Over the past three days the Supreme Court has heard a case that could have a critical impact on the financial health of banks in the UK. The case boils down to whether or not, when acting as credit brokers, car dealers have a fiduciary duty to consumers — that is, a legal obligation to act in the best interest of their customer. 

If this is the case, commissions paid by lenders — including Lloyds Banking Group, Investec and Close Brothers — could be seen as bribes, with the court looking at whether the commissions were suitably disclosed as to avoid being called “secret”. If the Supreme Court upholds the Court of Appeal’s judgment and rules against the lenders, the cost to the UK banking sector could reach a number just shy of the £50bn paid out as a result of the mis-selling of payment protection insurance, according to analyst estimates.

Three linked appeals

The court heard three linked appeals, two against FirstRand Bank and the third against Close Brothers. In each case, the claimants were financially unsophisticated consumers on relatively low incomes who engaged car dealers as their credit brokers to arrange hire-purchase agreements with lenders on their behalf to enable them to buy a second-hand car for less than £10,000. Each time, only one offer of financing was presented to the claimant, all of whom accepted that offer. 

In each case, the car dealer made a profit on the sale of the car, but also received a commission from the lender for introducing the business to them, and had an incentive to fix the rate of interest as high as possible within a permissible range in order to maximise the size of the commission.

In one case, this commission was kept secret from the claimants. In the other two cases, the claimant did not know and was not told that a commission was to be paid, but the lender’s standard terms and conditions made reference to the payment of a commission, and in one of those cases the dealer supplied the claimant with a document to sign which indicated that the dealer may receive a commission. 

The claimants are seeking, among other things, the return of the commission. 

Robert Weir KC, acting for the claimants, said: “The point in all three cases is if you’re going to tell me you’re going to get me a competitive deal . . . acting in my interests and ergo not your own it all goes into evidence you’re acting . . . on my behalf.”

But, using the example of a salesperson in a shop, Mark Howard KC, acting for FirstRand, said it was “nonsense” that the salesperson had a legal or ethical duty to act in the customer’s best interests. “[The salesman] is there to make a sale, his responsibility is to his employer or to himself [and] their own interests,” the court heard.

The case has attracted sufficient attention from the government and the Financial Conduct Authority to prompt both organisations to make a rare request to intervene in the case. Only the FCA’s intervention was granted.

The court heard that the FCA intervened because of the size of the market the decision will impact (the FCA’s most recent estimate of the size of the motor finance market is £41bn) as well as the hundreds of thousands of claims which have been made, some of which are currently pending in the county court system.

Jemima Stratford KC, acting for the FCA, repeated the language in the FCA’s written submission which said that to treat all motor dealers as fiduciaries would be “too sweeping an approach” and would sit oddly with the regulatory and legislative framework of the regulator. 

But the FCA warned that the court should exercise caution before accepting banks’ arguments that they were not covered by bribery law, saying this would be a “surprising outcome”. “We are charting what might be termed a middle course,” Stratford told the court. 

Knock-on impact

Another concern, shared by much of the financial sector, is the knock-on impact on other forms of financing. Depending on the ruling, questions may begin to be asked about whether any other product sold through a third party intermediary — such as a mortgage or home insurance — would come under the same scope.

The FCA has already told banks to be ready for a redress scheme — which it said it will confirm within six weeks of the decision. Part of the reason for the speed of the scheme’s implementation is to lessen the number of consumers who rely on claims management companies in order to secure redress.

Regardless of which way the Supreme Court rules, some sort of redress scheme is highly likely, said Caroline Wayman, global head of financial services at PA Consulting and former CEO of the Financial Ombudsman Service.

“The FOS and firms already have a large number of cases . . . a redress scheme of some sort is inevitable — there’s still a set of questions about the whole discretionary commissions side of things,” she added.

FCA intervention will be required to ensure customer redress is handled fairly while avoiding a “total collapse” of the motor lending sector, said David Hamilton, partner at Howard Kennedy.

The route to establishing any consumer redress programme will be “more convoluted” than PPI, he warned, given the nuances of the Court of Appeal’s judgment. 

“Formulating clear redress parameters may well become a cottage industry in its own right.”

But others are not too concerned about the impact on the banking sector. While the continued uncertainty is credit-negative for small banks with high exposure to motor finance, said Anna Sherbakova, senior analyst at Moody’s Ratings, a ruling might not have as outsized an impact. 

“Negative impact from an adverse ruling on the UK’s large and diversified banks would likely be limited given their high levels of capital, strong profitability and ability to adjust financial policies to absorb any potential costs,” she added.

The judgment is expected in July.