Policy
Response
Office of Fair Trading: Personal Current Accounts in the UK - (April 2007 - OFT918)
|
Contact: Chris Lawrenson Date: 22 Jun 2007 |
Print page | Email |
Response by the Building Societies Association
Introduction
1. The Building Societies Association (BSA) represents all 60 building societies in the United Kingdom. Building societies have total assets in excess of £310 billion and hold residential mortgages of almost £210 billion, approximately 18% of the total outstanding in the UK. Societies hold almost £200 billion of retail deposits, accounting for over 19% of all such deposits in the UK. Building societies also account for over 37% of all cash ISA balances. Building societies employ almost 50,000 full and part-time staff and operate through around 2,150 branches. Six building societies offer current accounts (five with overdraft facilities).
2. The OFT’s study into retail bank pricing is intended to enable the OFT to consider wider questions about transparency in the provision of personal current accounts. The Association believes that the banks and building societies that provide current account services are best placed to supply the OFT with the product and procedural information it needs on this aspect of its study.
3. However, the OFT’s study, which is running in parallel with its investigation into the fairness of bank current account charges, is also intended to help the OFT obtain the necessary context for assessing fairness of unauthorised overdraft charges. An important part of the overall context is the legal position.
4. The Association’s view is that the underlying legal provisions relating to fees and charges are not as well understood as they should be. Sometimes they are misrepresented or over-simplified by some of the campaigns and in the media, thus providing a misleading picture to the public. The legal principles, in relation to both penalties and unfair terms, have been developed over a long period of time and it does not help consumers to be presented with misleading, or over-simplified, accounts of their characteristics.
5. This paper, therefore, seeks to set the record straight on the legal principles that are key to the fairness or unfairness of financial services’ charges and fees. It is a short paper that focuses only on some popular misconceptions about the law – it does not claim to be a comprehensive account of the relevant legal principles.
Grounds for Challenge
6. A charge is most likely to be challenged either under the common law principle of ‘penalty’ or as an ‘unfair term’.
7. The fundamental principles of liquidated damages and penalties are set out in the Judgement in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79. A charge in relation to a breach of contract will be deemed a 'penalty', and therefore, unenforceable, if it is "for an extravagant amount in comparison to the greatest loss that could conceivably flow from the breach". If the sum is a penalty, the victim of the breach is not allowed to recover it – only the amount to which he would have been entitled had the contract not contained a penalty clause.
8. The use of the terms "penalty" or "liquidated damages" in a contract is not conclusive – the court must examine the facts and circumstances of each case (also see paragraph 30 below). The matter must be judged, on an interpretation of the terms and circumstances of each particular contract, in respect of the time when the contract was made: not the time of the breach.
9. Under the Unfair Terms in Consumer Contracts Regulations 1999 a contact term that 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 under the contract, the consumer's detriment. The leading Judgement, which explains these terms, is that of Lord Bingham in Director General of Fair Trading v First National Bank plc.
10. An unfair term is not binding on the consumer. As with the common law position (above), the relevant assessment must be made having regard to the circumstances at the time of the conclusion of the contract - – but see Regulation 12 and Director General of Fair Trading v First National Bank plc [2002] 1 AC 481 at paragraph 33.
11. The 1999 Regulations contain an "indicative and non-exhaustive" list of terms that may be regarded as unfair – one specifies a term, similar to common law penalties, that requires a customer to pay a "disproportionately high sum in compensation" if he breached the contract (see below).
Legal Misunderstandings
(a) Penalties and liquidated damages
(i) Reflection of a firm’s costs
12. Certain campaigns insist that a charge must exactly reflect a firm’s costs. This disregards one of the main objectives of liquidated damages clauses; ie that they allow a charge to be set even where precise pre-estimation in each case is not practicable. By setting a charge, a firm is able to quantify risks involved in relevant products, introduce commercial certainty and avert the need for complicated resolution of disputes about the matter in the event of a breach of contract (Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd).
13. In a recent judgment (Murray v Leisureplay plc [2005] EWCA Civ 963), the Court recognised the difficulty of estimating the amount of genuine compensation - in this case, in respect of a wrongful dismissal, possibly years later. The Court acknowledged that it had to give a degree of leeway and would only strike out a term if it was truly excessive.
14. There is no legal requirement that a charge must exactly reflect the firm's costs. This has always been the legal position and the fact that the Murray Judgment was as recent as 2005 shows that this position has not changed. The key point is that the sum must have been intended to act as compensation and not as a threat to deter the other party from breaching the contract.
(ii) Inappropriate use of penalty as a ground for action
15. Increasingly, charges or fees that are not levied in respect of a breach of contract are being challenged on the principle of penalty – see, most recently, the, as yet, unreported (but published) Judgements in Berwick v Lloyds TSB (2007) and Smith v Mortgage Express (2007). However, it is important to note that there has to be an actual breach of contract before the penalty principle is triggered – ie one party must have failed, or refused, to perform the contract as agreed, or have done so contrary to its terms.
16. In one leading Judgement (Export Credit Guarantees Department. v Universal Oil Products [1983] 2 AER 205) the Court expressed the point as follows –
“The clause was not a penalty because it provided for payment of money on the happening of a specified event other than a breach of contractual duty by the contemplated payer to the contemplated payee.”
More recently, Judge Kaye QC, in the High Court (Smith v Mortgage Express), addressed the matter as follows (in a case concerning a mortgage early redemption charge) –
“In my judgment, looking at the contract as a whole, I have no doubt that this is merely a provision as to what should happen, not if the borrower broke the contract, but if the borrower elected a right to redeem the mortgage at an early stage. It was, after all, part of the package that was being offered to him.”
17. Subject to the terms of the particular contract, charges made by a bank or building society for paying items when a customer draws either in excess of their balance, or of any authorised overdraft limit, may be charges for the provision of a service rather than either compensation for a breach of contract on the customer's part or a deterrent. In such a case, the charge could not, as a matter of established law, amount to a penalty - see, inter alia, Berwick v Lloyds TSB.
18. In Lloyds Bank v Voller [2000] 2 AER (Comm) 978, Wall J in the Court of Appeal stated (at paragraph 16) –
“If a current account is opened by a customer with a bank with no express agreement as to what the overdraft facility should be, then, in circumstances where the customer draws a cheque on the account which causes the account to go into overdraft, the customer, by necessary implication, requests the bank to grant the customer an overdraft of the necessary amount, on its usual terms as to interest and other charges.”
19. It has been suggested (New Law Journal: 20 April 2007), following from this Judgement, that a bank could argue, even if the customer had breached the contract by maintaining insufficient funds, that there had been a variation of the existing contract, subject to the bank’s usual terms covering, for example, interest and charges. It could be argued that the bank had waived the breach, that the existing contract had been varied, and that the penalties rule was, therefore, inapplicable.
(b) Unfair Terms
(i) Proportionality
20. It is frequently stated that a term will be unfair if it imposes a charge that is not proportionate to the relevant breach of contract. Indeed, the OFT has made this point in its Consultation on revised guidance under the Unfair Terms in Consumer Contracts Regulations 1999 (OFT311cons: April 2007). Paragraph 5 states that “It is unfair to impose disproportionate sanctions for breach of contract”. This is not a correct statement of the law. The Association does not support unfair charging, but it is crucial to get the underlying law right.
21. Paragraph 1(e) of Schedule 2 to the 1999 Regulations states that a term may be regarded as unfair if it requires “any consumer who fails to fulfil his obligation to pay a disproportionately high sum in compensation”. Schedule 2 to the 1999 Regulations sets out an “indicative and non-exhaustive list of terms which may be regarded as unfair” (our italics).
22. The indicative terms – including the one in paragraph 1(e) - are still subject to the underlying test in Regulation 5(1), which (as noted above) states that a contact term that 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 under the contract, to the consumer's detriment.
23. The key features of good faith and significant imbalance were explained in Director General of Fair Trading v First National Bank plc, in summary, as follows -
- Good faith: this is a requirement of "fair and open dealing" – fairness refers
to the substance of the contract and requires the supplier not to take advantage of a customer's necessity, lack of experience, weak bargaining position etc. Openness requires the term to be expressed fully, clearly and legibly, containing no concealed pitfalls or traps, and appropriate prominence should be given to terms that might disadvantage the customer. - Significant imbalance to the consumer's detriment: a term causes
significant imbalance if it is so weighted in favour of the supplier as to tilt the parties' rights and obligations under a contract significantly in his favour. In considering imbalance, it is important to examine the circumstances at the time of the contract.
(ii) Core terms
24. The 1999 Regulations are not intended to act as a price control mechanism (Lord Bingham – Director General of Fair Trading v First National Bank plc, at paragraph 12). This is why Regulation 6(1) excludes from the assessment of fairness in the Regulations terms relating –
"(a) to the definition of the main subject-matter of the contract, or (b) to the adequacy of the price or remuneration, as against the goods or services supplied in exchange" (so long as they are expressed in "plain, intelligible language").
This is the so-called "core terms provision".
25. The courts appear keen not to allow the provision to be interpreted too broadly. For instance, in the Director General of Fair Trading v First National Bank plc case, the Court held that a term in a consumer credit agreement requiring the debtor to pay interest on the outstanding principal sum, was not a core term because it was "ancillary" to the main obligation. It was, therefore, subject to the assessment of fairness under the Regulations (but, in fact, was held to be fair).
26. However, recent Judgements make it clear that the courts will not dismiss out-of-hand a firm’s argument that a term is core. For example, in Smith v Mortgage Express (2007), Kaye J held that a mortgage early redemption charge term fell within the ‘core terms’ exemption, under Regulation 6(2) of the 1999 Regulations and, therefore, was outside the scope of the Regulations –
“… the price paid for early redemption within, it has to be remembered, a limited period of three years, when set against a discount of interest payable by the borrower for the first two years, is part, if you like, of the package, it is part of the price that is being paid by the borrower in return for what he receives, namely a 20 year mortgage at a discounted rate for two years, and all the other terms and packages that he is dealt”
The same conclusion was reached in respect of a current account charge in Berwick v Lloyds TSB (2007).
27. Therefore, core terms are a legitimate concept in consumer contracts and whether or not a term is core depends on factors such as its drafting and what precisely it applies to.
(c) Miscellaneous
(i) Unfair Contract Terms Act 1977
28. Although this Act is often mentioned on campaign websites challenging default charges, the 1977 Act mainly regulates ‘disclaimers’ (exemption clauses) and, despite its title, does not require general fairness across all contract terms. The 1977 Act was cited by the claimants in both the very recent Judgements (Berwick and Smith) and, in each case, the respective judges concluded that it was irrelevant.
(ii) Wilson v Love
29. Certain campaign websites state that the old Judgement in Wilson v Love (1896) is authority for the assertion that a charge is a penalty if it does not reflect an item’s true cost. In fact, the Judgement - [1896] 1 QB 626 - does not say this.
30. The Judgement concerned a farm lease by which the tenants were not allowed to sell hay or straw off the premises during the last 12 months of the term. If they did, they had to pay what the least specified as a “penalty” of £3 per ton sold. The tenants sold off hay during the last 12 months of the term. Evidence showed that the value of the hay was less than £1 a ton. The value of straw was only 4 – 5 shillings a ton (20p – 25p). The term in the lease was held to be a penalty because -
(i) it was a case where the damages could have easily been estimated and the specified sum was obviously substantially greater than the true value
(ii) the term covered two separate items (hay and straw) that were of different values – therefore, it was much more likely to be a penalty than liquidated damages
(iii) in the lease, the parties described the payment as a “penalty”. Although this is not conclusive, it means that a stronger case has to be made that the sum was liquidated damages.
