English law contains no general principle that contractual terms must be fair or reasonable: parties must live with the bargain they have made. This is one of the ways in which English law is "lender-friendly": it enables lenders to enforce their rights without being subject to wide-ranging defences based on subjective criteria such as "fairness", which can often only be assessed properly at trial. Adam Pierce explains how a recent case illustrates this general approach, and summarises when fairness and reasonableness can be relevant to loan agreements under English law.
The African Export-Import Bank v. Shebah Exploration case
In African Export-Import Bank v. Shebah Exploration & Production Company  EWHC 311, lenders under a syndicated facility agreement had accelerated the loan and demanded repayment. Part of the borrower's defence relied on persuading the court that a set-off exclusion clause in the facility agreement might not be effective. To run this argument, the borrower claimed that the facility agreement, based on a form recommended by the LMA, was (or at least might be) the lenders' "standard terms of business". If that were the case, section 3 of the Unfair Contract Terms Act 1977 (UCTA) would apply to the set-off exclusion clause, and so it would only be effective if it was reasonable. Not surprisingly, the court did not accept the "standard terms of business" argument. It was therefore irrelevant whether the set-off exclusion clause was reasonable, and the lenders obtained summary judgment.
But when can loan agreement terms be challenged as unreasonable or unfair? Set out below is a high-level checklist of the English law rules most likely to be relevant.
Rules on fairness and reasonableness affecting loan agreements generally
Section 2, UCTA
Any exclusion of liability for negligence must be reasonable. "Negligence" here includes any breach of an obligation to take reasonable care or exercise reasonable skill, whether arising from the terms of the contract or otherwise. This applies to all contracts, other than a contract subject to the Consumer Rights Act 2015 (on which see below). So it could, for example, apply to a clause in a syndicated facility agreement excluding an agent's liability under the agreement other than for its "gross negligence or wilful default".
Under English common law, any obligation on a party to a contract to make an extra or increased payment as a result of its breach of the contract will be an unenforceable "penalty" if that extra or increased payment:
- is "extravagant, exorbitant or unconscionable"; or
- imposes a detriment on the defaulting party out of all proportion to the other party's legitimate interests in the performance of the breached obligation.
In the context of a loan agreement this is most likely to be relevant to the borrower's obligation to pay default interest on overdue amounts. See Dentons - Cavendish Square – how the new penalties test affects banking transactions.
Sections 244 and 343 Insolvency Act 1986
If a company enters a UK administration or liquidation, or an individual enters a UK bankruptcy, the officer holder can apply to court to set aside or vary obligations under any "exorbitant credit transaction" the insolvent party entered into in the previous three years. A credit transaction will be extortionate if it required the insolvent party to make "grossly exorbitant payments" or "otherwise grossly contravened principles of fair dealing", taking into account the risks for the lender. This is a high threshold, and it is rare for courts to set aside or vary obligations under loan agreements on this basis.
Rules on fairness and reasonableness affecting standard form loan agreements
Section 3 UCTA
In business-to-business dealings, a party contracting on its written standard terms of business cannot rely on a term:
- excluding or limiting its liability for breach, or excluding any right or remedy in respect of that liability; or
- entitling it to render no performance, or a substantially different performance from that reasonably expected of it, unless the term is reasonable.
The first limb above could, for example, be relevant to a term excluding the borrower's set-off rights (as in the African Export-Import Bank case). The second limb could be relevant to a term entitling the lender not to fund in certain circumstances (other than because of a borrower default).
UCTA does not define "written standard terms of business". Case law suggests it covers terms that an organisation generally uses for all, or nearly all, its contracts of a particular type, with no (or very limited) negotiation or amendments.
Consumer-related rules on fairness and reasonableness
Section 62, Consumer Rights Act 2015 (CRA)
The CRA consolidates the main consumer protection rules around fairness of contractual terms, as previously set out in UCTA and the Unfair Terms in Consumer Contracts Regulations 1999. Under section 62, any unfair term in a contract is non-binding on a "consumer". An individual is only a "consumer" under the CRA if "acting for purposes which are wholly or mainly outside that individual's trade, business, craft or profession". However, the burden of proof is on the other party to show that is not the case.
Sections 140A to C of the Consumer Credit Act 1974
This "unfair relationship" regime applies to all loan agreements where the borrower is an "individual" (which includes some small partnerships involving individuals), other than regulated mortgage contracts. This is the case even if the loan agreement is not a regulated agreement, for example because of a high net worth or business purpose exemption. It gives a court discretion to make an order, including setting aside a term of the agreement, if it finds that the relationship between creditor and debtor is unfair to the debtor because of (among other things) "any of the terms of the agreement or of any related agreement".
Some UK lenders also voluntarily subscribe to the Lending Code. Among other things, this requires loan terms they provide to consumers, micro-enterprises and small charities in the UK to be "fair in substance".