Unfair Relationships under
The Consumer Credit Act 2006
What will the new regime mean for lenders?
One of the most controversial elements of the latest Consumer Credit Act, is the new concept of an ‘unfair credit transaction’. This will come into force on 6 April 2007 and empower consumers to challenge a wide range of contract terms and lender practices as unfair. It is designed to replace the existing ‘extortionate credit’ test under the Consumer Credit Act 1974 (the Act), which has been criticised as too narrow.
Also from 6 April 2007, the Financial Ombudsman Service (FOS) jurisdiction is extended to encompass all consumer credit lending. There is a great deal of uncertainty as to how the new law will be implemented and in particular, whether we can expect to see more agreements being found to be unenforceable.
The need for change
Under the 1974 Act, a credit bargain is extortionate if it requires the borrower to make payments which are ‘grossly exorbitant ’ or otherwise ‘grossly contravenes ordinary principles of fair dealing’. The court may re-open an agreement found to be extortionate so as to do justice between the parties.
The extortionate credit test has been widely criticised. According to the DTI, since the inception of the Act ‘only about 30 extortionate credit cases are known to have reached the courts and, of those, only ten were proven’ (‘Fair Clear and Competitive the consumer credit market in the 21st century’ DTI White Paper December 2003).
The White Paper, which led to the changes under the 2006 Act, proposed to redress what it saw as the key failings of the test by;
-allowing consumers to challenge lender behaviour after an agreement is made
-shifting the focus from cost to take in other factors, such as the level of security required, default charges and lack of transparent information making it easier faster and cheaper to challenge an agreement with a new Alternative Dispute Resolution (via the Financial Ombudsman Service (FOS).
The new unfairness test
The Consumer Credit Act 2006 aims to ‘enhance consumer rights and redress by empowering consumers to challenge unfair lending and through more effective options for resolving disputes.’ The new, more flexible, framework under clause 19 provides that an agreement may be found to be ‘unfair’ because of;
-its terms, or the terms of any related agreement (i.e any previous agreement with the lender consolidated by the new agreement and any linked transaction, such as payment protection insurance
-the way on which the creditor has exercised or enforced his rights under the agreement or any related agreement
-anything else done, or not done, by or on behalf of the creditor (before or after the agreement, or any related agreement, is made)
Some commentators have contrasted the systems on the basis that the extortionate test was about cost and the new test takes in all aspects of the relationship. The reality is more complex. Although charges are central to the notion of an extortionate bargain they have never been a prerequisite to a successful claim. Under the old test an agreement could be struck down if it ‘grossly contravened the principles of fair dealing’ even if the borrower’s financial obligations were not ‘grossly exorbitant’. Relevant factors included the age, health, capacity and business experience of the debtor, whether they were under financial pressure, the creditor’s risk, relevant to the value of any security and any other relevant considerations.
The key difference is that when deciding if an agreement was extortionate, these factors were only taken into account at the time the agreement was made. The new test is much broader. The court can have regard to all matters it considers relevant any stage during the relationship, i.e. when the loan is sold, when it is entered into, when it is in force and after it has ended.
Remedies
If the court finds that the relationship between borrower and lender is unfair, it has a wide range of remedies including;
-requiring the creditor to repay any sum paid by the debtor
-ordering the creditor to act or cease to act in a particular way in connection with the agreement
-reducing the amount payable under the agreement
-directing the return of any security under the agreement
-altering any of the terms of the agreement.
Key Concerns
There are a number of areas of concern about the new provisions:
Wide scope
This is an extremely wide provision – any agreement providing credit of any amount is captured. Regulated mortgage contracts are excluded under section 19(5), however, this only covers FSA regulated mortgage contracts. Those entered into before 31 October 2004 will come under the new test.
The entire relationship is subject to the unfairness rules; i.e. all dealings before, during and after the contract is made. There is no limit as to time, either. Expired agreements may be subject to a claim. Section 19(4) expressly provides that ‘a determination may be made in relation to a relationship notwithstanding that the relationship may have ended’
Actions under the unfairness provision may be brought by consumers individually and by the OFT exercising its powers under Part 8 of the Enterprise Act 2002. This enables the OFT to take enforcement action against lenders where unfair relationships affect consumers generally. Examples given in the House of Lords include where a lender uses standard terms or operates in a common manner in respect of borrowers generally so as to make each relationship unfair. OFT guidance will provide further information on how these powers will be used.
Uncertainty
The lack of definition or guidance as to what will constitute an unfair relationship is undesirable for consumers and lenders. All the indications, from the White Paper to more recent DTI and government publications, as well as Parliamentary comment, suggest that the courts and the FOS are to be encouraged to take the widest possible view of the term ‘unfair relationship.’
The Government rejected attempts to amend the Bill to require regulations to be made indicating the circumstances in which the relationship between the creditor and debtor may be regarded unfair. They have argued that this would undermine the flexibility of the provisions. They contend that to give undue emphasis to some things by spelling them out would necessarily limit the range of issues that the court may consider and risk creating a ‘box-ticking’ mentality amongst lenders which would shift emphasis from the substance to the form of the lender/borrower relationship.
For lenders, it is a question of trying to piece together available information to try and anticipate how the courts will intrpret the provision. Fairness clearly goes beyond the transparency of the agreement. If not, compliance with the Consumer Credit (Agreements) Regulations 2004 would be sufficient to make any agreement fair.
The report of the Joint Committee on Human Rights (24 October 2005) offered some views on where lenders should look for guidance:
‘We consider there to be suitable guidance available to the meaning of ‘unfair’ in the case-law interpreting the same term in other, closely analagous statutory contexts, in particular the Unfair Terms in Consumer Contracts Regulations 1999. The House of Lords in a recent decision (The Director General of Fair Trading v First National Bank [2001] UKHL 52) gave extensive consideration to the meaning of ‘unfair’ in those Regulations in the specific context of a credit agreement regulated by the Consumer Credit Act 1974.’
Under the 1999 Regulations (regulation 4 and schedule 2) a term is unfair if it;
-causes a significant imbalance in the parties' rights and obligations
-to the detriment of the consumer and
-is contrary to good faith.
Examples include;
-forcing a consumer in breach to pay disproportionately high compensation
-irrevocably binding a consumer on terms with which he had no opportunity to become familiar before the conclusion of the contract
-allowing the seller/supplier to alter unilaterally, without valid reason, any -characteristics of the product or service provided.
The House of Lords expanded upon these principles in the First National case, suggesting that fairness required;
-no significant imbalance between the parties. This may arise where the supplier is granted a beneficial option or discretion or power, or a disadvantageous burden, risk or duty is imposed upon the consumer
-fair and open dealings
-full, clear and legible terms with no concealed pitfalls or traps
-appropriate prominence for terms which might disadvantage the consumer
-not taking advantage, deliberately or unconsciously, of the consumer's necessity, indigence, lack of experience, unfamiliarity with the subject matter, weak bargaining position or any other relevant factor.
These illustrations are a good starting point, but policy makers comments suggest that the interpretation of unfairness may go much further. Taken to its most extreme, the new regime may impose a requirement on lenders to undertake and verify fact finds about potential borrowers. Not only about their financial circumstances, but about their personal circumstances, their health, and medical history.
Lenders can anticipate a considerable period of uncertainty until some decisions on what constitutes unfairness start to filter through. A piecemeal and unsatisfactory solution. Of even greater concern is that fact that the standard will not be established by the courts alone – FOS, a rather different animal, and, most importantly, free to consumers, is likely to be their first port of call, and therefore to set precedents.
The Financial Services Ombudsman
One of the most significant changes for lenders is that all customers of consumer credit licence holder will have access, free of charge, to an Alternative Dispute Mechanism in the form of the Financial Services Ombudsman (FOS). FOS will have jurisdiction over any act or omission by a consumer credit licensee in the course of a licensed business.
To date, only customers of FSA-regulated lenders have been able to go to FOS, and there have been relatively few consumer credit cases. However, this may change when consumers are able to take claims of unfair relationships to FOS under the new regime. While only a court may make an order under the new section 140B (the powers of the court in relation to unfair relationships) FOS has significant powers of redress. Particularly as it is not bound by legal precedent, as confirmed in the recent case of IFG Financial Services Limited v Financial Ombudsman Services Ltd [2005]. Here, the High Court held that the relevant law was only one of a number of factors which FOS is required to consider in reaching a decision and that FOS may legitimately ‘depart from the result mandated by the law if he considered that another result provided the result that was fair and reasonable in the circumstances.’
Furthermore, FOS’s decision is final. There is no right of appeal for the regulated entity, only the option of judicial review to challenge the decision-making process, rather than the decision itself.
Although FOS is a more informal body than the courts, in practice it wields enormous power. Financial services providers who refuse to comply with decisions against them face court enforcement action and face disciplinary proceedings by their regulator.
Retrospectivity
The Act will apply to:
credit agreements entered into after the Act becomes law
credit agreements in existence when the Act becomes law which are ongoing at the end of the transitional period (one year after the commencement date). However, for agreements in this category, the Court will be limited to granting relief in relation to:
payments demanded or sums charged after the Act becomes law
conduct on the part of the lender that makes any repayment of the debt, interest, fees or charges unreasonably high after the Act becomes law; or
any other obligation on the borrower that is unfair under the new test and has to be complied with after the Act becomes law.
The Court may set aside credit agreements where there has been unfairness prior to the Act becoming law, but only if the unfairness manifests after the Act becomes law; and with effect from the date on which the Act becomes law. The financial exposure of lenders is limited by only permitting the Court to give relief in respect of unfairness or excessive costs that occurs after the Act becomes law.
Nevertheless, lenders who have advanced medium-long term loans should be reviewing all those which are likely to extend beyond the transitional period to double check they do not include terms which are likely to fall foul of the widened unfairness test.
The partial retrospectivity has triggered another debate, concerning its impact on the securitization market.
Many personal loans, mortgages and credit cards, entered into before lenders became aware of the new requirements, have been securitised under arrangements, which could not have contemplated that they would become subject to the new unfair relationship provisions.
In the House of Lords, it was argued that the UK securitisation market (which has has brought in some £235 million of new funds to UK lending markets) relies on the underlying loans having stable and consistent terms and conditions and a pre-determined risk profile. Case law which defines unfairness too broadly risks triggering a buy-back scramble under securitised deals. This could destabalise the credit market, increasing capital costs for lenders which would be passed on to borrowers as higher charges.
This has cut no ice with the Government. It has reponded that it would be unreasonable to exclude long term agreements – of up to 20 years plus – simply because they were concluded prior to the commencement date. On the securitisation issue it was opined that no funding arrangements should be based, even in part, on the inability of consumers effectively to seek redress for behaviour by lenders that cause them harm.
The burden of proof
This rests on the creditor. An amendment to place the burden of proof on the debtor if it is proven that the terms of the agreement were in plain, intelligible language was rejected on the grounds that the proposed new Section 140B(10) provides that the debtor must allege that an unfair relationship exists before the creditor must show that it is not.
The government felt that lenders are better placed to show that their conduct is not unfair and that consumers will find it difficult to access relevant information.
In practical terms, this obligation imposes a massive obligation on creditors to keep accurate records. What is more, records must be kept for a significant period, given the possibility of claims after the agreement has expired.
Unfairness and Irresponsible Lending
Throughout the legislative process there have been calls from consumer groups and politicians for irresponsible lending to be linked directly to unfairness, so lending irresponsibly would automatically render an agreement unfair. This was resisted, along with attempts to seek guidance generally, in the interests of retaining maximum flexibility.
However, on the third reading of the Bill before the House of Lords on 21 March 2006, an obligation to lend responsibly crept in under a slightly different guise. Rather than introducing a direct duty on lenders, an amendment was passed to ensure that the OFT can take into account include practices in the carrying on of a consumer credit business that appear to the OFT to involve irresponsible lending in determining fitness to hold a licence under the Act:
Lord Borrie spelt it out in debate thus; ‘Lending to those who are already overcommitted with debt is irresponsible. I trust that this new provision will incentivise lenders and potential lenders to take a good deal of care in checking out the borrower's means to repay and the extent to which repayment may be inhibited by the obligations that the borrower has to other lenders’.
Aside from issues of OFT accountability, in particular the concern that the OFT will define its own powers and then enforce them without consultation, this amendment is likely to impact on fairness. Overlap between the two concepts is anticipated. A finding that a lender has acted irresponsibly is likely to trigger allegations of unfairness and vice versa.
Summary
Lenders cannot afford to be complacent about the new regime. It is likely that more borrowers will be encouraged to try their hand at alleging unfairness, because it can be used as a sword as well as a shield; a borrower will not have to wait until they are facing enforcement proceedings to raise the issue. They don’t even have to be in arrears. Depending on the approach taken by FOS and the courts in the early days, lender could face a wave of speculative claims. As endowment providers have already discovered, in the absence of contemporaneous records to evidence exchanges with customers, it is more difficult to dispute the customer’s version of events. All dealings, including meetings, telephone calls and emails, need to be documented to enable the creditor to evidence what was said/done if a customer alleges unfairness.
In addition, it is possible that lenders will need to be able demonstrate that they took steps to ascertain that the borrower had the means to repay the loan, not only in terms of income but all outgoings, including other credit commitments, or risk having contracts overturned. Depending on how paternalistic the courts and FOS are prepared to be, we may be just a short time away from compulsory detailed factfinds and suitability certification for every loan.
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