One of the key changes introduced by the Consumer Credit Act 2006 (CCA) relates to the introduction of a new ‘unfair relationship’ test to replace the ‘extortionate credit bargain’ provisions of the original 1974 Act. Ultimately, this will be used by the courts to regulate all parts of the creditor/debtor relationship by giving the courts power to determine that certain practices are unfair even if no substantive part of the CCA has been infringed. By way of example, borrowers can challenge credit agreements on the grounds of unfairness. The new test is due to come into effect for new business on 6 April 2007, and on 6 April 2008 for business already written before that date.
As the CCA’s regulator, the Office of Fair Trading (OFT) holds powers under the Enterprise Act to deal with unfair relationships where business practice results in collective harm to the interests of consumers. As such, it has published draft guidance on how it intends to utilise its powers where it is alerted to a potential breach of the unfair relationship test. It cannot take up complaints on behalf of individual consumers but rather acts in the wider public interest. However, it is not necessary to demonstrate actual loss to consumers for enforcement action to be taken.
The key points can be summarised thus:
Draft guidance was issued in June 2006. The aim is to publish final guidance by 31 December 2006. Consultation closes on 29 September 2006.
Guidance is not designed to define what constitutes an unfair relationship but to indicate how the OFT expects to operate enforcement powers in this area.
The OFT believes there are two general triggers that might prompt action under this test: contract terms and business practices. Each is explained below.
Contract terms
In considering whether contract terms are unfair or otherwise, the OFT will have particular regard to the Unfair Terms in Consumer Contracts Regulations 1999 (UTCCR) and the Unfair Contract Terms Act 1977 (UCTA). However, a term may be unfair under UTCCR but not give rise to an unfair relationship. Equally, a term may not be unfair under UTCCR but may still trigger consideration of whether the relationship is unfair.
Under UTCCR for example, ‘core terms’ cannot be reviewed for fairness (these relate to price/remuneration or those which define the main subject matter of the contract). But under the new test these terms may now give rise to, or contribute to, a finding of an unfair relationship.
In practice the OFT believes it will be unlikely that a court will make such a determination solely based on high interest rates or charges. Some aspect of their application or lack of transparency will probably have to run hand in hand for the terms to be unfair, for example, a lack of awareness of the charging of a fee in a particular case, or the level of the fee. However, the OFT also states that it cannot rule out that some interest rates may be so high they are oppressive or exploitative, and would therefore make the relationship unfair.
Business practices
Any action taken by a lender before or after the making of an agreement, including the enforcement of its rights under the agreement, is in theory subject to the unfair relationship test. This applies regardless as to whether the practice contravenes the existing law or not.
Examples given here of breaches of current law that would be considered as falling under the unfair relationship test include breaches relating to advertising, pre-contract disclosure or the form and content of credit agreements. Post-contract transparency and provisions relating to early settlement and termination, might also fall into this category.
Practices not necessarily amounting to breach of law but which would be considered under the unfair relationship test include those relating to marketing, operation or enforcement of credit agreements. Irresponsible lending is also referred to specifically as an example of an unfair or improper business practice. Further guidance will be issued on what this might mean in different market sectors.
The OFT goes on to remind lenders that its non-status lending guidelines remain in force, and that they contain high level principles calling for transparency in all dealings with borrowers, no high pressure selling and responsible lending, i.e. the proper assessment of a customer’s ability to repay.
The OFT also makes it clear that any breach of the Financial Services Authority’s (FSA) rules or principles in relation to linked insurance products would be taken into account in determining whether the relationship was unfair. Non-compliance with industry codes of practice and the findings of the Financial Ombudsman Service (FOS) might also be relevant. The provisions of the Unfair Contract Practices Directive, due to come into force in December 2007, will also be reviewed as illustrative of a practice which would be deemed unfair.
General principles
It is next worth considering the OFT’s likely approach to enforcement, the general principles of which include:
Only taking action where necessary and proportionate.
Businesses should have a reasonable opportunity to put things right (generally through a minimum 14 day consultation period before enforcement).
Wherever possible, court action only to be taken after undertakings have been sought.
The use of www.crw.gov.uk to publicise completed cases and post court judgements on the finding of an unfair relationship.
The use of reporting requirements on licensees as part of the consumer credit licensing regime to notify the OFT of relevant court judgements.
Greater use of the licensing regime to impose requirements on licensees to avoid unfair practices which give rise to unfair relationships (this will be pertinent to the continued assessment of a trader’s fitness to hold a licence).
Conclusions
These new powers enable the OFT to move against almost any market practice which it believes is not fair to consumers whether it is pre-contract, during the term of the agreement or within any enforcement action. Lenders will be particularly exposed where they outsource any part of the process, because while a contractual indemnity can be agreed with a broker or agent, it is of little use if their licence is withdrawn. In addition, the reputational issues associated with enforcement will be problematic where it is the third party that is at fault.
The OFT explicitly makes the link with responsible lending, and it is hard not to see this as anything other than a less prescriptive version of the MCOB responsible lending provisions. Equally, the FSA’s ‘Treating Customers Fairly’ (TCF) principles are referenced. This suggests that the high level objective is to introduce TCF to the world of second charge lending.
As has been seen with the FSA’s increasing use of UCTA and UTCCR to regulate the level of fees and charges and how they are applied, a similar pattern is emerging with the OFT talking explicitly about challenging interest rates and fees under this new test.
The link to fitness to hold a licence is also strongly made. As such, firms facing enforcement under the unfair relationship test might have conditions imposed on their licence, or encounter problems when those licences come up for renewal. In extreme cases it is implicit that a licence could be withdrawn.
Some may see this as a step towards principles-based regulation of the secured loans sector. If so, it is difficult to quantify its impact other than over time and by reference to court decisions or published enforcement actions from the OFT. It also raises questions about contractual certainty, and could add to the concerns of personal indemnity insurance providers about principles-based regulation.
Finally, given the reversed burden of proof imposed on lenders by the new test, it is more likely that more borrowers will resort to litigation to challenge lenders at the point of redemption or repossession action.
The unfair relationship test is bound to be felt by lenders and brokers in a number of ways. The full extent remains unclear at this time. But those operating in the secured loans sector now, or planning to do so shortly, should take the time to understand both the detail and the implications of the test.
