LLM COMMERCIAL LAW ( ): FOUNDATIONS OF COMMERCIAL LAW. Question:

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1 LLM COMMERCIAL LAW ( ): FOUNDATIONS OF COMMERCIAL LAW Question: Statutory controls affecting the enforceability of certain contract terms treat the consumer and business differently. The legislative structure is discriminatory and overly complex. Discuss this statement, with particular reference to the Unfair Contract Terms Act 1977 and the Unfair Terms in Consumer Contracts Regulations Answer (Mark = 85%): (see overleaf)

2 Introduction The Industrial Revolution in the United Kingdom spawned an imbalance of bargaining power between the manufacturing businesses and the end-user or consumer. Manufacturers goods were often unique, with demand outweighing supply. They benefited from the inequality of bargaining power; and their standard forms of contract proliferated. Within such standard form contracts, businesses routinely sought (and continue to seek) to limit their liabilities as against consumers: either by the use of exclusion clauses, totally negating their liability; or by limitation clauses, which partially do so. The courts have often adopted a paternalistic, hostile attitude to such clauses, for example by construing them strictly contra proferentum. 1 For a time, a (now discredited 2 ) doctrine of fundamental breach was used to defeat the clear wording of exclusion clauses in cases where a breach of contract was deemed by the court to be sufficiently serious. Parliament also became progressively more concerned at the plight of the modern consumer. The Molony Committee was appointed in 1959 to report 3 upon measures desirable for the further protection of the consuming public. 4 Following on from Molony, the Law Commissions of England and Scotland carried out further work throughout the 1960s and 1970s, leading to the enactment of the Unfair Contract Terms Act 1977 (hereafter UCTA ). A further layer of statutory control has since been added by the Unfair Terms in Consumer Contracts Regulations 1999 (hereafter the UTCCR ). This paper examines the scope and complexity of these statutory constraints, which result in different treatment of the consumer and businesses. The assertion that the current controls are overly-complex and discriminatory is discussed. Finally, the proposals for reform currently being advanced by the Law Commission are briefly explored. Positive Discrimination towards Consumers? Are unilaterally-imposed exclusion clauses unfair to the consumer? Are attempts to shield consumers from the effects of exclusion clauses in turn unfair to businesses? Should freedom of contract instead prevail? Discriminatory is a word which imparts a negative connotation. If consumers deserve to be subjected to freedom of contract, then it is submitted that statutory controls of exemption clauses in favour of consumers truly do discriminate against businesses. Molony (1962), although criticised at the time for being insular and good-hearted but unimaginative (Diamond, 1963, p.75), succinctly highlighted the problems confronting the modern consumer: Whereas the consumer of 50 years ago (1912) needed only a reasonable modicum of skill and knowledge to recognise the composition of the goods on offer, their manner of production, and to assess their quality and fitness for 1 E.g. Andrews Bros (Bournemouth) Ltd. v Singer and Co. Ltd [1934] 1 KB 17 (Exclusion of implied statutory term held not to apply when express term broken) 2 By the House of Lords in Photo Production Ltd v Securicor [1980] AC Molony Committee, Report of the Final Committee on Consumer Protection, Cmnd 1781, (1962) 4 Ibid

3 purpose, the consumer of today (1962) finds it difficult if not impossible to do so because of the development of complicated production techniques. 5 the consumer now spends a good deal of money on appliances and equipment of types unknown or known only to a favoured few 30 years ago (1932). [Their] quality can only be assessed (if at all) by a qualified expert using special equipment. 6 In such a maze consumers find it beyond their powers to make a wise and informed choice and are vulnerable to exploitation and deception. 7 The corollary, in the context of contractual exemption clauses, was encapsulated by Lord Reid: Exemption clauses differ greatly in many respects. Probably the most objectionable are found in the complex conditions which are now so common. In the ordinary way the customer has no time to read them, and if he did read them he probably would not understand them. And if he did understand or object to any of them, he would generally be told to take it or leave it. Freedom of contract must surely imply some choice or room for bargaining. 8 Beale (1978, p.114) observes that the classical theory of contract law regarded the contract as an empty form which the parties might use to create mutual rights and obligations as they wished, and relief from unfair contracts was confined to cases where there had been no genuine consent because of fraud, misrepresentation or physical duress. However, as De Lacy (1999, p.776) suggests: the law must recognise that in certain situations, a law of contract based upon the principle of equality of bargaining power is inappropriate. Furthermore, Atiyah (1986, p.366) highlights the dichotomy between the literal meaning of standard-term contracts and the intent of the contracting parties, opining that [we cannot] continue to assume that written or printed contracts are conclusive evidence of what the parties have agreed to. In the face of such powerful criticisms it seems plausible to afford greater protection to the vulnerable consumer. Conversely, proponents of freedom of contract have pointed to the basic definitional function of exemption clauses. Coote (1964 and 1970, p.228) argues that exemption clauses define the obligations of the parties, and criticises the view that they should have nothing to do with obligation, but operate merely as procedural obstacles. Sealy (1978, p19) concurs, calling Coote s definitional thesis inescapable. Adams and Brownsword (1988, pp.95-96), however, criticise Coote s thesis as elegantly formalistic, [ignoring] both the historical development of the problem, and the realities of the situation. But McKendrick (2003, pp ) takes issue with this latter view. Arguing that exclusion clauses per se are unobjectionable, but that unfair terms are the evil to be eradicated, he continues: the correct approach must be to deal with exclusion clauses as part of a general doctrine of duress, inequality of bargaining power or unconscionability. There is thus a raging debate between the proponents of freedom of contract and those who would protect the consumer. Whether statutory controls on exemption clauses are seen as discriminatory or not depends upon which side of the debate one stands. It is submitted that 5 At paragraph 40 6 Ibid. paragraph 42 7 Ibid. paragraph 43 8 Suisse Atlantique Societe d Armement SA v NV Rotterdamshe Kolen Centrale [1967] 1 AC 361, (at 406) - 2 -

4 McKendrick strikes the right balance. On his view, statutory controls are right to discriminate in favour of the consumer, but only insofar as contract terms are substantively unfair. UCTA and the UTCCR Compared and Contrasted Comparing and contrasting the two pieces of legislation, substantial overlaps and differences are apparent. Enactment UCTA came into force on 1 February Sealy (1978, p.15) remarked that at a stroke, laissez-faire principles which have dominated contractual thinking for well over a century have been cut away; and the reasonable man, until now the measure of things in the law of tort, becomes a significant figure also in matters of contract. The Act, despite its name, concentrates almost solely upon the control of exemption clauses; not all clauses which may be unfair. Its enactment was not universally welcomed. Coote (1978, p.312) criticised the drafting of the Act for being premised on the basis that [exemption] clauses do not affect the accrual of obligation but operate only as defences to accrued rights of action noting further that the ostensible intention of the Act was to limit freedom of contract. MacDonald (1994, p.442) acknowledges the force of such observations, concluding that there is effectively a conceptual vacuum at the centre of UCTA. Fifteen years later, in order to address perceived marked divergences in the laws of the member states of the European Union, a Directive 9 was adopted by the European Council to approximate the laws, regulations and administrative provisions of the Member States relating to unfair terms in contracts concluded between a seller or supplier and a consumer 10. Member states of the European Union were then obliged to enact laws which prescribed that unfair terms used in a contract between a seller and a consumer would not bind the latter. The Directive defined an unfair term as any term which contrary to the requirement of good faith, causes a significant imbalance in the parties rights and obligations to the detriment of the consumer. 11 The resultant legislation in the UK took the form of the Unfair Terms in Consumer Contracts Regulations 1994, which were in turn supplanted by the 1999 regulations of the same name. As Reynolds (1994, p.1) predicted at the time, the Regulations were introduced with no attempt to repeal, modify or secure any connection with [UCTA], an expedient which he considered would lead to a situation of nightmarish complexity. Structure, Style and Geographical Scope UCTA is drafted in a dense and technical style (Law Commission 2005, para. 2.4(5)), compressing 200 pages of Law Commission reporting into a bare twenty pages of legislation (Sealy 1978, p.16). Even the its most ardent adherents admit to the Act not being a masterpiece of draftsmanship (Adams, 1978, p.706). 9 Directive 93/13/EEC (5 April 1993) on Unfair Terms in Consumer Contracts 10 Ibid. Article 1 11 Ibid. Article 3-3 -

5 One source of UCTA s complexity is readily apparent from the structure of the Act: discrete provisions apply to Scotland as distinct from the rest the United Kingdom 12. This reflects separate approaches taken by the two Law Commissions during the drafting stage. 13 The UTCCR apply to the whole UK, and are not (pace UCTA) burdened with separate provisions for different parts of the UK. However, the Regulations closely follow the EC Directive and so use terms which may be alien to English and Scots readers, lawyers and non-lawyers alike (Law Commission 2005, para. 1.15). Contracts and Contract Term Coverage Sealy (1978, p.16) contends that, after UCTA, there is no longer a law of contract, but a law of contracts : a distinction must now be made between non-business contracts, business contracts, consumer contracts, written standard term contracts and international supply contracts. UCTA s.1(3) provides that its sections 2 7 apply only to business liability. However, for parties to purely private contracts (including consumers), UCTA does not apply; the common law controls 14 will continue to have relevance. The UTCCR, by contrast, apply to any non-negotiated, non- core, unfair term in a contract concluded between a seller (or supplier) and a consumer. 15 Businesses are not protected. Thus the UTCCR, by applying potentially to any term, are wider than UCTA, which concentrates predominantly upon exclusion clauses 16. However, in applying only to consumer contracts, the UTCCR are narrower than UCTA which can apply in business-to-business transactions. Tests Applied UCTA treats contract terms in two ways: either rendering them void altogether, or subjecting them to a test of reasonableness. UCTA ss.3-7 offer succour to the consumer. For example, by UCTA s.3 a businessman who imposes his standard terms of business upon a consumer cannot rely on any term exempting him from breach of contract 17 or rendering performance substantially different from what was expected of him 18 save insofar as such terms satisfy the requirement of reasonableness. UCTA s.6(2) prevents the businessman, as seller in a contract of sale, from contracting out of the implied undertakings in ss of the Sale of Goods Act 1979 when he deals with a consumer; but when he deals with another businessman, such exclusions are permitted if they satisfy the aforementioned test of reasonableness. 12 Part I of the Act applies to England, Wales and Northern Ireland; Part II of the Act to Scotland; and Part III of the Act contains provisions affecting the whole UK. 13 The Scottish Law Commission was generally thought to be more conservative during the drafting process (see Sealy 1978). For the sake of clarity, references to the Act in the remainder of this paper shall be to Part I only. 14 Incorporation and construction 15 Regulation 4(1) 16 MacDonald (2004, pp.80-81) argues that UCTA (through s.3(2)(b)) can be used in a much wider context than just for clauses written in the form of exclusion clauses; but that its rare invocation by the courts suggest that it has been little understood. 17 UCTA s.3(2)(a) 18 Ibid. s.3(2)(b) - 4 -

6 Guidelines for the reasonableness test are set out at Schedule 2 to UCTA. However, in practice, it has been the discretion of the judges at first instance, rather than the factors listed in Schedule 2 per se, which have proved decisive. 19 The UTCCR tests for unfair terms via its highly complex Regulation 5. Regulation 5(1) provides: A contractual term which has not been individually negotiated shall be regarded as 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. Thus the UTCCR are narrower than UCTA in the sense that UCTA applies irrespective of whether or not a term has been individually negotiated. Howells and Brownsword (1995, pp ) interpret Regulation 5(1) 20 as prescribing a three-element test for unfairness: ( contrary to the requirement of good faith ; significant imbalance ; to the detriment of the consumer ), and argue that the underlying pattern of the protective regime [closely resembles] that under the reasonableness test of UCTA]. It is certainly the case, as MacDonald (2004, p.83) asserts, that the respective tests are both a simple weighing of factors, with no particular structure. To assist, a grey list of indicative unfair terms is provided at Schedule 2 to the Regulations. The core concept of good faith, that criterion described by Collins (1994, p.249) as mysterious and exciting to an English lawyer was considered by the House of Lords in Director General of Fair Trading v First National Bank [2002] 1 AC 481 where Lord Bingham provided detailed guidance: The requirement of good faith in this context is one of fair and open dealing. Openness requires that the terms should be expressed fully, clearly and legibly, containing no concealed pitfalls or traps. Appropriate prominence should be given to terms which might operate disadvantageously to the customer. Fair dealing requires that a supplier should not, whether deliberately or unconsciously, take advantage of the consumer's necessity, indigence, lack of experience, unfamiliarity with the subject matter of the contract, weak bargaining position 21 All terms drafted in advance are always be regarded as not having been individually negotiated 22 ; and if one clause has been individually negotiated, the rest of a standard form contract does not escape scrutiny 23. The burden of proving that a term was individually negotiated falls squarely onto the seller or supplier. 24 UCTA, in contrast, does not discriminate against a term being individually negotiated in a consumer contract; albeit that negotiation is a factor listed in Schedule 2 (the Reasonableness Test ). Core provisions of the contract are exempt from being subject to the fairness test through Regulation 6(2). This provision is capable of causing a clutch of difficulties (Brownsword and Howells, 1995, p.247) 25. Not the least of which has been outlined by MacDonald (1994, p.460): There [is] a problem in applying a test of fairness which looks to a significant 19 E.g. Stag Line v Tyne Ship Repair Group ( The Zinnia ) [1984] 2 Lloyd s Rep 211 (Convoluted, prolix exclusion clause written in fine print); and Rees-Hough v Redland Reinforced Plastics [1985] 2 Con LR 109 (Compensation paid in past dealing between the parties in lieu of reliance on exclusion clause; exclusion clause not referred to during pre-contract negotiations; availability of product liability insurance to pipe manufacturer, etc.). See further, generally, Adams and Brownsword (1988). 20 In its previous incarnation - Regulation 4(1) in the 1994 Regulations 21 At para. 17 of the judgment 22 Regulation 5(2) 23 Regulation 5(3) 24 Regulation 5(4) 25 Commenting upon the corresponding Regulation 3(2) of the 1994 Regulations - 5 -

7 detrimental imbalance in relation to [a] non-core term if the imbalance basically lies in the core terms. Regulation 6(2) provides: In so far as it is in plain intelligible language, the assessment of fairness of a term shall not (a) relate to the definition of the main subject matter of the contract, or (b) to the adequacy of the price or remuneration What is the threshold for plain intelligible language? Should the courts follow the suggestion of Collins (1994, p.248) that the standard be set by reference to the naïve and inexperienced consumer, or should the expertise of the reader be a factor? As has been pointed out (Brownsword and Howells, 1995, p.248), limb 6(2)(a) raises the notorious legal puzzle of the definitional or defensive function of exclusion clauses 26 ; and limb 6(2)(b) engenders obvious potential ambiguity as to what adequate price or remuneration might entail. Definition of Consumer The complexities of the UCTA extend to the defined terms themselves. The definition of a consumer has caused particular difficulties. A party to a contract deals as consumer pursuant to UCTA s.12 if he neither makes the contract in the course of a business nor holds himself out as doing so 27 ; and if the other party does make the contract in the course of a business. 28 As observed by Kidner (1987, p.51) s.12 contains a number of ambiguous terms, including: a party to a contract ; holds himself out ; and in the course of a business. The latter phrase, described by Brown (1999, p.385) as calculatedly forthright but tantalisingly abstract, was cogently disseminated by Kidner: it is suggested that the most important word here is a, for there is a distinction between in the course of a business and in the course of business. The former suggests things done by and for a business, while the latter suggests acts limited to the kind of business in which a person is engaged. Thus when a bookseller buys a lightbulb he does so in the course of a business, since he needs and uses lightbulbs for his business, but he does not do so in the course of business since he is not in the lighting business. Unfortunately, Kidner s compelling analysis has not found favour with the courts, resulting in an uneasy penumbra of uncertainty between certain business and consumer dealings. In R&B Customs Brokers v United Dominions Trust Ltd. [1988] 1 WLR 321, the brokerage company acting in the course of its business purchased a car for business and personal use of one of its directors. Nevertheless, the Court of Appeal held that the company dealt as a consumer pursuant to UCTA s.12, and so could avoid an exclusion clause. The court was influenced by the definition of consumer in case law concerning the Trades Descriptions Act Howells (1988, p.139) opines that in any business situation, exclusion clauses should be merely subject to a reasonableness test, robustly repudiating the premise that a criminal statute may be used to interpret a civil law matter; he argues that it is wrong that businessmen should seek to use consumers statutory protection when acting in a course of a business. 26 See the discussion of Professor Coote s thesis, above 27 UTCA s.12(1)(a) 28 Ibid. s.12(1)(b) 29 Particularly the decision in Davis v Sumner [1984] 3 All ER

8 The later case Stevenson v Rogers [1999] 2 WLR 1064 concerned the sale of a fishing boat under the Sale of Goods Act 1979 ( SGA ). Although there was no exclusion clause, the decision sets up a jarring incongruity [between SGA and UCTA] (Brown, 1999, p.387). The Court of Appeal held that although this was a one-off sale (the defendant fisherman not being in the business of selling boats), the term implied by s.14(2) of SGA would apply to the sale. Potter LJ 30 could see no reason to re-introduce some implied qualification, difficult to define, in order to narrow the wide scope of the words. By treating the fisherman as a boat-salesman, the decision creates a manifest tension with R&B Customs. Most recently, in Feldarol Foundry Plc. v Hermes Leasing (London) Ltd. [2004] EWCA Civ 747, the Court of Appeal missed an opportunity [to] resolve the tension (Twigg-Flesner, 2005, pp.42-43). Tuckey LJ, refusing to disturb the authorities, stated that he did not consider it right to displace [the construction of SGA s.14(2)] simply to achieve harmony with a decision upon the meaning of [UCTA s.12]. The UTCCR are also potentially problematic in this respect. A consumer is defined 31 as: any natural person who, in contracts covered by these Regulations, is acting for purposes which are outside his trade, business or profession. As Lawson (2003, p.199) points out: the bizarre conclusion to which [a] literal meaning would lead, that those with no occupation at all are outside the scope of the Regulations, cannot seriously be maintained adding that the common sense view is that the definition will be read as outside such business, if any, as he might have. 32 Nonetheless, whichever view is taken, by confining the consumer to a natural person the result in R&B Customs is averted. Enforcement The enforcement of UCTA is purely a matter as between the parties to the Contract. However, the UTCCR, as well as permitting the weaker party to sue in the normal way, have an additional mechanism: standard-form contract terms are actively policed by the Office of Fair Trading ( OFT ) 33, and other Qualifying bodies 34, who may apply for an injunction against the issuer of the unfair term. In the Director-General of Fair Trading case Lord Steyn evinced a marked preference for such measures: The system of pre-emptive challenges is a more effective way of preventing the continuing use of unfair terms than ex casu actions 35 Burden of Proof There is a stark contrast here between UCTA and the UTCCR: the Regulations place the burden on the consumer to prove a term unfair 36, whereas UCTA s.11(5) puts an onus on the businessman to prove a term satisfies the reasonableness test. 30 At p Regulation 3(1) 32 Lawson R, Exclusion Clauses and Unfair Contract Terms, 7th Edition, 2003, (Sweet and Maxwell) 33 Regulation Listed at UTCCR Schedule 1 35 At para Albeit that the burden is upon the seller who claims a term was individually negotiated to show that it was Regulation 5(6), discussed above

9 Summary After a comparison of UCTA and the UTCCR, MacDonald (2004, p.72), it is submitted correctly, concludes: Plainly, there are considerable distinctions and overlaps between UCTA and the UTCCR and great complexity for those affected by them. The complexity is particularly unfortunate in relation to provisions intended to protect consumers but it is also undesirable from the perspective of businesses seeking to ensure that they are not using terms which are ineffective under either piece of legislation. Reform In 2001 the government referred the Law Commissions to consider the desirability and feasibility of (i) a unified regime which would be consistent with 1993 Council Directive; (ii) extending the scope of the UTCCR (or any new legislation) to protect businesses, in particular small enterprises; and (iii) making any replacement legislation clearer and more accessible to the reader, so far as possible without making the law significantly less certain. Following a consultation exercise, the Law Commissions in February 2005 published their report and recommendations, along with a draft Unfair Contract Terms Bill 37. There was overwhelming support from consultees for a single piece of legislation covering the whole of the UK 38. Business-to-Consumer Contracts For business-to-consumer contracts, the Commissioners recommend that there should be no significant reduction in consumer protection 39, and that a consumer should be natural person 40 acting for purposes unrelated to his or her business 41. The UCTA two-tier test (that is, terms either being void or subject to a reasonableness test) remains under the proposed draft Bill 42 ; as does the UTCCR exception for core contract terms, which are not subject to a fair and reasonable test. 43 MacDonald (2004, pp.89-90) criticises the structure of the draft Bill for straying from its own aims of being easy to comprehend. She argues that the burying of the fair and reasonable test into the middle of the legislation, when it applies to nearly all clauses, is mistaken. The proposed fair and reasonable test does not expressly refer to good faith. 44 The Commissioners dispensed with such a reference because firstly the implementation of EU Directives is results-oriented; and secondly, good faith is an unfamiliar concept to legal practitioners. 45 Section 14 of the draft Bill provides that a contract term is determined as fair 37 Law Commission Report (Law Com no. LC292) 38 Ibid. paragraph Ibid. paragraph Ibid. paragraph Ibid. paragraph Ibid. paragraph Section 14 of the Draft Unfair Contract Terms Bill see below 44 Law Commission Report (Law Com no. LC292) paragraph Ibid. paragraph

10 and reasonable by taking into account its transparency 46 and the substance and effect 47 of the term. A grey-list schedule 48 of indicatively unfair terms is proposed in similar vein to the UTCCR. Business-to-Business Contracts In the proposals for business-to-business contracts, a person who contracts for purposes mainly related to his business should not be classified as a consumer 49. The fair and reasonable test proposed for consumer contracts is recommended to apply also to businessto-business contracts. 50 The grey-list schedule will not apply to business-to-business transactions. The Commission propose a novel, separate regime for small businesses (defined as those businesses having nine employees or less). 51 This was prompted by the feedback from consultees, who explained how very harsh terms shifting risk often result from inequalities of bargaining power that are particularly persistent in industries such as construction, manufacturing and farming where small businesses are common 52. The chief recommendation is that small businesses should be given powers to challenge any noncore, non-negotiated, standard term of a contract under the same fair and reasonable test proposed for consumers 53. The burden of proof as to showing (un)fairness (which falls on business in the proposals for business-to-consumer contracts) is recommended to be borne by the small business. The pre-emptive role of the OFT, and other bodies, (as per the UTCCR) is preserved in the proposals for all transactions. Conclusion In relation to consumer contracts, there is a question of the balance between the interests of consumers and the interests of business, as well as between fairness and certainty. 54 In performing their respective balancing acts, UCTA and the UTCCR have individual inherent complexities, which are compounded by overlapping jurisdiction. The drafting of both instruments could be simplified and made more accessible to consumers, who are the principal beneficiaries of the legislation. Both statutory controls undoubtedly discriminate in favour of the consumer (albeit in differing ways). The extent to which this is beneficial rests upon the outcome of the unsettled theoretical debate over the degree to which freedom of contract should be emasculated. 46 A transparent term is further defined in s.14(3) as: (a) expressed in reasonably plain language, (b) legible, (c) presented clearly, and (d) readily available to any person likely to be affected by the contract term or notice in question. 47 Further defined in s.14(4). This is a list of factors similar to an expanded version of UCTA Schedule 2 including: possibility of insurance(s.14(4)(e)), knowledge of the weaker party (s.14(4)(h)), relative bargaining strength (s14(4)(i)) etc. 48 Schedule 2: Contract Terms which may be Regarded as Not Fair and Reasonable 49 Law Commission Report (Law Com no. LC292) paragraph Ibid. paragraph Ibid. paragraph Ibid. paragraph 5.3(1) 53 Paragraph MacDonald (2004, p.93) - 9 -

11 If passed into law, the Law Commission s proposed reforms will simplify the law, and place more emphasis upon the substantive fairness and reasonableness of any particular contract term. Whether a successful balance will be struck between consumer and business interests, and between fairness and certainty, remains to be seen

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