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Consumers have won a landmark car finance mis-selling case that could pave the way for companies to be forced to pay billions of pounds in compensation to borrowers.
On Friday, judges from the court of appeal ruled in favour of three borrowers whose cases were merged earlier this year, saying it was unlawful for lenders to have paid a commission to car dealers without the borrowers’ knowledge.
The ruling on the test case, which involved customers filing claims against FirstRand Bank and Close Brothers, said consumers needed to know all the material facts that could affect their borrowing decision including the total commission to car dealers, and how it was calculated, in order to be able to consent to the loan.
The news sent Close Brothers shares down 15% on Friday afternoon, with the lender saying it would temporarily pause issuing new car loans while it reviewed the ruling. FirstRand said it was “concerned by the judgment and does not agree with its findings”.
Both companies said they intended to appeal against the ruling in the UK supreme court.
The decision could have wide-ranging implications for car lenders across the UK, with some lawyers speculating that consumers could collectively receive billions of pounds in compensation, and in some cases have their car loan written off or rescinded.
The decision could also influence the Financial Conduct Authority’s (FCA) investigation into whether commission arrangements made between 2007 and 2021 – the year they were banned – were harmful to consumers.
The FCA will decide whether to take any further action, which could include launching a customer compensation scheme funded by the lenders that sat behind the arrangements, by May 2025. It has already warned car lenders to hold back cash for potential payouts.
The consumer champion Martin Lewis said the FCA investigation could lead to the largest compensation bill since the payment protection insurance scandal, which cost banks a total of more than £50bn. Some analysts believe it could collectively cost the car finance industry £8bn to £13bn.
The Finance and Leasing Association (FLA), which represents car lenders ranging from big high street banks including Barclays to the finance arms of manufacturers such as Ford and Volkswagen, is urging the City regulator to immediately review the court ruling.
“This is a significant and unexpected judgment, the implications of which stretch far beyond the motor finance sector, making it an issue that demands the immediate attention of the Financial Conduct Authority,” said the FLA director general, Stephen Haddrill.
Lloyds Banking Group, which is the most exposed among UK high street banks, has already put aside £450m for potential fines, while Close Brothers earlier this year cancelled its dividend and announced plans to raise £400m to shore up its balance sheet.
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Lloyds shares were down 5.5% on Friday afternoon, with some analysts suggesting that the bank may still have to put aside £1.5bn to cover potential compensation.
“It’s hard to put an exact number on these things, and Lloyds isn’t the only name with skin in the game,” said Matt Britzman, senior equity analyst, Hargreaves Lansdown. “But it does have more exposure than most of its peers, and while the broader Lloyds investment case looks solid, this remains one of the biggest risks.”
The FCA said: “We note the court of appeal judgment … and are carefully considering its decision.”
The cases are linked to historical arrangements in which lenders gave car dealerships and brokers the power to set interest rates on car loans, and earn higher commission as that number grew. The practice – known as discretionary commission arrangements (DCAs) – was banned by the FCA in 2021, amid concerns it was incentivising dealers and brokers to charge higher interest rates.
However, the FLA has argued that DCAs also allowed dealerships to charge lower interest to customers at times when they needed to clinch a sale. The industry has also warned that hefty fines could disrupt lending by putting extra financial burdens on businesses.