dismissing the plaintiff’s complaint for “failure to state a claim,” the Federal District Court for the Eastern District of Kentucky held that the alleged unlawful “tying arrangement” could not be found to be a violation of the Sherman Antitrust Act since the plaintiff failed to demonstrate an antitrust injury, namely that the injury that occurred as a result of CAF’s actions were the type of injury that antitrust laws were intended to prevent.”

Specifically, the court stated that “Midwest’s allegation of an injury to its ability to sell GAP insurance products is not an antitrust injury;” and that “the law is settled that injury only to a competitor and not to the market does not create an antitrust injury.”

In Saccucci Auto Group, Inc. v. American Honda Motor Company, 2010 U.S. App. LEXIS 16127 (1st Cir. Aug. 4, 2010), the plaintiff-automobile dealer sued American Honda Motor Company and American Honda Finance Corporation (“Honda”) as a result of Honda’s prohibition on allowing its dealers to market and sell Honda Vehicle Service Contracts over the Internet, which policy instituted at the urging of a Honda’s Dealer Advisory Board, a body composed of independent Honda dealers who are elected to represent dealer interests.

In dismissing the plaintiff’s claims that Honda violated Rhode Island’s Dealer Act, which regulates the business relationship between automobile manufacturers and their dealers, the Court found that Honda neither engaged in “coercive conduct” or engaged in “arbitrary action” to the dealer’s detriment in violation of the Dealer Act, when it instituted a policy to suspend or permanently “deactivate” a dealer’s contractual right to sell Honda Vehicle Service Contracts for violating Honda’s no Internet sales policy.