Fair and reasonable: the new test for unfair contract terms?

On 7 August 2002 the Law Commission (“the Commission”) published a consultation paper on Unfair Terms in Contracts jointly with the Scottish Law Commission. The paper proposed replacing the Unfair Contract Terms Act 1977 (“UCTA”) and the Unfair Terms in Consumer Contracts Regulations 1999 (“UCCTR”) with a single piece of legislation in order to make the current law clearer and more accessible. The paper also considered whether there should be wider controls over unfair terms in contracts between businesses. The Commission is currently considering the responses it received to the paper and plans to produce a final report in Spring 2004.

The purpose of this article is to briefly examine current provisions relating to unfair terms in contracts between businesses and highlight the more significant of the Commission’s proposals contained within part 5 of the consultation paper.

The basic principle

The basic principle of all UK jurisdictions is freedom of contract: the parties to a contract should be free to agree to any terms they like provided these terms are not illegal or otherwise contrary to public policy. However, restrictions to this basic principle have been evident for many years, such restrictions justified by the fact the parties may not always be well informed or have insufficient bargaining power so as to look after their own interests.

Unfairness may arise, for example, because one party may “agree” to terms without being aware of what they contain or of their impact: or one party finds it has no choice but to agree as the suppliers offer similar terms and it has insufficient bargaining power to alter the terms.

Existing law

The existing law provides that certain terms have no effect in contracts between businesses. Clauses which exclude liability for death or personal injury, caused by negligence or breach of duty have no effect and the Commission believes this should continue under the new legislation. There are also currently two further situations where particular clauses in contracts between businesses may have no effect under UCTA. The Court of Appeal in R&B Customs Brokers Limited v United Dominions Trust Limited [1998] 1 WLR 321 held that a company may “deal as a consumer” if it enters a transaction incidental to its business activity and which is not of a kind made regularly. Consequently any clause excluding or restricting the other party’s liability for breach of Sections 13-15 of the Sale of Goods Act 1979 or for breach of equivalent legislation will have no effect. The Commission’s view is that where a person is making a contract to obtain goods or services “related to” even if not “in the course of” his business, he should be treated as a business and not a consumer.

Section 6(1) and 7(3A) of UCTA prevents any seller from excluding or restricting his implied undertaking as to title pursuant to section 12 of the Sale of Goods Act 1979 and section 2 of the Supply of Goods and Services Act 1982. The Commission propose that the substance of sections 6(1) and 7(3A) of UCTA should be incorporated within any new legislation.

Standard forms

Unfair terms are regularly to be found in standard form contracts between businesses. Although a party should read and understand the terms of the offer, this takes time and it may be too expensive to employ someone simply to read through contractual terms. Further, there are circumstances where a business customer may have little bargaining power with a supplier, for example, where the proposed purchase is for goods of a low volume or value. The Commission’s provisional view is that a “good case can be made for extending the power to challenge unfair terms” in at least some contracts between businesses, from the types of terms subject to the reasonable test of UCTA to the wider range of terms subject to UTCCR.

Types of business

The Commission considered whether an extension to challenge unfair terms in contracts between businesses should apply to all or only a limited type of business. The Commission explained that where a clause is held to be unreasonable, there has been more emphasis on the unequal bargaining power of the parties than on their relative size. The most significant determinant of bargaining power appears to be whether the transaction is of the kind made regularly by a business or whether it is unusual for that business. If a transaction is made regularly, then arguably it is less likely to be at a disadvantage to the other party. It is likely to have more relevant expertise: the cost of finding out the meaning of terms can be spread over a large number of transactions and if the purchaser can show to the supplier the prospect of regular repeat orders, the purchaser may have more bargaining power. However, if the transaction is not of the type made regularly, then the business is likely to be in a weaker position. This, the Commission believes, is true whatever the size of the business.

Notwithstanding the Commission’s views in relation to routine transactions, it does not believe that the fact that a particular transaction is routine for a business is alone sufficient to ensure fairness. The Commission’s view is that all businesses should be treated alike in being able to benefit from protection. The Courts should take into account the business size, whether it makes transactions of the type in question regularly, or occasionally, when assessing the fairness of the terms complained of.

When considering whether the new legislation should extend the scope of control over unfair terms in business contracts, the Commission considered whether controls should apply to all “unfair” terms, whether negotiated or not, or whether the existing controls should be replaced by a “fairness test” applicable only to standard or non-negotiated terms. The Commission’s view is that it is not necessary to extend the controls to terms, which have been negotiated between businesses. The justification provided for this view is that where a business has been given the opportunity to negotiate a particular term in its contract, it will be aware of the term and therefore will have had the chance to consider the possible consequences of entering into a contract on that basis. If it cannot prevent the term from being included in the contract, then it may be able to advance its position by ensuring that other terms are favourable, or by accepting the risk and insuring against it. The Commission therefore proposed that only where the term in question “has not been negotiated” or is “standard” should the test of fairness apply.

What therefore is the test of fairness?

The Commission’s proposal is that the basic test should be whether, judged by reference to the time the contract was made, the term was a fair and reasonable one. However, how is fairness to be assessed? One element considered to be important by the Commission is transparency (i.e. not only that the language is plain and intelligible but that the terms are readily accessible and the layout of the contract document is easy to follow).

UCTA currently provides “guidelines” for the application of the reasonableness test. The Commission considered that a list of factors relevant to the application of the “fair and reasonable” test would be helpful in relation to contracts between businesses, particularly to give guidance to businesses as to how they may ensure that their terms are reasonable. Such factors would include:

• the extent to which the term “on its own or in conjunction with other terms” differs from what would apply in the absence of express provision on the point, or from terms required by any relevant authority;
• the possibility and likelihood of insurance;
• other ways in which the business might protect its position (i.e. advice from an expert);
• the business’s knowledge and understanding; and
• the strength of the bargaining position of the parties.

An indicative list of unfair terms?

The Commission also considered whether the new legislation should include an indicative list of terms, which may be unfair, such that a business should have the burden of proving that any term, which is so listed, is fair and reasonable. The purpose of such a list is to give information to businesses as to what in an individual case is likely to be regarded as an unfair clause. The Commission’s view is that any indicative list for contracts between businesses should be limited to clauses excluding and restricting liability for breach of contract or for negligence, but that there should be power to add to this list by Ministerial Order. Further, where a term in a contract between businesses has not been listed, the burden of proving that the term is not fair and reasonable should be on the party disputing it.

Conclusion

Although the above outline the more significant of the Commission’s proposals, particularly the introduction of the “fairness test” it is debatable as to whether any of these proposals are ground-breaking. Undoubtedly a more coherent regime for the regulation of unfair contract terms is desirable and certainly clearer guidance on what may constitute an “unfair” term is to be welcomed. With the Commission taking approximately eighteen months to consider its responses to the proposals, with a further report not due until Spring 2004, the Commission has a significant opportunity to achieve its aims. Let’s hope it does so.

For further information please contact Alex Smith at [email protected] or on +44 (0)20 7367 3480