Re Digital Satellite Warranty Cover Ltd and others
The three businesses involved in this action sold extended warranty contracts relating to satellite television dishes, digital boxes and associated equipment. All three targeted people who had purchased Sky satellite systems and whose warranties were about to run out.
Initial contact was made by mailshot or telephone. In the case of Digital Satellite Warranty Cover Ltd (DSWC), the mailshot indicated that the warranty would cover not only equipment breakdown or malfunction but also accidental damage. Transcripts showed that similar promises were made in telephone conversations with potential customers.
A customer buying the cover would receive a warranty certificate that included certain exclusions, but which did not exclude accidental damage. There was also no exclusion for accidental damage in the company's standard terms and conditions.
DSWC's contractual obligation was to repair or replace faulty or damaged equipment. There was no obligation on it to pay money to the customer in any circumstances.
The Financial Services Authority (FSA) claimed DSWC and the other two businesses (which contracted on broadly similar terms) were selling and carrying out insurance contracts without authorisation under the Financial Services and Markets Act 2000 (FSMA).
The First Council Directive 73/239EEC (as amended) does not define insurance. It divides non-life insurance risks into classes, which include fire and natural forces (class 8), other damage to property (class 9) and miscellaneous financial loss (class 16).
An amending Directive added a further class 18, which concerned assistance in cash or in kind provided to persons getting into difficulties while travelling or otherwise.
In the UK, section 19 of FSMA prohibits anyone from carrying out a regulated activity in the UK unless they are an authorised person or an exempt person. The Regulated Activities Order (RAO) defines those activities that require authorisation.
General insurance is defined as a contract falling within Part 1 Schedule 1 of the order. This sets out classes of risk that reflect those in the First Council Directive: fire and natural forces (paragraph 8) damage to property (paragraph 9), miscellaneous financial loss (paragraph 16) and assistance while travelling or otherwise (paragraph 18).
Miscellaneous financial loss in paragraph 16 of the RAO is sub-divided into: (a) losses attributable to interruptions in the carrying out of a business; (b) losses attributable to the incurring of unforeseeable expense; and (c), risks not within (a) or (b) and which are not covered by contracts within any other provisions of the Schedule.
The court had to decide whether the contracts were insurance contracts and, if so, whether their activities fell within Schedule 1 of the RAO.
One of DSWC's main arguments was that the warranty contracts provided a benefit in kind. Even if this were insurance, the First Directive (and therefore the RAO) only specifically deals with benefits in kind insurance in relation to assistance for persons who get into difficulties while travelling or otherwise (Article 18). It argued that all other forms of pure benefits in kind insurance were therefore not covered by the Directive and so remained unregulated.
The judge held that all three businesses were entering into contacts that were capable of being insurance contracts, in breach of the general prohibition in FSMA.
At common law, a contract of insurance is understood to mean an agreement for the payment of a sum of money or corresponding benefit on the happening of an uncertain event that is generally adverse to the interests of the person taking out the insurance.
Even if these contracts did not cover accidental damage, the judge was satisfied they were contracts of insurance at common law. The uncertain event was the equipment breakdown or malfunction, the repair and replacement service represented a corresponding benefit and the insured (as owner) clearly had an insurable interest.
But did the risks fall within Schedule 1 of the RAO? The judge concluded they came under paragraph 16 as "miscellaneous financial loss".
More specifically, they fell within 16(b) (losses attributable to the incurring of unforeseeable expense). If not, the judge was satisfied they fell within the sweep-up provision at 16(c). In either case, the risk covered was essentially the same: the possibility of the equipment breaking down or malfunctioning.
In the case of all three businesses, however, he was satisfied that the contracts also provided wider cover which would bring them within class 8 or 9 of the schedule. The contracts entered into by DSWC, for instance, included cover for accidental damage.
If distinct elements of a contract fall into different classes of insurance, the judge thought authorisation to carry out business in each class would be required.
Neither DSWC nor the other two businesses had ever had any FSA authorisation. Accordingly, the judge made orders for all three of them to be wound up.
The appeal court agreed with the judge. The risk covered by a contract which provides for repair and replacement of the equipment and a contract which provides an indemnity for the costs involved is essentially the same. In both cases, the risk is the breakdown of the equipment which will lead to expense on the part of the insured.
So, although the cover provided for the risk of malfunction to be dealt with by repair or replacement, that risk was essentially a financial one attributable to the insured incurring unforeseen expense (class 16(b)) or other risks (class (c)).
As for the argument that the First Directive only deals with benefits in kind insurance in class 18 (travel assistance), the Court of Appeal did not consider this type of cover was excluded from the other classes of insurance, if the risk it covered would otherwise fall within one or more of those classes.
In any event, the strong impression given by the First Directive was that it was intended to impose minimum levels of regulation. It did not exclude the right of national governments to extend regulation to a wider class of benefits in kind insurance.
Whether an extended warranty contract might be construed as a contract of insurance is a live issue in the retail market. "Service contracts" (as non-insurance third party extended warranties are often called) are routinely marketed and sold to UK customers by many major retailers. The contracts under consideration in this case are very similar to service contracts and the decision therefore raises a serious question mark over the legality of those structures.
The case also demonstrates the appetite of the FSA for policing the regulatory perimeter by taking action against unauthorised firms that operate in the regulated insurance space. This will be welcome to authorised insurers, who have seen unauthorised firms straying into traditional insurance areas.