The FSA has recently issued a statement of good practice on the fairness of terms in consumer contracts with particular reference to variation clauses.
Although this statement does not constitute official guidance from FSA, it is important because it reflects statutory and regulatory obligations already in existence. It draws together duties of fairness imposed under the Unfair Terms in Consumer Contracts Regulations (the UTIC Regulations), Financial Services and Markets Act 2000 (FSMA), the FSA Principles for Business and Handbook Rules, the FSA Treating Customers Fairly initiative and the Banking Code.
There are a number of consequences that can flow from non-compliance with the requirements of these regulations and FSA initiatives, and these include:
- FSA investigations followed by a request for undertakings from firms to stop including the unfair term in new contracts and stop relying on it in contracts which have been concluded;
- Unfair terms of a contract may be found unenforceable against a consumer by the court which can have legal, reputational and operational consequences; and
- All other enforcement measures held by FSA may be used to discipline firms for a breach of a rule or principle.
There are a large number of contracts in existence at the moment that breach the requirement for fairness, a common problem being their variation clause.
The UTIC Regulations
The UTIC Regulations apply to all standard form contracts (i.e. ones not individually negotiated with the customer) that have been signed since 1 July 1995.
The overarching test of fairness is set out in Regulation 5. A term will be unfair if "contrary to the requirement of good faith, it causes a significant imbalance in the parties' rights and obligations arising under the contract, to the detriment of the consumer".
Schedule 2 to the Regulations sets out an indicative and non-exhaustive list of terms which may be regarded as unfair. An example in Schedule 2 of a term that may be unfair is one which enables the firm unilaterally to change the terms of the contract. Terms of this kind give firms significant power to alter their agreement with consumers by changing an element of the contract such as price, interest rate or insurance premium. Terms of this nature are included in many consumer contracts and as such are potentially unfair under the UTIC Regulations.
Schedule 2 suggests that terms which enable a firm unilaterally to change contract variables are less likely to be unfair if:
- the term enables the firm to change a contract variable only with a valid reason which is specified in the contract; or
- the term permits a change in the rate of interest or other charges for financial services under the contract and there is a valid reason (which is not specified in the contract) for that change and the contract provides for the firm to give the consumer notice at the earliest opportunity thereafter (rather than in advance) and the consumer is free to dissolve the contract immediately; or
- in a contract of indeterminate duration, the contract provides for the firm to give the consumer reasonable notice in advance of making the change and the consumer is free to dissolve the contract.
Valid Reason – Although what constitutes a valid reason is ultimately the decision of the court, some examples are provided by the FSA as to what they consider to be fair. Any clause that allows a firm to respond proportionately to changes in the general law or decisions of the Financial Ombudsman Service (FOS), to reflect new industry guidance or codes of practice will be likely to be considered fair. Similarly, any clause that responds proportionately to the Bank of England base rate (or other such market rate), or to other legitimate increases in the costs of providing the relevant product or service will also be likely to be considered fair. Any such clause must be clearly and unambiguously defined.
Notice - Schedule 2 of the Regulations refers to "reasonable notice" or to notice being given "at the earliest opportunity" after a change to the contract has been made. What adequately satisfies these conditions depends on the particular product or service in question. It is advisable to give notice wherever possible so as to reduce the likelihood of any terms being deemed unfair. FSA is also keen to ensure that where a term is fair, it is relied upon in a manner which is also fair (see below). Providing notice will help to satisfy this requirement.
Free to Dissolve the Contract - The FSA suggests that "free to dissolve the contract" means a consumer can withdraw from a contract without inhibition, such as the requirement to make a payment or to give prior notice or to lose a benefit. Dissolving the contract may not be in the interests of the consumer in every situation so the overriding objective remains the need for fairness.
The FSA paper provides some specific guidance on the application of these principles to interest rate changes and changes to long term insurance premiums and is available here. This will open a PDF in a new window.
FSA requirements in excess of the UTIC Regulations – fairness in all dealings
FSA Principle 6 requires a firm to 'pay due regard to the interests of its customers and treat them fairly' and Principle 7 requires a firm to 'pay due regard to the information needs of its customers and communicate information to them in a way which is clear, fair and not misleading'. This is the basis for the Treating Customers Fairly initiative, an initiative which has been driven forward throughout the market in recent times. Firms need to make careful judgements when writing their consumer contracts to achieve the right balance. Even a term that may be technically fair in its drafting may be challenged if it is used unfairly in practice; the crux of the issue is overall fairness for the customer.
The FSA takes the view that the UTIC Regulations are intended to operate in a free-market economy and do not constrain a firm from managing its business prudently. They would not intend to enforce the UTIC Regulations in a way which impedes the legitimate commercial judgements that firms make having regard to the overall well-being of their business and of all their consumers. However, the UTIC Regulations are designed to give effect to a Directive whose purpose is to protect consumers on the assumption that there tends to be an inequality of bargaining power between firms and their consumers. Prudence and fairness are not mutually exclusive factors. However, many firms will have to review their existing contracts in light of this new FSA guidance.