In May 2018, the FCA issued a consultation on a proposed new Guidance Paper to be issued in respect of the use of “variation” terms (terms that allow a variation of the contract terms by product or service providers) in consumer contracts used for financial services products.
The FCA chose to raise this particular issue for guidance because:-
- it deals with a significant number of issues raised by consumers concerning variation terms;
- complex issues arise in assessing unilateral variation terms for their fairness - there are potential benefits to both firms and consumers if they are used correctly (while the use of unilateral variation terms appears on the “grey list” of indicatively unfair terms in Schedule 2 to the Consumer Rights Act (“CRA”), the FCA acknowledges that such terms can be fair if drafted appropriately);
- it wishes to ensure that firms have regard to the rulings set out in cases concerning fairness in variation clauses which have been considered by the European Court of Justice.
An interesting statement made by the FCA is that, in line with their approach to accountability, they expect firms to allocate to an appropriate individual at the firm, the responsibility for ensuring that consumer contracts are fair and transparent. In this matter they are anticipating the extension of the senior managers’ regime to all firms during the course of next year and to insurers later in 2018.
The draft Guidance Paper incorporates in Annex 1, a restatement of guidance already issued by the FCA on some of the key issues that it expects firms generally to take note of when drafting consumer contracts. These include:-
- frequent reviews of contracts for fairness;
- carrying out regular reviews of product documentation including contract terms;
- learning lessons received from complaints, cancellations and any evidence of unfairness in contract terms.
In effect FCA considers that there should be a culture within a firm of meeting customers’ legitimate interests.
Focus on unfairness generally
The draft Guidance paper reviews the state of the law on unfair terms in consumer contracts. In particular it notes that a term is unfair if, contrary to the requirement of good faith, it causes significant imbalance in the parties’ rights and obligations under the contract to the detriment of the consumer. The FCA notes that the fairness test has two elements; good faith and significant imbalance. They state that “the fairness test is a holistic assessment and these elements may overlap with each other in their application to any particular set of facts. It is important to bear in mind that a term that meets the requirements of fairness in one particular consumer contract is not necessarily fair in another”. The FCA goes on to note that in determining whether a term of a contract is fair, you should:-
- take into account the nature of the subject matter;
- refer to all the circumstances at the time the term was agreed and all the terms of the contract. Circumstances include how the product was advertised, pre contract information and generally any material provided. It should be circumstances existing at the time it was entered into and not those arising later.
The FCA also focuses on transparency as a requirement under the CRA and for determining whether a contract is unfair. While lack of transparency may not make a contract unfair, it can be a factor in establishing fairness, particularly in the context of a variation. The FCA reviews recent EU case law which emphasises the need for a contract dealing with variation of charges to set out, in a transparent fashion, the reason for and method of variation so that the consumer can see, on the basis of clear, intelligible criteria, the alterations that may be made to those charges. The Guidance also refers to the need for the consumer to know and foresee the consequences of any variation of a contract, hence the need for transparent terms.
Against that background, the FCA considers variation terms in particular. It notes that unilateral variation terms are common in contracts with a longer duration such as current accounts, personal pension, mortgage or credit card agreements. It also accepts that this can be beneficial as they allow contracts to be capable of variation and thus more available to consumers. However, the FCA, while accepting the benefits on the one hand, emphasises the need to maintain good drafting as an unfair variation is not binding and may cause consumer harm. The onus is clearly on firms to get the balance right.
The FCA revisits Part 1 of the Schedule 2 to the CRA, being the “grey list” of terms which is indicative of terms which might be considered unfair and those that relate to variation. It also refers to the qualifications in Schedule 2, which offer some protections to financial services firms by removing certain terms from the list of those indicatively unfair, particularly in the context of clauses giving the firm the right to alter the rate of interest payable, or the amount of charges without notice, where there is a valid reason and the firm (i) gives the consumer appropriate notice of the change at the earliest opportunity and (ii) the consumer is entitled to cancel the contract immediately.
On the same basis a term under which the firm reserves the right to alter unilaterally the conditions of a contract of indeterminate duration is not indicatively unfair if (i) the firm is required to inform the consumer with reasonable notice; and (ii) the consumer is free to dissolve the contract.
If a term contained in Part 1 of Schedule 2 (and thereby indicatively unfair) is subject to the qualifications in Schedule 2, the terms are not to be categorised as fair as such, only that they are assessed for fairness on the same basis as the other contract terms.
Having set the scene, the FCA then attempts to detail the factors that it will consider when assessing the fairness of variation terms. These include, in no particular order of importance, whether:-
- the variation term has been included to achieve a legitimate objective;
As the FCA notes, is the variation necessary or appropriate to the contract?
- the reasons given to justify the variation are no wider than those necessary to achieve a legitimate object;
- the extent of the change to the contract is wider than is reasonable necessary to achieve a legitimate purpose;
- the reasons for the change are objective;
- it will be possible to verify whether or not the reasons have arisen.
Each of the four preceding factors relates to the scope and effect of the variation term. Is the variation term no wider than reasonably necessary to achieve a legitimate objective? A variation term should not grant a firm an unreasonably wide discretion to make changes to the contract. The FCA states that in drafting a variation clause, the firm should carefully consider what, if any, changes may be reasonably necessary during the contract duration. They should also consider the reasons which might prompt such changes, having regard to legitimate interests of the firm and the consumer. Reasons are more likely to be valid if they are outside the firm’s control. The firm should not be able to pass on risks and costs that the consumer would reasonably expect the firm to bear.
The FCA sets out some examples of circumstances that may be covered by this rationale. For example, changes to costs brought about by updated technology may be justifiable, particularly in products such as credit cards and pensions. The FCA note that in considering the validity of passing on such charges, however, only those which are relevant or fairly allocated to the product should be passed on. Changes to the contract brought about by regulatory requirements, legislative changes or court decisions are likely to be a valid reason as it is in the consumer’s interest that a firm complies with legal requirements. Again the FCA cites changes to pension and mortgage terms as changes which may be justified for these reasons.
A variation to charges may also be justified if the cost of funding changes. The FCA notes that this is a factor which is likely to be outside the control of the firm and could include bank rate, interbank lending rates, cost of capital, costs of attracting retail deposits etc. Costs of funding might be justified for standard variable rate mortgages, and credit cards. However the FCA considers that changing the cost structure simply to remain competitive is not likely to be permissible as this is not a cost directly related to the cost of the product. It would not be transparent as consumers are unlikely to understand how at the time of entering into the contract, this may affect the cost of the product.
Contracts which rely on a term stating that they may be varied for any other reasons will not be viewed favourably, at least for contracts of definite duration. Such a term is too favourable to a firm and would not strike a fair balance between it and its consumer.
- the variation allows for variations in favour of the consumer where reasons may, in some circumstances, favour the consumer but in other circumstances favour the firm or can only operate in favour of the consumer.
Clauses may be looked at more favourably where the variations may favour the consumer as well as the firm or indeed when the variation may only operate for the consumer’s benefit.
- the reasons for variation are clearly expressed
- at the time of the contract concluding, the consumer will understand the consequences that a change to the terms might have for him or her in the future. For a variation term that entitles the firm to vary the price (i) does the contract set out the method for varying the price; and (ii) will the consumer understand the economic consequences of the variation term?
Both the foregoing factors relate to transparency which the FCA notes is of fundamental importance to the European Court of Justice. The consumer must have explained in a clear manner the reason for, and method of variation of price, so that there are clear intelligible criteria for the consumer to assess the implications. The FCA suggests that firms consider providing information that could help the consumer understand the effect of the variation term, although this may be relatively onerous and will be subject to issues of practicality. This could include information on how the term could be used and the effect on the consumer.
- any notice of variation is required and the form of the notice
The FCA emphasises that notice of any variation is important as it allows consumers time to react to the change. The FCA suggests that as part of the notice requirement and subject to practicalities, any notice of variation should be obliged to provide an explanation of the change and its consequences.
- the contract gives the consumer the right to terminate the contract before or shortly after any variation takes effect
When drafting variation terms, firms should note the consumer’s right to exit and how this can be exercised. This should include any financial or practical barriers that would prevent them doing so.
- the term strikes a fair balance between the legitimate interests of the firm and the legitimate interests of the consumer
In effect, you must consider the contract from the viewpoint of both sides. The FCA notes that provisions favouring a firm may indirectly serve the interests of the consumer as well when both their rights and obligations are considered under the contract and the benefit of the contract to the consumer is considered.
The Guidance is helpful in providing some form of template against which firms can assess their variation clauses. However, looking at all of these factors, our sympathies are with the individuals who must draft consumer terms and conditions. Clearly they have a difficult path to navigate ahead. As the Guidance notes, firms should be proactive in reviewing their terms regularly, in light of issues such as revised Guidance and any complaints received. The impact of contractual terms in action must be monitored.