This sounds like a horrible situation. First, call Subaru of America and explain everything you explained here. Although I've never contacted them, I've had to handle situations with dealerships similar to this and corporate was very helpful. Second, was this extended warranty actually from Subaru? Or was it a third party? How did you get the extended warranty? Finally, I am not sure how they will handle the engine if you refuse to pay. I have studied business law and what they can do is have a "mechanic's lien." It basically means they hold your car as collateral until you pay. Worst case scenario they can sell your car for the repairs and pay you the difference. This is extreme and obviously if you are found to be in the right that won't happen.