The Financial Services Authority (FSA) has recently showed it wants to complement its “Treating Customers Fairly” initiative by exercising its powers under consumer protection legislation. This note looks at two recent examples of FSA’s willingness to take enforcement action under the Unfair Terms in Consumer Contracts Regulations 1999 (the Regulations). The first part discusses FSA’s warning about terms in general insurance contracts that exclude liability for consequential loss. The second part considers an undertaking given by a mortgage lender to FSA not to rely on certain terms giving it a wide discretion, including the power to demand immediate repayment of loans.
But part one is relevant not only to insurance contracts and part two is relevant not only to mortgage contracts. FSA clearly expects all firms to consider the impact of its undertakings and comments on all of their contracts with consumers.
1 Exclusions of liability for “consequential loss”
FSA has recently warned that clauses in general insurance contracts that use the phrase “consequential loss” may fall foul of the Regulations. This warning has ramifications not only for the insurance industry, but for any company that uses the expression “consequential loss” in its standardform contracts with consumers.
Meaning of “consequential loss”
A person who breaches a contract is generally liable to the innocent party for any loss that falls within the two rules established in Hadley v. Baxendale. Under the first rule, the contract-breaker is liable for any loss that arises “naturally” or “according to the usual course of things” from the breach. This type of loss is often called “direct”. Under the second rule, the contract-breaker is liable for any additional loss that the parties would reasonably have expected to flow from the breach based on their particular knowledge.
Commercial contracts often contain clauses that seek to exclude liability for “consequential loss”. The courts have held on several occasions that this expression refers to loss falling outside the first rule in Hadley v. Baxendale. A contractual provision that excludes liability for “consequential loss” will normally therefore only exclude those losses that would otherwise be recoverable under the second rule.
FSA’s view of “consequential loss”
According to its recent statement, FSA considers the phrase “consequential loss” may offend the Regulations in two ways. First, it is not “plain, intelligible language” because it has a specific legal meaning. The average consumer would not therefore understand what types of loss are covered by a contract that excludes “consequential loss”. The Office of Fair Trading (OFT), which enforces the Regulations, has expressed similar concerns.
Second, a contractual term that excludes “consequential loss” may be unfair under the Regulations precisely because most consumers would not know what it means. According to FSA, this uncertainty constitutes a “significant imbalance in the parties’ rights and obligations to the detriment of the consumer”.
As FSA’s statement points out, there are significant risks to companies that rely on standard-form contracts that do not comply with the Regulations. In particular, were a court to agree with FSA and conclude that a “consequential loss” provision is not written in plain and intelligible language, it could construe the clause in favour of the consumer. If the court deemed the provision unfair, the clause would not bind the consumer at all. In either event, the company could find itself making payments to consumers for the very liabilities that it had sought to exclude.
FSA’s statement is explicitly concerned with general insurance contracts, but its observations plainly have wider resonance. Any company that relies on standard-form terms and conditions when it contracts with consumers would do well to review its exclusion clauses to ensure that they make the position clear.
FSA’s statement sets out a number of (insurance-related) illustrations of wording that excludes loss falling under the second rule in Hadley v. Baxendale without using the offending phrase “consequential loss”. These illustrations include the following:
- “We will not pay for any indirect losses that result from the incident that caused you to claim. For example, …”
- “We will not pay for any losses that are not directly associated with the incident that caused you to claim. For example, …”
It is open to doubt whether the average consumer will understand this wording, with its references to “direct” and “indirect” losses, any better than clauses that refer to “consequential loss”. Nevertheless, these examples have FSA’s blessing.
One thing, at least, is clear, however: the days of the “consequential loss” clause in consumer contracts are numbered.
2 Too much discretion for mortgage lender
More recently, FSA published an undertaking given by National Australia Group Europe Limited (NAG) that it would not seek to rely on mortgage terms that FSA considered unfair under the Regulations.
The terms in question were contained in the “Home Loan General Offer Conditions” (the Conditions) and the Rapid Repayment Mortgage contract (the Mortgage) of Yorkshire Bank, part of the NAG group. FSA felt that certain terms in these contracts breached the Regulations (specifically Regulation 5) by creating “a significant imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the consumer”.
Discretion to withhold facility and demand immediate repayment
The Conditions contained terms allowing Yorkshire Bank to exercise the following three powers in specified circumstances:
(a) withhold the facility;
(b) forbid any further withdrawals; and
(c) demand immediate repayment.
FSA felt that having these rights could, in some of the specified circumstances, create a significant imbalance to the detriment of the consumer. In particular, the terms would allow Yorkshire Bank to withhold the facility where a consumer had failed to pay any money due to Yorkshire Bank or one of its associated companies. So Yorkshire Bank could use the power if a consumer was up to date with his facility payments and yet owed a relatively small amount to an associate bank. According to FSA, it would not be proper for Yorkshire Bank to have the right to withhold the facility in these circumstances.
Similarly, FSA considered the right to demand immediate repayment in the event of relatively minor breaches of contract (such as exceeding the consumer’s overdraft) created an imbalance in the parties’ rights.
FSA had similar concerns about the right to demand immediate repayment in the Mortgage. Yorkshire Bank could demand immediate repayment if the consumer’s circumstances had “changed to the extent that in the opinion of the Bank discontinuation of the Facility is warranted”. FSA felt that this provision gave Yorkshire Bank far too much discretion to demand immediate repayment and was a further breach of Regulation 5.
FSA required NAG to undertake not to rely on the potentially unfair terms when dealing with existing customers. It also required it to produce amended terms that will give Yorkshire Bank discretion to exercise its powers in more limited, reasonable circumstances.
Balancing the parties’ rights and obligations
The new terms substantially reduce the scope for Yorkshire Bank to exercise the right to demand immediate repayment of loans. Yorkshire Bank can only demand immediate repayment in specified circumstances including a fraudulent or misleading application, the incorrect registration of a charge over the secured property, a compulsory purchase order in relation to the secured property or insolvency.
The new terms also give the consumer time to remedy any breach of a material obligation under the Conditions or the Mortgage “within a reasonable time”.
Similarly, the new terms allow Yorkshire Bank to reduce or remove an overdraft facility when there is a change in circumstances and it is “reasonable” to reduce the overdraft to reflect the change.
This undertaking indicates the view FSA may take of similar terms or terms with similar effects. Probably OFT (which also enforces the Regulations), and the courts (which ultimately decide whether a term is fair) will take a similar view.
FSA is clearly keen to flex its muscles in relation to terms in consumer contracts that it feels are unfair. Perhaps most significantly, FSA has spoken about the relationship between the Regulations and Principle 6 (Treating Customers Fairly). It seems likely that FSA will regard any unfair term in a consumer contract as a failure to treat customers fairly. A challenge by FSA could therefore have wider ramifications than merely preventing reliance on the terms in question. FSA has made it clear it expects all firms to consider all undertakings, not just those within their industry sector. Prudent retail firms should now review their consumer contracts carefully to consider whether they are open to challenge.