Extrapolation in Warranty Audits – Fair or Unfair?

1.1    We recently advised a National Dealer Council on the lawfulness of extrapolating warranty audit ‘exceptions‘ discovered during a distributor warranty audit.

1.2    One of the main issues we focused on in our detailed advice on the topic was whether the principle of extrapolation in warranty audits would be considered an unfair contract term under the Motor Dealers and Repairers Act 2013 (NSW) (MDR Act).

1.3    The test for unfairness under the MDR Act is the same as the test in the Australian Consumer Laws.

1.4    Meaning of unfair

To establish unfairness you must demonstrate the following:

(a)    It would cause a significant imbalance in the party’s rights and obligations arising under the contract;

(b)    It is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term, and

(c)    It would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.

A Court must also consider the extent to which an Audit Policy is transparent to individual Dealers and in relation to the Dealer Agreement as a whole.

1.5    Significant Imbalance

(a)    A significant imbalance in relation to the extrapolation method arises as follows:

(i)    The process is imbalanced because notwithstanding that the Dealer may have obtained authorisation, a distributor may say the Dealer cannot rely on it.  The result is that the Dealer bears all of the risk.

(ii)    The ‘effect’ of the extrapolation process is unfair and imbalanced in application as:

(A)    The process makes an assumption that where a sample size has exceptions, the rest of the audit period is also affected without any evidence as to the un-sampled period. The imbalance is that this assumption is made against the Dealer on no possible justification other than, we assume, the convenience to distributors of not having to audit the entire period.

(B)    The results by application of the unfair/imbalanced assumption could be materially detrimental to the Dealers by consequence of a combination of these factors:

(1)    Distributors can often examine and audit payments dating back five years.

(2)    Distributors can often determine the sample size, e.g. greater of either 50 claims or 5%.

(C)    In practice, we understand that distributors have relied on minor technical non-compliances to found some of the exceptions.

(b)    In assessing whether an Audit Policy and particular terms of the Audit Policy are unfair, case law suggests a Court will consider the impact of removing or deleting the impugned term from the contract and comparing the effect of that with continuing with the term.

(c)    It is not plausible to suggest that deleting particular terms of an Audit Policy, such as extrapolation, can be regarded as having a significant impact on distributors.  Distributors ought to be put to proof and any repayment of warranty claims should be evidence based and not assumed via extrapolation.

(d)    There does not appear to be a reasonable justification for the disparity and imbalance of Audit Policies that contain extrapolation. The lack of a significant impact on distributors, the significant impact on individual Dealers of applying the Policy too harshly and the effect of extrapolation suggests that Audit Policies, or parts of it, could be regarded as creating a significant imbalance.

(e)    Furthermore, a Court will consider the inclusion of the term on the substance of the transaction/contract as a whole.  If an Audit Policy is to be considered fair and reasonable, then Dealers will need unconditional authorisation from distributors before carrying out warranty work for consumers. This will cause delay and significant inconvenience for consumers.

1.6    Reasonably Necessary

(a)    The onus is on distributors to prove that their Audit Policy and its particular features (such as how they conduct the audit, whether minor technical non-compliances are treated as ‘exceptions’ and the extrapolation method) are reasonably necessary to protect their legitimate interests. The right to carry out an audit and the exercise of that right protects distributors from the risk of fraud or oversight by Dealers. It is not at all clear what interests of distributors the ‘extrapolation method’ protects. The ‘extrapolation method’ appears to be a disproportionate response in relation to protecting against fraud or oversight.

(b)    Why can a distributor simply not carry out a fair and reasonable audit? The aim of the audit is to recover overpayments made either accidentally or fraudulently. The objective is not the recovery of legitimate warranty payments made in fulfilling legal obligations afforded to consumers.

(c)    We understand that Dealers currently consult with distributors where authorisation may be in doubt and prior to commencing the warranty work for the customer. Why is it reasonably necessary for distributors to ask Dealers to keep the same records for a further five years, to carry out audits in an overly strict and harsh manner and then to extrapolate, in circumstances where the warranty claim could have been declined at the outset?

1.7    Detriment

There is no doubt that Dealers are caused detriment through the unfair, harsh and oppressive application of an Audit Policy and/or through the application of the extrapolation method, which may result in them being forced to repay distributors for perfectly legitimate warranty work. The detriment is predominantly financial, as the repayments can amount to tens, if not hundreds, of thousands of dollars.

1.8    Examples

The legislation sets out examples of particular terms that may be regarded as being unfair, such as:

(a)    A term that permits, or has the effect of permitting, a distributor to avoid or limit performance of the contract.  It could be argued that an  Audit Policy has the effect of permitting a distributor to avoid its warranty obligations under the Dealer agreement and/or under its own express manufacturer’s warranty with the consumer;

(b)    A term that permits, or has the effect of permitting, a distributor to unilaterally determine whether the contract has been breached or to interpret its meaning.  Most Audit Policies are undertaken internally with not external oversight. Even the appeal process is internally managed by the distributor. Therefore, a distributor unilaterally determines whether the Audit Policy has been breached and then extrapolates the results.

In summary, we concluded that there are reasonable prospects that a Court would conclude that terms that permitted extrapolation of warranty audit exceptions would be regarded as unfair contract terms under the MDR Act.

There are many other terms and conditions of a Dealer Agreement or Policy or Standards documents that form part of the Dealer Agreement that may fall foul of the unfair contract terms legislation in the MDR Act and if each term is reviewed under the legislation then any advice may assist Dealers and/or National Dealer Councils in their discussions with distributors.


Vinesh George
Company Secretary and Legal Counsel, AADA | Principal,
VS George Lawyers

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