Whether a service contract is subject to state insurance regulations has a significant impact on a consumer’s legal claims. Insurance regulations may require the retailer selling the contract to be licensed to sell insurance and comply with other insurance agent requirements. The service contract owner may have to comply with insurance solvency requirements, unfair claims payment laws, rate and policy filing requirements, and unfair insurance practices laws.
Consumer Warranty Law: 20.3.2 Factors Indicating Whether a Service Contract Is Regulated As Insurance
A number of states have special laws regulating automobile service contracts or other forms of service contracts,17 and these statutes are sometimes explicit about whether service contracts are treated as insurance,18 are not to be treated as insurance, or are to be treated as insurance if they include certain characteristics and are not to be treated as insurance if they lack those characteristics.19 Other state pronouncements may perform a similar function.
Consumer Warranty Law: 20.4.1 Compare Service Contract Language with Stated Grounds for Coverage Denial
If a consumer’s repair claim covered by a service contract is denied, obtain the ground for the denial in writing, so the obligor does not later change its reason for denying the claim.27 Also read the service contract’s exclusionary language with great precision, particularly as it relates to the stated grounds for denying coverage.
Service contracts are limited in time, and motor vehicle contracts may also be limited as to mileage driven. Read the contract language carefully to see how time and mileage are to be computed. For example, one company sold a five-year contract on a used car, starting from the date the contract was purchased, but the contract stated elsewhere that it began to run on the same day as the new vehicle warranty.33 Such conflicting provisions should be interpreted against the drafter.
The Magnuson-Moss Warranty Act requires that a service contract “fully, clearly, and conspicuously discloses its terms and conditions in simple and readily understood language.”36 If contract exclusions do not meet this standard, the consumer has a cause of action under the Act for actual damages and attorney fees.
Even if a claim denial is consistent with the written contract, the consumer still may have various legal claims when the contract is at variance with prior representations concerning that contract. Review advertising claims, brochures available at the retailer, internet-based representations, and the preliminary paperwork given the consumer concerning the service contract. Explore all oral representations the retailer made to the consumer.
Service contract claims can be denied not just on the basis of a disputed interpretation of the contract, but also based on the disputed accuracy of the obligor’s inspection of the defective product. Some service contracts deny responsibility for repair if one of the many non-covered parts contributes to the damage to a covered part. For example, a service contractor may claim that a defective automobile gasket not covered by the service contract caused the engine damage, and therefore the service contractor is not responsible.
Service contract coverage may be denied when the consumer did not obtain prior approval for repairs, as required by the agreement. But this denial has been found to be unfair and deceptive when the service contract administrator had a practice of not responding to consumer requests for prior approval.51
Service contract coverage may be denied because, even though coverage was purchased, the product was never eligible for the service contract policy in the first place. For example, the vehicle involved is excluded from the category of vehicles for which coverage is available. Then the consumer has a UDAP claim against the party selling the contract. The contract owner may also be liable for the acts of its agent. While there is not case law in this area regarding service contracts, analogous precedent can be found concerning the sale of credit insurance or other lines of insurance.
Aggrieved consumers can complain about service contract performance to the retailer. If the service contractor is a manufacturer, consumers can pursue their complaint through the manufacturer’s hierarchy, from the district sales office to the national headquarters. A letter to the manufacturer or administrator may result in an additional inspection or re-evaluation of the claim. Some manufacturers have established dispute resolution mechanisms to handle warranty complaints which may also hear service contract complaints.
In bringing a legal claim for the service contractor’s failure to perform covered services, plead that the consumer actually requested the services from either the obligor or the obligor’s authorized agent.52 Alleging that the obligor discouraged the consumer from making a request may be insufficient; state that the consumer specifically requested that the covered service be performed.53
Service contracts may include binding arbitration clauses, limiting consumers’ ability to challenge service contract denials in court. Even when the service contract does not include an arbitration requirement, defendants may try to enforce the arbitration clause found in the sales agreement for the covered product.
The Magnuson-Moss Warranty Act provides for actual damages, equitable relief, and attorney fees when a service contractor fails to meet its obligations under a service contract.62 Individual Magnuson-Moss claims must usually be brought in state court, although certain class actions may be brought in federal court.63
State deceptive practices (UDAP) statutes provide a remedy for various service contract practices, usually providing attorney fees and often minimum, multiple, or punitive damages.72 Failure to pay a service contract claim may be a UDAP violation, and the bad faith failure to pay a claim is certainly a UDAP violation.73 So are misrepresentations about policy coverage, misstatements that the service contractor will be fair in paying claims, and failure to disclose important facts about the service contractor’s claims payment
Consumer Warranty Law: 20.5.6 Breach of Duty of Good Faith; Special Application to Service Contracts
Section 11.4.8, supra, discusses whether breach of the obligation of good faith inherent in any contract gives rise to an affirmative claim for actual and punitive damages. Even in states in which such an affirmative action is not available, many states provide an affirmative action based on a claim of bad faith in an insurance transaction.
Consumer Warranty Law: 20.5.7 Unfair Insurance Claims Settlement Practices Statutes; Licensing Requirements
When a state explicitly regulates a service contract as insurance, additional legal claims come into play.
Certain state service contract statutes provide an explicit private remedy for violations or for the contractor’s failure to pay a claim.82 Each statute is different—some statutes provide attorney fees, minimum damages, or multiple damages.83 The Third Circuit has found that a provision in a service contract waiving the consumer’s right to attorney fees under the state service contract statute is a violation of that statute.84 Violation of a service contract statute also may be a state UDAP v
The service contract contractor arranges for work to be done under the contract, but often the party performing the work is a separate entity. When the work performed is of substandard quality, the consumer has two approaches to obtain redress.
The service contract owner is primarily responsible for paying claims, so it will be the prime defendant in any litigation for breach of the service contract. When the contract owner is insolvent, consumers can explore alternative parties to hold liable. Even if the contract owner is not insolvent, consumers may wish to raise their service contract-related claims against the holder of their installment sales contract, who will often not be the service contract owner. This section examines the liability of various parties other than the service contract owner.
When a service contract is regulated as insurance or offered by an insurance company, a state insurance insolvency fund may be available to pay out claims when that insurance company is insolvent.88 When a service contract is not regulated as insurance, a number of state statutes require that the service contract obligor take out reimbursement insurance or a bond that will pay out claims in case the obligor becomes insolvent.89
Service contract owners often employ a third party to process and approve claims, called the service contract administrator. The administrator may also offer advice to the service contractor on how to set up the service contract program, but the service contract typically will state that the administrator has no liability to the consumer.
A retailer typically sells another company’s service contract in conjunction with its sale of the product protected by the service contract, retains a large portion of the price, and may even perform the promised repairs. In some cases, the retailer or a company related to the retailer reinsures the contract, so that as a practical matter the retailer retains all the benefit and risk from the contract, and the service contract “owner” does little more than participate in a legal fiction, for a fee.
In addition to the reimbursement insurer, administrator and retailer, other parties aiding and abetting the scheme may be liable for a service contract owner’s failure to pay out on a claim. For example, the Nevada Supreme Court allowed a potential class action to go forward against an accounting firm regarding its participation in the undercapitalization of a service contract insurance company.104
In many consumer transactions, it is more practical to raise claims and defenses against the holder of the consumer’s loan obligation related to the covered product than it is to bring an affirmative suit against a third party. When the retailer is liable for the failure to pay on a service contract claim,105 the retailer’s assignee (or a third party lender referred by the retailer) is also liable pursuant to the Federal Trade Commission’s Holder Rule.106
Consumers cancel service contracts before their expiration for any number of reasons: the consumer sells or trades the product, the product is repossessed, or the consumer realizes that the contract is a bad deal. The question then is how to compute a refund on a prepaid service contract.