The Regulations implement the European Union Unfair Contract Terms Directive (93/13/EEC).  They apply to standard form contracts entered into since 1 July 1995 by a business and a consumer across all commercial sectors.  The Regulations make unfair contract terms unenforceable against a consumer, with the exception that terms that describe the central subject matter of the contract, or that set the price, are not assessed for fairness, as long as they are written in plain and intelligible language.

Common Unfair Terms

The Guidance draws attention to what the FSA considers to be the five most common types of unfair contract terms in the marketplace. 

1.   The Right to Unilaterally Vary a Contract

The FSA stated that the most common problematic terms are those granting a business the ability to unilaterally vary a contract without a consumer’s express consent.  Businesses can reserve for themselves too much discretion in the context of these variation clauses, making them potentially unfair.

The Guidance sets out the FSA’s interpretation of the Regulations, indicating that contract terms allowing businesses to unilaterally vary the contract are less likely to be unfair if

• A valid reason for the change is specified in the contract.  Although only the courts can determine what constitutes a valid reason, the FSA notes that variations made as a result of changes in the law, industry guidance, market indices, or tax rates, or in response to legitimate changes in the cost of providing the product or service are likely to be acceptable
• The consumer is provided with reasonable notice in advance of the variation of the contract.  The Guidance states that what constitutes sufficient notice will differ according to the product and the type of variation involved.  Contracts should set out clearly how notice is given to consumers, with personal notification being the fairest method
• The consumer has the right to terminate the contract following receipt of notice of a variation.  The Guidance urges businesses to ensure that there are no financial or practical barriers to consumers terminating a contract if they object to a variation.  Where businesses unilaterally vary the rate of interest charged, the option to terminate the contract immediately is appropriate, whereas for other contracts, the ability to terminate the contract within a specified timeframe may be enough to reduce the likelihood of the provision being unfair.

2.   The Right to Unilaterally Terminate a Contract

A key consideration in assessing the fairness of a business’s ability to unilaterally terminate a contract is the effect on a consumer; termination provisions have the potential to be unfair if a consumer incurs costs, or is substantially inconvenienced as a result.

Termination provisions are more likely to be viewed as being unfair in fixed term contracts, such as annual insurance contracts.  The right to terminate should be reserved for use by a business only in circumstances where there are serious grounds for termination.  Even then, the FSA encourages businesses, where possible, not to terminate unless the consumer has failed to remedy the situation when requested to do so; unilateral termination should be a last resort.

The Regulations make provision for situations when a business needs to terminate a contract of indeterminate duration with or without giving reasonable notice.  The Guidance suggests that termination without notice, or with notice and immediate effect, is only acceptable where there are serious grounds, or for a valid reason.  What constitutes “serious grounds” or a “valid reason” will depend on the contract as a whole and the product in question.  The contract term is less likely to be unfair if it is clearly specified in the contract that the termination must be for a valid reason, as the consumer then knows the business can be challenged on the grounds of validity.

3.   Discretion to Exercise Contractual Powers

The Guidance points out that contract terms that allow businesses to be excessively flexible in relation to if, when, and how they are able to exercise their powers can be unfair.  For instance, the FSA objects to banks reserving the right to limit the amount a customer can withdraw from an account without notice.  In the FSA’s opinion, this kind of provision goes beyond protecting the banks’ business interests.  Furthermore, the Guidance states that any contractual provision drafted in ambiguous terms, so the meaning of the term is subject to the business’s interpretive discretion, also has the potential to be unfair.

While a business should be able to use discretion to protect itself from issues beyond its control, there is the capacity for such contractual freedom to be abused.  To avoid this, the scope of the business’s discretion should be defined in a clear and balanced way.  Any contract term reserving to the business the right to exercise power should be considered in line with the Regulations, and it should only be capable of being exercised when it would be proportionate to do so.

4.   The Right to Transfer Obligations

Any contractual term that allows a business to transfer its rights and/or obligations under a contract to a third party without the consumer’s agreement concerns the FSA because such a transfer could result in a reduction of the consumer’s guarantee.  Contract terms drafted so as to only permit a transfer if they result in the same, or a better, guarantee for the consumer are less likely to be found to be unfair.  If a transfer of rights and/or obligations under a contract would result in the reduction of a consumer’s guarantee, the consumer’s prior consent should be sought. 

5.   Terms That Are Not in Plain and Intelligible Language

The use of phrases, such as “time is of the essence” or “consequential loss”, without definition can leave consumers unable to understand and appreciate fully the terms they have agreed to.  Any ambiguity stemming from contract terms that are not in plain and intelligible language could be interpreted by the courts in favour of the consumer.  This concept extends to all the terms in a consumer contract, without exclusion.  If the contract term is so unclear as to cause a significant imbalance to the detriment of the consumer, the term may be contrary to the requirement for good faith under the Regulations, making it likely to be unfair and, therefore, unenforceable.

Proactive Steps

The FSA, the Office of Fair Trading, and the Financial Ombudsman Service have published a large amount of literature about the fairness of contract terms.  However, it is important to note that these authorities do not have the ability to decide whether or not a term is fair, as this can only be determined by the courts.  Businesses may be unable to enforce certain contractual provisions, and they may find themselves exposed to unexpected liabilities if contractual wording is not given due and careful consideration.

Following publication of the Guidance, all FSA-regulated businesses should be proactive in ensuring that their contract terms are reasonable, fair, and transparent.  In order to achieve this, businesses will need to have adequate systems and controls in place.  We can help you to conduct a review of existing contracts to ensure they comply with the Guidance.  In addition, we can assist your business with developing adequate processes and procedures to ensure the principles set out in the Guidance are enshrined in all your consumer contracts.

Please click here for a link to the Guidance.