Out-Law News 5 min. read

FSA issues guidance on how businesses can avoid using unfair contract terms

Businesses are using consumer contracts that give them too much leeway to unfairly change the terms of those contracts, the Financial Services Authority (FSA) has said.

The financial services regulator said that businesses that specify "a valid reason" within contracts for why they have the right to alter those terms are "less likely" to be drafting unfair contractual provisions.

Similarly, if a contract stipulates that consumers face variations to interest rates or other charges they have to pay then the business should inform those consumers "at the earliest opportunity" after changes take effect and consumers should be "free to dissolve the contract immediately" as a result.

Businesses that use contracts that have no end date should have to notify customers in advance of changes taking effect and allow those consumers to break out of the agreement, the FSA said.

Some companies have drafted contracts setting out reasons why they have a unilateral right to alter terms without those reasons being valid, the FSA said.

"We consider that ‘valid reasons’ specified in a contract should be clearly and unambiguously defined, so a consumer can challenge a harmful variation that they have not clearly agreed to. In our view, a term should explain with sufficient clarity if, when and how a variation is likely to occur. What constitutes a ‘valid reason’ will depend upon the contract as a whole and the product in question," the FSA said in new guidance (12-page / 184KB PDF) it has issued on unfair contract terms.

Reasons the FSA said it is "likely" to deem not valid include where businesses claim a unilateral right "to cover unexpected costs; for any reason a firm sees fit; for any reason a firm considers reasonable at the time of the change; or solely to increase profit margins". Contracts that express firms' rights to alter terms for 'any other valid reason' will not be said, on its own, to have provided a valid reason for that right to exist, the regulator said.

The FSA issued the recommendations as part of wider guidance into acceptable terminology firms can use in contracts. The regulator said the guidance, addressed to firms authorised and regulated by the FSA, was required because it "regularly" saw examples of "unclear of unfair" terms being used in contracts despite such terms being prohibited under consumer protection laws.

The Unfair Terms in Consumer Contracts Regulations sets out rules that businesses must comply with when drawing up contracts for customers. Under the Regulations "unfair" contract terms are prohibited and refer to terms in a contract which have not be "individually negotiated" that cause "a significant imbalance in the parties' rights and obligations arising under the contract, to the detriment of the consumer," contrary to the requirement that they be drafted in "good faith". Under the Regulations written contracts must also be drafted in "plain, intelligible language".

The FSA said it "commonly" found problems with contract terms that give businesses the right to unilaterally vary the contract; the right to terminate the contract; discretion to exercise contractual powers; the right to transfer its obligations under the contract; and terms that are not in plain and intelligible language.

The guidance also sets out circumstances where businesses must inform consumers about changes to contract terms, setting out examples of where prior notification is required, where providing information after the event can be acceptable and where informing individuals personally is not always required.

Contracts that stipulate a unilateral right of businesses to alter the terms are more likely to be considered unfair if they do not give consumers the right to break out of the agreements, the FSA said. Even where consumers are given the right to exit contracts without bearing financial cost businesses often put "practical barriers" in place to make it difficult for those customers to end contracts.

The FSA said that businesses should avoid using terms in contracts that "create substantial inconvenience or cost to a consumer" when those firms wish to cancel out of those agreements. Such terms "have the potential to be unfair," it said.

Businesses are less likely to be deemed to be operating with unfair cancellation terms in "determinate duration" contracts if they specify contract terms that say they will only cancel contracts "if there are serious grounds to do so" and "even then" should only do so if the "consumer has failed to provide a remedy" for any breach of contract.

Firms can legitimately use contract terms that give them the right to exercise "contractual powers" but those terms may be considered unfair unless they "define the scope of a firm’s discretion in a clearly defined and balanced way," the FSA said. Companies should also avoid using terms that specify its right to exercise contractual power that are vaguely drafted and could be ambiguously interpreted, it said.

"In principle, there are no objections to terms which give firms an element of discretion in order to operate efficiently. However, we are concerned about terms which give excessive discretion to firms as to if, when or how they will be able to exercise their contractual powers. In our view, such discretion can cause a term to be unfair," the FSA said.

Businesses that include contractual provisions that allow them to transfer obligations to other parties risk those terms being deemed as unfair if any transfer, without consumer consent, could "reduce the guarantees" to that consumer, the regulator said.

"In our view, terms which permit a firm to transfer its rights and obligations to a third party, where such a transfer results in the same, or better, guarantees for a consumer are less likely to be unfair under the Regulations. As such, terms should be clearly drafted to indicate that this will be the case," the guidance said.

If a transfer of obligations would reduce consumers' guarantees the businesses should seek "informed consent" from those individuals before going ahead with the transfer. Making consumers "fully aware of the impact of the changes to their contract, is more likely to reduce the potential for unfairness," the FSA said.

The regulator said companies should avoid using "technical or legal" language in contracts after expressing concern that they "leave consumers unable to fully understand the terms of the contract they have entered into". It said terms should be "clearly drafted" and avoid "ambiguity" if businesses want to avoid them being considered unfair. The terms should also relate to how businesses would act in practice, it said.

The FSA has the power to take legal action against businesses that use unfair terms in consumer contracts. The regulator can apply for a court injunction banning businesses using certain unfair terms in contracts.

"Ultimately, only a court can determine the fairness of a term. We cannot approve terms for the purposes of the Regulations; it is for firms to ensure that their terms are clear and not unfair under the Regulations, in the context of the product or service in question. It is important to bear in mind that wording which is clear and not unfair in one particular agreement is not necessarily clear and not unfair in another," the FSA said.

The regulator said its guidance is "intended to raise awareness of the types of issues that we commonly identify as being of concern under the Regulations and to restate our expectation that firms ensure they meet the requirements of the Regulations".

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