New York State Seal
STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

The Office of General Counsel issued the following opinion on July 18, 2002, representing the position of the New York State Insurance Department.

RE: Service Contracts

Questions Presented:

1) Does the Insurance Department review and approve the language of service contracts that are sold in New York State?

2) Where a service contract is sold by the product dealer but another person is obligated to perform the services under the service contract (the service contract provider), does the person who purchased the service contract (the service contract holder) have any recourse under the New York Service Contract Law against the product dealer should the service contract provider fail to honor its obligations under the service contract?

3) Should a service contract provider elect to comply with the financial responsibility requirements of N.Y. Ins. Law Article 79 (McKinney 2000) by establishing a funded reserve account and financial security deposit under N.Y. Ins. Law § 7903(c)(2) (McKinney 2000) and the service contract provider thereafter fails to fulfill its obligations under its New York service contracts, what recourse does a service contract holder have?

Conclusions:

1) No.

2) No, unless the contract specifically provides for such recourse.

3) The service contract holder would have a cause of action against the service contract provider in a court of law. In addition, under the New York Service Contract Law, the service contract holder can make a service contract claim to the claims trustee named by the service contract provider under the provider’s default contingency plan agreement that is filed with the Department when it applied for registration as a service contract provider. Also, the service contract holder may apply to the Superintendent to share in any funds remaining in the funded reserve account and the funded security deposit to pay such claim.

Facts:

The ABC Corporation ("ABC") is in the business of selling automobile service contracts under which it is obligated to provide the services specified. The service contracts are marketed to consumers by automobile dealers. ABC applied for and became registered as a service contract provider in New York State as of January 3, 2002 for the period ending February 28, 2003. It elected to comply with the financial responsibility requirement contained in Article 79 of the Insurance Law by the method specified in N.Y. Ins. Law § 7903(c)(2) (McKinney Supp. 2002): maintaining a funded reserve account and placing in trust with the Superintendent a financial security deposit.

ABC maintains its funded reserve account in the DEF Bank, located in Pennsylvania. Its financial security deposit is funded with a surety bond in the face amount of $50,000 issued by the XYZ Casualty and Surety Company.

The inquirer sent the Department marketing materials that are used by ABC to contact automobile dealers in order for them to sell its service contracts to consumers. These materials include blank forms of ABC’s six different service contract forms and an ABC Press Release dated Winter 2002 touting its New York service contract program. The following passage in the Press Release that the inquirer highlighted states the following:

…ABC joins only a handful of companies that have complied with the regulations and met the strict financial requirements to be licensed as a service contract provider without the need for a secondary insurance underwriter on its contracts. ABC’s entire product line, which has been reviewed and approved by the Department of Insurance, will be available in the state…

Of the six service contract forms, four contain the following language, "I understand and agree that the limited warranty I am purchasing is an agreement between myself and ABC. I further understand and agree that the car dealer from which I purchased this contract has no liability to the agreement, other than submitting the payment and necessary paperwork to ABC for processing." Two of the service contracts, the "Unlimited Mileage Contract" and "Gold Contract," do not contain the foregoing language. All six service contracts state that, "Obligations of the provider under this service contract are backed by the full faith and credit of the provider."

Analysis:

The New York Service Contract Law was enacted by Chapter 614 of the Laws of 1997, amending several sections of the Insurance Law and adding a new Article 79. It became effective on January 15, 1998. Under the New York Service Contract Law, the marketing and selling of service contracts in New York does not constitute the doing of an insurance business. However, the Law establishes a legal framework for the doing of a service contract business which includes, among other things, the requirement that all service contract providers (persons obligated to provide services under a New York service contract) be registered with the Superintendent of Insurance (N.Y. Ins. Law § 7907 (McKinney 2000).

Before any service contract can be issued, sold or offered for sale in New York State the service contract provider is required to demonstrate their financial responsibility by one of three methods specified in N.Y. Ins. Law § 7903(c) (McKinney Supp. 2002). ABC, when it applied for registration in New York, chose to establish a funded reserve account and make a financial security deposit. This method is specified in paragraph (2) of the foregoing statute as follows:

(2)(A) maintain a funded reserve account for its obligations under its service contracts issued and outstanding in this state, which reserve account (I) contains reserves in an amount not less than forty percent of the gross consideration received upon the sale of, less claims paid under, all its service contracts then in force, but not less than zero, and (ii) shall be subject to examination and review by the superintendent; and

(B) place in trust with the superintendent a financial security deposit, having a value of not less than five percent of the gross consideration received upon the sale of, less claims paid under, all service contracts issued and then in force, but not less than fifty thousand dollars, consisting of one or more of the following:

(i) a surety bond issued by an authorized surety;

(ii) securities of the type eligible for deposit by authorized insurers in this state;

(iii) cash; or

(iv) a letter of credit issued by a qualified United States financial institution.

The Press Release –

The New York Service Contract Law requires that New York service contracts contain certain provisions and that they be sold in a certain manner, but it does not require that the service contracts be either prior approved by or even filed with the Department.

N.Y. Ins. Law § 7906 (McKinney 2000) prohibits certain acts. As to the Press Release, which is material used in connection with the sale of service contracts, subsection (b) provides that the following is prohibited:

(b) A provider shall not in its service contracts or literature make, permit or cause to be made any false or misleading statement, or deliberately omit any material statement that would make the service contracts or literature misleading if omitted, in connection with the sale, offer to sell, or advertisement of a service contract.

This issue will be referred to the appropriate parties within the Department for investigation.

Recourse available to service contract holders in New York –

The inquirer is concerned that service contract holders who have purchased an ABC service contract in New York may have no recourse to the automobile dealers that sold them the service contracts and that they may also not be able to collect on their service contract claims should ABC refuse to or be unable to fulfill its obligations under its New York service contracts.

The first provision that the inquirer points to is contained in four out of the six ABC service contract forms. It provides as follows:

I understand and agree that the limited warranty I am purchasing is an agreement between myself and ABC. I further understand and agree that the car dealer from which I purchased this contract has no liability to the agreement, other than submitting the payment and necessary paperwork to ABC for processing.

However, even as to the two service contracts which do not contain the foregoing language, ABC is still clearly identified in these service contracts as the obligor. Its name is prominently placed at the top of each of the form contracts and elsewhere in the service contract.

Pursuant to N.Y. Ins. Law § 7905(c) (McKinney 2000), service contracts not insured by service contract reimbursement insurance (another method of financial responsibility) are required to contain a statement, substantially as follows:

"Obligations or the provider under this service contract are backed by the full faith and credit of the provider."

The second provision that the inquirer points to in all of the ABC service contracts fulfills the foregoing statutory requirement. The foregoing statement places the service contract holder on notice that their recourse is to the service contract provider who is responsible for and stands behind its obligations under the service contract.

Accordingly, under the language of the ABC service contracts there does not appear to be any recourse available to the service contract holders against the automobile dealers who sold them the service contracts. The automobile dealers are not obligated under the service contracts to provide services as the terms of the service agreements provide that the obligation is solely upon ABC. However, if the automobile dealer has done anything to indicate to the service contract holders that it was the one who is obligated to provide services, the inquirer was directed to bring it to the Department’s attention so that we can investigate the matter.

In addition, there is a statutory and regulatory structure in place which protects New York service contract holders in the event that the service contract provider is unable to, or otherwise fails, to pay on valid service contract claims. The Superintendent is authorized to take action that is necessary or appropriate to enforce the provisions of Article 79, Regulation 155 in order to protect service contract holders in New York State. N.Y. Ins. Law § 7910 (McKinney 2000) specifies how the provisions of Article 79 are to be enforced by the Superintendent. Under the statute the Superintendent is authorized to conduct investigations or examinations of providers, administrators, insurers or others in order to enforce the law and protect New York service contract holders. Service contract providers are required, upon request, to provide the Superintendent with access to accounts, books and records.

When a service contract provider has violated the Service Contract Law, the Superintendent may issue a cease and desist order against the provider, issue an order suspending the provider’s registration or prohibiting the provider from doing any element of a service contract business, or issue an order imposing a civil penalty.

The Superintendent has promulgated N.Y. Comp. Codes R. & Regs. tit. 11, §§ 390.0 – 390.13 (2001) (Regulation 155), which implements the New York Service Contract Law. Section 390.10(a) of Regulation 155 requires a service contract provider that demonstrates its financial responsibility by the method chosen by ABC to also file an audited financial statement with the Superintendent. Section 390.10(d) of Regulation 155 requires that such service contract providers, on or before June 30th of each year, or 180 days after the end of the provider’s fiscal year, whichever is later, file an audited financial statement for the prior calendar year with the Superintendent. The statement must include an opinion by an independent certified public accountant. The notes to the foregoing statement must show how the service contract provider meets the statutory reserve and trust requirements and how the assets in the account and trust meet these requirements. The audited financial statement is necessary for the Superintendent to evaluate whether the service provider has met the financial responsibility requirements. At this time, ABC has not been registered long enough in New York to be required to file an audited financial statement.

Pursuant to Regulation 155 if, at any time, the certified public accountant or the service contract provider determines that the provider has materially misstated its financial condition as reported to the Superintendent or that the funded reserve account does not meet the requirements of the law, the provider is required to submit this information to the Superintendent in writing within fifteen days of the determination. The Superintendent may thereupon seek to suspend or revoke the service contract provider’s registration. If the registration is suspended for more than sixty days, revoked or otherwise terminated, and service contracts have been issued and are outstanding in New York State, the provider is required under the Regulation to immediately transfer the funded reserve account to the Superintendent for safekeeping and for the use and protection of contract holders and the administration of service contract claims.

Section 390.12 of Regulation 155 requires that every service contract provider registration application under which the provider elects to provide proof of its financial responsibility by means of a funded reserve account and financial security deposit or by net worth qualification must include a "default contingency plan agreement" that provides, in pertinent part, as follows:

(a) for the appointment of a claims trustee that is acceptable to the superintendent and who is registered as a provider, in the event of a provider’s default in performance as specified in sections 390.10(e) and 390.11(c) of this Part;

(b) that the appointment shall be made within 15 days of the provider’s default;

(c) that the superintendent may make the appointment in the event the provider fails to make an appointment within the time specified in subdivision (b) of this section or if the appointed trustee fails to serve or resigns;

(d) for the trustee to administer all claims outstanding and which may arise after the provider’s default;

(e) for the trustee to receive from the superintendent the funded reserve account, any securities deposited with the superintendent as financial security, …;

(f) for the trustee to apply all funds received pursuant to subdivision (e) of this section exclusively to the payment of claims arising from service contracts issued by the provider;

(g) for the trustee to have the power to bring actions or proceedings against the provider to obtain the funds provided for by subdivision (e) of this section and any additional funds that may be necessary for the payment of claims and expenses arising from service contracts issued by the provider; and

(h) that all funds received by the trustee pursuant to the default contingency plan shall be treated as trust funds and shall not be used for any purpose except as specified in subdivision (f) of this section.

Section 390.10(e) of Regulation 155 provides that if the service contract provider’s registration is suspended for more than sixty days, revoked, or otherwise terminated, and there are outstanding New York service contracts, the provider is required to immediately transfer to the Superintendent the funded reserve account for safekeeping and for the use and protection of New York service contract holders. The foregoing monies, and any securities deposited with the Superintendent under the financial security deposit, would go to the claims trustee to be administered in accordance with the default contingency plan.

The foregoing provisions of the law and Regulation 155 provide a structure for enforcing the Service Contract Law for the benefit of New York service contract providers when the registration of the service contract provider has been suspended or revoked or if the service contract provider has failed to honor a valid service contract claim. The Superintendent, on behalf of New York service contract holders, can collect the funds held in the funded reserve account and the financial security deposit, and pay out valid service contract claims, to the extent the funds in the financial responsibility vehicles permit him to do so.

For further information, you may contact Associate Attorney Barbara A. Kluger at the New York City office.