In a landmark ruling, judges from the Court of Appeal determined that it was unlawful for lenders to pay commissions to car dealers without informing borrowers, marking a significant victory for consumers in a mis-selling case that could potentially lead to billions in compensation for borrowers.

On Friday, the court ruled in favor of three borrowers whose cases were consolidated earlier this year. The judges emphasized the importance of transparency, stating that consumers must be aware of all material facts that might influence their borrowing decisions, including the total commission paid to car dealers and how it is calculated, in order to provide informed consent for their loans.

The ruling has had immediate financial repercussions, causing Close Brothers’ shares to drop 15% on Friday afternoon. The lender announced it would temporarily halt issuing new car loans pending a review of the decision. FirstRand, on the other hand, expressed its concern over the judgment and disagreed with the findings, stating their intention to appeal to the UK Supreme Court.

Legal experts suggest that this decision could lead to extensive implications for car lenders throughout the UK, with estimates indicating that consumers might collectively receive billions in compensation. In some cases, borrowers may even see their car loans written off entirely. This ruling may also influence the Financial Conduct Authority’s ongoing investigation into commission arrangements from 2007 to 2021, the year such practices were banned due to their adverse impact on consumers.

The FCA is expected to determine whether further action is warranted, which could include a compensation scheme funded by the lenders involved, with a deadline set for May 2025. They have also issued warnings to car lenders to set aside funds for potential payouts. Consumer advocate Martin Lewis noted that the FCA’s investigation could result in the largest compensation bill since the payment protection insurance scandal, with some analysts estimating the car finance sector could face losses between £8 billion and £13 billion.

The Finance and Leasing Association (FLA), which represents a broad spectrum of car lenders, has urged the City regulator to review the court’s ruling immediately. FLA Director General Stephen Haddrill remarked on the far-reaching implications of the judgment, emphasizing its necessity for the attention of the Financial Conduct Authority.

Among the high street banks, Lloyds Banking Group appears to be the most vulnerable, having already set aside £450 million for potential fines. Close Brothers also took proactive measures earlier this year, canceling its dividend and planning to raise £400 million to bolster its balance sheet. Following the ruling, Lloyds shares decreased by 5.5%, with analysts speculating that the bank might need to reserve up to £1.5 billion to address potential compensation concerns.

“It’s challenging to pinpoint an exact financial impact, and Lloyds isn’t the only player at risk,” commented Matt Britzman, a senior equity analyst at Hargreaves Lansdown. “However, Lloyds has more exposure compared to its peers, and while the overall investment case for Lloyds appears stable, this development poses a significant risk.”

The FCA acknowledged the Court of Appeal’s judgment and stated that it is currently assessing the implications of the ruling. The ongoing cases are tied to historical practices where lenders permitted car dealerships and brokers to set interest rates on loans, which inadvertently incentivized higher commissions linked to those rates. This practice, known as discretionary commission arrangements (DCAs), was banned by the FCA in 2021 due to concerns over its effect on consumer interest rates. However, the FLA contends that DCAs also allowed dealerships to offer lower interest rates to customers at critical moments, highlighting the complexity and broader implications of this ruling for the lending industry.