Service Contract Or Warranty: The Answer Depends On What Your Salespeople Say And How Your Paperwork Reads

Keith Whann

The Supreme Court of Arizona said it best, “a service contract cannot also be a written warranty.” While many compliance issues impact a motor vehicle sale, one area that continues to pose significant problems is understanding the difference between a written warranty and a service contract and how they impact a dealership’s ability to disclaim implied warranties. So what’s the difference? The answers can be found in the Magnuson-Moss Warranty Act.

Let’s start with how you know if you are offering a warranty or a service contract. The term "service contract" is defined in the Act as “a contract in writing to perform over a fixed period of time, or for a specified duration, services relating to the maintenance or repair or both of a consumer product.” A “written warranty” is defined “as any undertaking in writing in connection with the sale by a supplier of a consumer product to refund, repair, replace, or take other remedial action with respect to such product in the event that such product fails to meet the specifications set forth in the undertaking, which written affirmation, promise, or undertaking becomes part of the basis of the bargain between a supplier and a buyer for purposes other than resale of such product.” The key phrase here is “becomes part of the basis of the bargain.” This means that a “written warranty” is given to the customer by the dealership when the vehicle is sold and the customer is not required to do or pay anything other than the purchase price of the vehicle in order to benefit from the agreement. An agreement that would meet the definition of a written warranty, but for its failure to satisfy the basis-of-the-bargain test, is a service contract.

The Magnuson-Moss Warranty Act also contains an important caveat regarding a dealership’s ability to disclaim implied warranties. If a dealership provides a limited warranty to a purchaser or “enters into” a service contract with a purchaser at the time of sale or 90 days thereafter, the term of the limited warranty or service contract will govern the duration of the implied warranties. Seems pretty straightforward, but when and how a dealer may disclaim the implied warranties has been the subject of numerous lawsuits, especially when it comes to the issue of service contracts and whether the dealer “entered into” the contract with the purchaser. Some Courts have held that a dealer who sells a service contract is an agent for the service contract provider, but does not "enter into" the service agreement. Other Courts have found that the service contract must originate with or be the sole responsibility of the dealer. The key is likely in how the dealership presents the contract to the purchaser and what the purchase agreement and service contract documents say.

In the case of Lockhart v. Community Auto Plaza, Inc., the Iowa Court of Appeals found that it did not have to look any further than the language in the Dealership’s purchase agreement for an answer as to whether the Dealership breached implied warranties and violated the Magnuson-Moss Warranty Act. The Customer signed a "motor vehicle purchase agreement" which stated that the vehicle was purchased "AS IS" and which attempted to disclaim all warranties. The disclaimer read as follows: “WARRANTY DISCLAIMER. YOU UNDERSTAND THAT THE VEHICLE IS SOLD "AS IS" WITH ALL FAULTS AND THAT WE MAKE NO WARRANTY OF MERCHANTABILITY AND NO WARRANTY THAT THE VEHICLE IS FIT FOR A PARTICULAR PURPOSE, unless we provide you with a written warranty or service contract within 90 days from the date of this contract. If we do so, any implied warranty will last only as long as the limited written warranty....”. In addition to the vehicle, the Customer also purchased a "5 YEAR OR 100,000 MILE" service contract that was issued by another company.

The Dealership argued that it did not "provide" the service contract because it did not issue the service contract and was not obligated under it. The Court of Appeals disagreed. Citing the language in the Dealership’s own purchase agreement, it concluded that a service contract was "provided" by the Dealership, as that term is ordinarily understood, since it recommended the purchase of that particular service contract, was acting as agent for the service contract company, earned a profit of $341.00 on the sale of the contract, and the service contract was listed as a term of sale on the Dealership’s purchase agreement.

In the case of Johnson v. Earnhardt's Gilbert Dodge, the problem wasn’t the Dealership’s purchase agreement; it expressly limited the implied warranty of merchantability to fifteen days or five hundred miles, whichever occurred first, in accordance with Arizona Law. The problem was the language in the service contract application, the service contract itself and the alleged representations made to the Customer concerning the Dealership’s obligations under the contract.

The Customer signed an application and paid the contract price (in addition to the purchase price of the vehicle) for a service contract that was subsequently issued to her from DaimlerChrysler. When she experienced mechanical problems with the vehicle, however, she filed her action against the Dealership alleging breach of the implied warranty of merchantability and attempting to revoke acceptance of the vehicle under the Magnuson-Moss Warranty Act. Because it was clear that the Customer paid separate consideration for the service contract, the Supreme Court of Arizona found that the Court of Appeals erred in finding that the agreement was a written warranty under the Magnuson-Moss Warranty Act. It wasn’t as convinced by the argument that the Dealership had not “entered into” the service contract. After reviewing the language in the documents and alleged statements made by the Dealership, the Supreme Court of Arizona found that the Court of Appeals made a mistake in holding as a matter of law that the Dealership was a party to the service contract, just as the Superior Court made a mistake when it held that the Dealership was not a party to the contract.

The Court noted that the service contract contained conflicting language about who was a party to the service contract. Some language supported the conclusion that only the Customer and DaimlerChrysler were parties to the service contract. For example the terms “we, us, our” were defined as “DaimlerChrysler Corporation,” “you, your” meant “the Plan purchaser,” and the contract said that the “Plan is a service contract between you and us” and “we are solely responsible for fulfillment of the provisions of the plan.” Other language, however, supported the position that the Dealership was also a party to the service contract, such as the service contract application that contained an express promise from the Dealership that it would “provide service to [Johnson] in accordance with the provisions of the service contract DaimlerChrysler will issue to the purchaser.” The Customer also testified that when the Dealership’s employee told her that she was purchasing the Dealership’s extended warranty and that DaimlerChrysler was the administrator, she understood this to mean it was a joint extended warranty provided by DaimlerChrysler and the Dealership. Since the language could be read either as a promise by the Dealership solely to DaimlerChrysler to repair the vehicle, or as a conditional promise by the Dealership to the Customer to repair her vehicle, the Court found that there was a question of fact that had to be resolved.

It is important for dealership employees to know about the products they sell, as well as what the documents they use say. In the case of limited warranties and service contracts, dealers should make sure that the warranty disclaimers printed on their purchase agreements track the language from the Magnuson-Moss Warranty Act. More specifically, the disclaimers should state that the implied warranties do not apply unless the dealership provides a limited warranty to or “enters into” a service contract with the customer on its own behalf. Using words such as “provides” or “gives” or a service contract not only causes confusion, it often leads to a lawsuit. Remember, it is also important to make sure that your sales presentation and the service contract documents themselves do not imply that the dealership is a party to the service contract. You can obtain additional information about this and other dealership compliance issues by visiting www.keithwhann.com.

This information is provided by Keith Whann of the law firm Whann & Associates, LLC and is for general information purposes only. You should contact legal counsel for specific application. © Keith Whann January, 2006.