Will banks be affected by a new unfair terms regime?

The Law Commission's current proposals to consolidate and extend the scope of the existing legislation on unfair terms will impact heavily on the banking community if ever implemented into the law. The "Unfair Terms in Contracts" consultation paper (Number 166) proposes to extend the protection available to businesses so that certain "unfair" terms in a standard form "business-to-business" contract, for instance, those that make it hard for a business to cancel a long-term contract, or that commit to paying price increases, could be challenged in future. These are currently outside the ambit of the Unfair Contract Terms Act 1977 ("UCTA") which applies only to exclusion and limitation of liability clauses in business-to-business contracts and are also outside the scope of the Unfair Terms in Consumer Contracts Regulations 1999 as there is no consumer contract.

The conclusions of post-publication consultation revealed that opinion on whether this should occur was divided. Subsequently, the Commissioners decided that any general expansion should be confined in the future to two specific areas: first, to make some specific additions to section 3 of UCTA and, secondly, only to extend the protection to small businesses. A 'small business' is taken to mean one with less than 50 employees, with the Commission adopting a broad interpretation of the definition of "employee" to include some independent contractors.

The rationale behind offering small businesses an increased amount of protection is that they lack the expertise, resources and bargaining power available to larger businesses. For example, whereas a plc is likely to have an in-house legal team to carefully scrutinise and negotiate all contractual arrangements before they are entered into, a small business, often relying exclusively on the experience of its sole director, is less likely to appreciate or challenge the terms of a standard form facility offered to it by a bank. The perceived need for a paternalistic culture is further highlighted by the Omnibus Survey performed by the Small Business Service in 2001 which stated that only 3% of Small and Medium Enterprises with less that 249 employees sought legal advice in the previous 12 months.

Three alternative approaches to extend the protection to small businesses were presented by the Commissioners. One was to treat small businesses as consumers and permit a challenge of both negotiated and non-negotiated terms. Another was to distinguish between contracts on the basis of whether they are of a kind that the business in question regularly enters into. However, both of these alternatives were dismissed in favour of a third, which was in fact the narrowest of the three, and which proposed confinement of the protection to non-negotiated contractual terms.

The non-negotiated term option, if implemented in its current form, would allow a small business to challenge any term of the contract that was not individually negotiated between the parties. However, a challenge of what the Commission calls the "core terms" i.e. the definition of the main subject matter or the adequacy of the remuneration would not be permitted under the proposed regime. The rationale here is that a small business is more likely to appreciate the meaning and effect of a term that has been individually negotiated. Further clarification on the extent of negotiation required is unfortunately not provided.

The types of term in a bank's standard form document likely to be caught include default rates of interest, automatic extension of contract terms, entire agreement and termination agreements. Further terms in particular to other specific documents might be open to attack; for example, it is possible to see guarantors raising new arguments as to why their guarantees were no longer enforceable. In order then to ensure that the clause in question is enforceable, a bank would need to satisfy the requirement of reasonableness (currently provided for in section 11 of UCTA). In determining this, a court would consider a number of factors including the relative bargaining positions, any inducements offered to the customer, and whether the customer knew, or ought to have known, of the existence and effect of the clause, amongst others.

Critics from a bank's perspective would argue that giving customers an opportunity to challenge terms that have not been individually negotiated might provide scope for opportunism. A small business that readily accepts a term at the time of contracting may choose to challenge it as unfair if the banking relationship was later to turn sour. In fact, the proposed regime does nothing to consider the situation where a small business knowingly accepts the inclusion and effect of a contractual term but still later decides to challenge it as unfair. The Law Commission seems content with the view that any ill-founded suits should be weeded out by a sympathetic court. Doubts have been raised as to whether this is enough assurance for a bank which may be left without recourse to its standard contractual terms, the basis of which it has assessed the risk to lend.

The consultation period is presently continuing.