Trading under non-compliant consumer contracts: Implications for business

Corporate Update

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The "Unfair Contract Terms Research" report dated 19 October 2016 produced by IFF Research is based on a study conducted on behalf of the Competition and Market Authority (CMA). It details various data indicating businesses' understanding of contracts entered into with consumers (consumer contracts) and how they handle them in their dealings with consumers. According to the report, it is based on interviews with senior people in companies with day-to-day responsibility for handling relationships with customers and clients at 1,250 businesses in the UK.

The data published in the report include the following:

  • The majority (88%) of businesses selling to consumers are engaged in at least one practice that has the potential for unfair terms to be used. However, out of all businesses interviewed in this study:
    • 54% did not know the rules around unfair contract terms
    • 60% were not familiar with Consumer Rights Act 2015 (CRA) which came into force on 1 October 2015
    • 40% of those responded that they knew rules around unfair contract terms were however not familiar with the CRA even though the CRA changed (among other things) the rules on unfair contract terms
  • On average, businesses reviewed their terms and conditions every 4.5 years
    • 41% have reviewed their terms in the past year
    • 65% in the last five years
    • 16% have never, and will never, conduct a review of their terms and conditions

The data suggests that, despite the first anniversary of the implementation of the CRA, one of the biggest consumer law reforms in the UK in many years, a large number of businesses may be operating under consumer contracts which are not legally compliant. Why are there so many businesses that have not reviewed their consumer contracts to make them legally compliant?

Lack of information on legal developments could be the reason. The CMA has understandably launched a new campaign in light of the report to promote understanding of unfair terms rules. However, regulations on unfair terms are not necessarily straightforward due to the way in which they are regulated in the CRA, with guidance and case law adding further considerations to be made in respect of each relevant term. In addition, the CRA contains other new rules which restrict the terms of consumer contracts.

There are also situations where companies are prompted to review their consumer contracts yet somehow decide not to do so. Have the risks and implications of the changes under the CRA been communicated to, and understood by, the management? Could one of the reasons for doing businesses using non-compliant consumer contracts be because the key stakeholders of businesses do not know what non-compliance to the CRA could actually mean to their businesses in practice, in particular, the possible financial implications for failing to get it right?

Instead of trying to explain the detailed requirements, which are anything but a check list exercise particularly around the assessment as to whether a term is 'unfair' and how the term needs to be presented, this article focuses on what a breach of the rules under the CRA (including the unfair contract terms rules) could mean to businesses to the extent they can affect the terms of consumer contracts.

Unfair terms

The CRA regulates unfair terms by setting out (i) the terms which are always unfair, (ii) 20 different types of terms which "may be regarded as unfair" (but, in practice, viewed by the CMA as unfair), (iii) general rules under which the terms which are neither classified as (i) nor (ii) but still unfair and (iv) the requirements that the terms which specify the main subject matter of the contract or appropriateness of the price payable under the contract by comparison with the goods or services supplied ("core terms") need to be both 'transparent' and 'prominent' in order to be exempt from the assessment as to whether they are unfair.

How a term is presented as well as the content of the term matters. The intention behind the drafting of a term is not relevant and there is no requirement to prove that a term has caused any actual harm. As the CMA says in one of its guidance documents, a term may be open to challenge "if it could be used to cause consumer detriment even if it is not at present being used so as to produce that outcome in practice".

So, what are the key consequences of using a consumer contract containing unfair terms? What are the financial risks for businesses trading under such contract?

  1. Term not binding. An unfair term in a consumer contract is not binding on a consumer although it does not prevent such consumer from relying on the term if the consumer chooses to do so.
  2. Therefore, even though the consumer contract says that the trader has certain rights against consumers, such rights cannot be enforced if the relevant terms are unfair. The trader might have less protection or rights than the trader might have expected when entering into the consumer contract.
  3. Core terms reviewed (and may be considered unfair) for not being transparent and prominent. If a term specifies the main subject matter of the contract or appropriateness of the price payable under the contract, but it is not both 'transparent' and 'prominent' in the way required under the CRA, the term is still assessed for fairness and may be considered to be unfair. In other words, depending on how the term is presented in the consumer contract, a core term which would otherwise be exempt from unfairness assessment could be an unfair term or at least assessed for fairness. If the terms are unfair, the core terms (price and/or subject matter of the contract) are not binding on the consumers, in which case this can directly affect the cash flow of the transactions entered into with the consumers.
  4. Other terms need to be severable to survive. A contract which contains unfair terms continues, so far as practicable, to have effect in other aspects. If an unfair term cannot be severed from other parts of the consumer contract, the parts which cannot be severed will also not be binding on consumers and not enforceable i.e. there is a risk of other parts of the contract not being enforceable.
  5. Inaccurate reflection of legal relationship. It a consumer contract has not been reviewed to make it compliant with the unfair terms rules under the CRA, it may contain a mixture of unfair terms and terms which are not unfair. The text of the consumer contract does not necessarily reflect the legal relationship between the trader and the consumer i.e. it is not obvious on the face of the contract which part of the contract is / is not enforceable.
  6. This does not help the business in dealing with consumers if the terms of the contract do not reflect the real legal relationship between the trader and the consumer. The assessment of fairness is not necessarily straightforward and whether a term can be severed from the rest of the agreement adds another layer of complexity in identifying which part of the agreement can be relied upon. If the staff insists the terms which are in favour of the trader, this could result in a dispute with the consumer.
  7. Court must consider fairness. The court has the obligation to consider the unfairness of the term even if neither party has raised this or indicated that it intends to raise it during the court proceedings. Therefore, if a dispute with a consumer goes to the court, the terms of the consumer contracts will always be looked at by the court where relevant. If a term is held to be unfair, in practice, enforceability of the same term in other consumer contracts entered with other consumers on the trader's standard terms will be questionable.

For example, business-to-business contracts often extensively limit or exclude the trader's liabilities. It is not uncommon for them to be replicated in consumer contracts which are not reviewed from consumer law perspective but those clauses are more likely than not considered 'unfair' if included in a consumer contract. A trader cannot expect that their liabilities towards consumers do not extend, for example, to 'consequential losses' or something which is verbally mentioned but not written in the terms and conditions. A term in a consumer contract saying that the trader is only liable to the extent set out in its product warranty is also likely to be considered unfair and not enforceable.

Another example is a contract which allows a trader to take a large deposit and retain it if the consumer subsequently cancels the booking. Such a term is likely to be viewed as an unfair term under the CRA if it requires the consumer to pay a disproportionately high sum in compensation if he fails to pay the balance. The trader's cash flow can be affected because the deposits that they have received will need to be returned to consumers if the term allowing the trader to retain the deposits is in fact an unfair term.

In both examples, the trader has more exposures (in the case of liability clauses) or less rights (in the case of a large amount of deposit) if the relevant terms are unfair.

Statutory liabilities which cannot be 'contracted out'

Under the CRA, a number of terms are not binding on the consumer to the extent they exclude or limit a number of trader's statutory liabilities which apply to a consumer contract for the supply of goods, services or digital content. These restrictions and statutory remedies differ depending on whether the contract is for the supply of goods, services or digital content. This includes not only a term which excludes or restricts a consumer's statutory right or remedy in respect of the relevant statutory liabilities of the trader but also a term which make such right or remedy or its enforcement subject to restrictive or onerous condition, a term which allows a trader to put the consumer at a disadvantage for pursuing such right or remedy and exclusion or restriction of rules of evidence or procedure.

What happens if the consumer contract includes a term in breach of these restrictions?

  1. Term not binding. The relevant terms are not binding on the consumer and not enforceable. The trader can therefore be liable in the situations where they expected their liability to be excluded or limited.
  2. Statutory remedies must be provided. The trader may need to provide the remedies that are not in their terms or expressly excluded if the CRA provides otherwise. This could be in the form of for example a full or partial refund, repair or replacement for a supply contract for goods. Therefore, the trader will need the funds for refunds and/or repair / replacement capability (where relevant) which might not have been contemplated when they entered into the contract.

For example, where the goods incorporate digital content and the latter does not conform to the contract, the trader cannot exclude its liability for the digital content element of its product being defective (for example on the ground that the digital content was supplied by another trader). A breach of the statutory requirement that the goods not being of satisfactory quality (which is also treated as a term of a consumer contract for supply of goods under the CRA) obliges the trader to give certain statutory remedies. Therefore, the operations in the supply chains may need to be aligned with such remedies even if they are not set out in the consumer contract or different from how the trader wanted to handle the goods which are not of satisfactory quality.

Pre-contractual information

The Consumer Contracts (Information, Cancellation and Additional Charges) Regulations 2013 (CCR) sets out information which must be given to consumers before they are bound by supply contracts for goods, services and digital content unless exempt from such requirement. Such information differs depending on what is supplied and the way in which the contract is entered into but includes, for example, the main characteristics of the goods, services or digital content and, in the case of a digital content supply contract, the functionality and compatibility with hardware and software that the trader is aware of or can reasonably be expected to have been aware of.

Whilst the information required under the CCR does not necessarily need to be written in a consumer contract, it is not uncommon for at least some of it to be included in the terms and conditions.

What are the implications of the changes under the CRA?

  1. Pre-contractual information being a term of contract. The pre-contractual information provided under the CCR has become a term of the consumer contract under the CRA. The information cannot be varied unilaterally by the trader unless expressly agreed by the consumer. Therefore, if there is an error in the information provided (e.g. the functionality of digital content which does not exist), the trader could be left with a consumer contract that cannot be performed (e.g. it does not have any goods with the capability described in the information given to the consumer before entering into a contract) or its performance was not envisaged or intended. A failure to perform the contract is a breach of contract. If the trader is unable to perform the contract, the trader will need to give remedies to the consumer. This can have financial consequences for the business.
  2. Potential conflict between pre-contractual information and terms of contract. If the consumer contract is not reviewed in conjunction with the information provided under the CCR (which could be provided separately from the terms and conditions), there is a risk of a mismatch between the terms of the contract and the information that is provided separately before the consumer is bound by the contract. This can cause uncertainties in the legal relationship between the trader and the consumer.
  3. Extension of statutory cancellation period. One piece of pre-contractual information which is normally found in the consumer contract (rather than provided separately) is the information on the consumer's right to cancel. Under the CCR, if the consumer contract is a distance contract (e.g. business-to-consumer online sale, sale over the phone, doorstep selling), and if the goods, services or digital contract supplied is not exempt from the CCR, the consumer has the right to cancel the contract for 14 days after entering the contract or goods coming into the physical possession. Once the contract is cancelled, the trader must reimburse all payments, other than payments for delivery, received from the consumer. The 14-day cancellation period is extended by up to 12 months until and unless the information on the conditions, time limit and procedures for exercising the cancellation right is provided to the consumer. Therefore, if there is any deficiency in the information provided, the cancellation period will be longer than 14 days i.e. the money received for a product sold more than 14 days ago may need to be reimbursed for up to 12 months (plus 14 days). The cash flow of the business beyond the standard 14-day cancellation period can therefore be affected.

There are other information requirements which affect the drafting of consumer terms, such as those on the ODR platform which were introduced earlier this year under separately legislation.

If business' standard consumer contracts have not been reviewed since the changes to the CRA, it should consider reviewing them. It is also good practice to make them subject to periodic reviews in a shorter cycle than 4.5 years, which is the average time span according to the report referred to above, given the number of changes that are happening in the area of consumer law, both at the EU and UK national levels.