Part II
An overview of the legislation on unfair terms and our proposals

1. The need for legislation on unfair terms

2.1                                      The laws of contract of all the UK jurisdictions accept the basic principle of freedom of contract: the parties should be free to agree on any terms that they like provided that their agreement is not illegal or otherwise contrary to public policy because it infringes some public interest.[1] In practice, however, there have been restrictions on the principle of freedom of contract for hundreds of years.[2] In general terms the restrictions are justified by the fact that parties are not always sufficiently well-informed, or may not have sufficient bargaining power, to look after their own interests. In England, the common law and, more particularly, various equitable doctrines allow the courts to intervene in certain cases in which the process by which the “agreement” had been reached was unfair. Thus contracts may be avoided on grounds such as fraud, non-fraudulent misrepresentation, duress, undue influence and “unconscionability”.[3] The position in Scots law is similar.[4] These doctrines do not, however, apply to many cases in which one party seems to have agreed to a contractual term that is very much against his own interests; and they do not apply at all if there has not been some “procedural unfairness” in the way the contract was made.[5] It is true that at common law certain types of contractual term are invalid irrespective of whether or not there was procedural unfairness; penalty clauses are an example.[6] Others, such as clauses in restraint of trade,[7] will be valid only if they are shown to be reasonable. However, only a very narrow range of terms is affected by such common law rules and no general doctrine against unfair terms has ever been developed.[8]

2.2                                      In particular, the doctrines of common law and the courts of equity were inadequate to deal with the problems that emerged with the development in the 19th century of standard form contracts (essentially, pre-printed contracts drawn up in advance by one party for use on more than the particular occasion). Standard form contracts can be extremely beneficial to both the parties provided that the standard terms strike a fair balance between them. Their use enables the parties to make complex contracts with a minimum of time and trouble in negotiating the terms; to standardise the risks they face, since each contract will be on similar terms; and to delegate the making of the contract to relatively unskilled personnel, as the legal complexities will have been sorted out in advance, leaving only such matters as the description of the goods or services, the price and the time for performance to be filled in.[9]

2.3                                      The proviso, that the standard terms strike a fair balance, is, however, a significant one. Before legislative controls were introduced many standard terms, particularly in consumer contracts but also in business-to-business contracts, were not fair. Since this consultation paper is not proposing any fundamental change in the way that terms should be controlled, it is not necessary to give a full account of the underlying problems, but a brief summary may help the reader. Some of the points that will be made here will turn out to be relevant to particular issues of detail which we have to consider later.

2.4                                      In the Suisse Atlantique case Lord Reid said of standard conditions:

In the ordinary way the customer has no time to read them, and if he did read them he would probably not understand them. And if he did understand and object to any of them, he would generally be told he could take it or leave it. And if he then went to another supplier the result would be the same. Freedom to contract must surely imply some choice or room for bargaining.[10]

Lord Reid’s statement highlights two different problems.

2.5                                      First, because the customer is simply shown or asked to sign the standard form, she may well not have the chance to read the terms, let alone understand them. Because the customer may not know of the terms, or may not understand their meaning or how they might impact on her, she may be taken by “unfair surprise”.

2.6                                      Secondly, even if the customer is aware of the term, he may find that the business is unwilling to remove (or alter) it. It has sometimes been suggested that this attitude on the part of business, and indeed the existence of unfair terms, is the result of “the concentration of particular kinds of business in relatively few hands”.[11] In fact there seems little evidence of this. Harsh terms are found even in relatively competitive markets.[12] This may happen although many customers would be willing to pay the additional amount that the business would have to charge were it to eliminate the term from all its contracts and accept the risk which the clause places on the customer. It may also happen that a business will refuse to change the terms for a customer who asks for more favourable terms. The business is unlikely to be willing to incur the cost of altering its conditions for a single customer.

2.7                                      The presence of harsh terms is more likely to be the result of customers in general being unaware of the existence or meaning of the non-negotiated terms. It may be that, even in a market in which there is competition over prices, if only a few customers ask for “better” terms, businesses will not offer them. Rather, the majority of customers will simply seek low prices and, to remain competitive, businesses will shift more and more costs onto customers through harsher and harsher terms. Customers, being largely unaware of the terms until it is too late, will not complain. As a result there will be a trend towards “low cost, harsh term” contracts.[13] Thus the market is inefficient in that many of the customers would have preferred better terms even if that would have meant them having to pay somewhat higher prices. It is only if a substantial margin of customers begin to seek better terms, or if some businesses decide to compete over terms (as, for example, car manufacturers have by offering longer warranties) that businesses generally will start to compete over these terms.

2.8                                      This may explain why our law, like every Western system of law,[14] has found it necessary to provide some controls over unfair terms, at least in standard form consumer contracts. In fact the controls extend beyond both consumer contracts and standard form contracts. These extensions have been justified in a number of different ways: on the grounds that business parties do not always realise what it is that they are agreeing to, or have the bargaining power to demand better terms; on the ground that problems of lack of understanding or of bargaining power can apply equally to clauses that were not drafted in advance by the other party;[15] or on the ground that the general law intends parties to have certain obligations and that these should not be reduced or limited.[16]

2.9                                      The courts in the UK developed some controls over unfair standard terms. First, they are sometimes able to hold that the clause has not become part of the contract if, for example, the term was printed on a sign or ticket and the party affected was not given reasonable notice of its existence.[17] This, however, will not protect a party who has signed a contract containing a harsh term; signature is taken to show agreement to the term.[18] Secondly, the courts can sometimes interpret the unfair term in such a way that it does not apply to what has happened.[19] However, this approach is always vulnerable in the sense that it will not work against a well-drafted clause.

2. A brief history of legislative controls over unfair terms in the UK

2.10                                      The principal control over unfair terms has been legislative. Until 1994 these controls centred on exclusion and limitation of liability clauses.

2.11                                      The first statute invalidating such clauses in contracts is said to have been the Canals and Railways Act of 1854.[20] Over the years various other controls were also put in place, for example by the Hire Purchase Act 1938. Wider controls, even of exclusion and limitation of liability clauses, did not come until the 1970s. In 1962 the Final Report of the Committee on Consumer Protection (the Molony Committee) had recommended a prohibition on sellers in consumer contracts “contracting out” of their implied obligations under the Sale of Goods Act 1893 (“SGA 1893”).[21] In 1966 the matter was referred to the Law Commissions, which in 1969 published the First Report.[22] This recommended a number of changes to the SGA 1893, including amendments to section 55 to prevent contracting out. The recommendations were put into effect by the Supply of Goods (Implied Terms) Act 1973 (“SOGITA”). SOGITA prevented any sellers from excluding or restricting liability under section 12 of the SGA 1893 (seller’s implied obligation as to title). In consumer sales sellers were prevented from excluding or restricting their liability under sections 13–15 of the SGA 1893 (merchantability, fitness for particular purpose and correspondence with description or sample); in other sales those liabilities could be excluded or restricted, but only to the extent that it could be shown to be fair and reasonable to allow reliance on the exclusion or restriction.[23]

2.12                                      In 1975 the Law Commissions published Exemption Clauses: Second Report (“Second Report”),[24] which recommended wider controls over exclusion and limitation of liability clauses. This resulted in UCTA, which incorporated, in slightly modified form, the controls in SOGITA.[25] It also imposed wider controls over exclusions and limitations of “business” liability both for breach of contract and for negligence in tort or delict. Certain exclusions or restrictions are made absolutely ineffective and others are subjected to a test of reasonableness. The protection of UCTA applies both to transactions between a business and a consumer and to many business-to-business transactions, particularly where a business deals on its own written standard terms. Despite its title, UCTA applies only to exclusion and limitation of liability clauses, broadly defined, and to indemnity clauses in consumer contracts. Thus other types of term were not subject to any statutory control. Some types of contract, for example contracts of insurance, were exempted from the operation of UCTA.[26]

2.13                                      UCTA contains separate provisions for England, Wales and Northern Ireland on the one hand and Scotland on the other. Part I of UCTA applies to England, Wales and Northern Ireland. (For brevity, in this paper we use “England” to include all three jurisdictions.) Part II applies to Scotland. Part III contains provisions which apply in all the jurisdictions. In this consultation paper, the relevant Scottish provisions of UCTA are cited in square brackets after the parallel provision for the remainder of the UK.

2.14                                      In 1993 the European Council of Ministers passed the Directive. This was implemented in the UK by the Unfair Terms in Consumer Contracts Regulations 1994 (“the 1994 Regulations”),[27]now superseded by UTCCR.[28] UTCCR apply a test of fairness to terms of any type (with limited exceptions for clauses defining the “main subject matter” and the price), provided that the term was not “individually negotiated” between the parties. UTCCR apply to all kinds of consumer contract. They also give powers to the Office of Fair Trading (“OFT”) and other bodies to prevent the use of such unfair terms in consumer contracts.[29]

2.15                                      The 1994 Regulations were made under section 2(2) of the European Communities Act 1972. Rather than attempt to amend UCTA to comply with the requirements of the Directive, it was decided to keep the implementing legislation separate and to follow closely the wording of the Directive. This approach has become known as “copy out”. In UTCCR, which were made in 1999 principally to give preventive powers to bodies other than the OFT, the opportunity was taken to follow the wording of the Directive even more closely than in 1994.

2.16                                      It is possible that the Council of Ministers may, in time, revise the Directive. Article 9 provides that the European Commission shall present a report to the European Parliament and the Council concerning the application of the Directive by the end of 1999. The Commission’s report is mainly in the form of a consultation paper on the working of the Directive and its possible reform.[30] Our paper assumes that the Directive remains in its present form.

3. A summary of the principal differences between UCTA and UTCCR

2.17                                      The outcome of the legislative history is two separate regimes dealing with unfair terms, UCTA and UTCCR. The differences between them will be explored in more detail in Part III, but it may be useful to summarise the principal differences at this point.

2.18                                      UCTA:

2.19                             In contrast, UTCCR:

4. Replacing UCTA and UTCCR with a unified regime

2.20                                      The first limb of the project, as set out in the first paragraph of our terms of reference, is a direct result of the legislative history described earlier.

2.21                                      The legislative approach of implementing the Directive via free-standing Regulations that “copy out” the Directive has some advantages. It is easier to ensure that the Directive has been implemented correctly if the implementing legislation is free-standing and largely follows the exact wording of the Directive, rather than being a series of amendments to UCTA. However, the approach means that there are two overlapping pieces of legislation, as UTCCR apply to exclusion and limitation of liability clauses as much as to other terms; and the way in which the two pieces of legislation operate, their concepts, definitions and terminology differ. For example, some clauses which would appear to be valid under UTCCR provided they are “fair” are in fact of no effect at all as a consequence of UCTA; others are subject to the “reasonableness test” under UCTA, but will be valid only if they satisfy both that test and the test of “fairness” under UTCCR.

2.22                                      The result is considerable complexity. This led to criticism as soon as the 1994 Regulations were made. The Editor of the Law Quarterly Review suggested that the UK may be in breach of its Treaty obligations because the law was not accessible to consumers.[31] The Department of Trade and Industry received complaints from businesses and consumer groups about the difficulties caused by the existence of the two regimes. In its Consumer White Paper published in July 1999,[32] the DTI announced that research would be carried out into how the law might be improved. It recognised that it would be a complex task because the replacement regime must continue fully to implement the EC Directive. After preliminary research had been carried out for the DTI by Dr Simon Whittaker of St John’s College, Oxford,[33] the matter was referred to the Law Commissions.

2.23                                      The first limb of the project is therefore to consider the desirability and feasibility of combining the two pieces of legislation into a unified regime that must, of course, comply with the Directive. We consider that a single regime must in principle be preferable if it can be achieved without compromising the various policy objectives which we set out in Part IV. That Part is principally concerned with how the regimes might be combined. Consultees may then see what we believe would have to be done and will thus be able to comment on whether they think a unified regime is desirable.

2.24                                      Control over terms in consumer contracts obviously involves striking a balance between the interests of the consumer, or the body of consumers, who might buy the particular product or service, and the interests of the business. In some situations it can be argued that there is in fact no conflict: what consumers want and what businesses would be happy to provide is in fact the same, but information problems of the kind described earlier[34] may prevent the parties reaching an efficient outcome. In other situations, interests may diverge. The individual consumer may find a term unfair while the business may feel that the particular consumer should not have greater rights than provided for in the contract, given the consumer’s agreement to the contract and the price that the consumer was charged. Even for future contracts, the business may feel that the “better terms” being demanded by the consumer may cost the business more than it will be able to make up through any increased sales.

2.25                                      To invalidate a particular type of clause in all circumstances can only be justified if a clear case can be made that it will almost always be unfair to the consumer. Under UCTA only certain types of clause are invalid in all circumstances. More usually, in deciding whether the term was fair and reasonable, the question of the appropriate balance is left to the court to determine. Under UTCCR the question is always left to the court to decide. But the choice of what types of clause should be subject to the courts’ control also involves striking a balance. Should, for instance, only exclusions and limitations of liability be subject to control, or should the controls apply to any type of unfair clause? Should the controls only apply to clauses which were part of a standard form contract and not negotiated, or should the consumer have the possibility of challenging a clause even if there was some degree of negotiation over it when the contract was made?

2.26                                      There is also a question of balance in a second, different sense: a balance between fairness and certainty. The wider the powers of the court to declare a clause invalid because it is unfair, the greater the uncertainty faced by the business.[35]

2.27                                      The principal issues of balance of both types were decided by Parliament when UCTA was passed in 1977 and by the Council of Ministers when the Directive and the SCGD were issued in 1993 and 1999 respectively. It is not part of this project to change this balance in a major way. The Directive imposes minimum requirements of consumer protection. These must be maintained. Within its limited field of application, UCTA goes somewhat beyond the Directive. We will argue later that there should be no significant reduction in the protection which UCTA currently gives consumers. Conversely, it is not part of the provisional proposals of this consultation paper to increase consumer protection significantly. What is being considered is essentially the simplification of the legislation so that it will be easier for businesses to comply with it and easier for consumers and their advisers to discover the consumer’s rights.

2.28                                      However, if the legislation is to be made less complex, there will probably have to be slight changes in the balance between business and consumer, and between fairness and certainty, on particular points. This is simply because the two pieces of legislation adopt different techniques of control; unifying them will produce somewhat different results in some cases. To that extent “consumer policy” (other than the need to simplify in itself) will occasionally be in issue. The issues will be addressed in detail at the relevant points of the paper. It is our provisional view that none of them raises major questions of balance between business and consumer.

2.29                                      Although we do not propose any major changes in the degree of protection from unfair terms afforded to consumers, it is our provisional view that the changes we propose would go a long way to meeting a very real need for simplification of the law. They would make the law simpler for both businesses and consumer advisers to understand and apply, and would reduce the burden on businesses that deal with consumers in having to comply with two overlapping and different regimes.[36]

5. Extending the scope of UTCCR to protect businesses

2.30                                      As we indicated above, UCTA applies to terms in contracts between one business and another as well as to terms in consumer contracts, in most cases providing that the relevant terms will be valid only if they satisfy the requirement of reasonableness.[37] However, UCTA applies only to various kinds of exclusion and limitation of liability clause.[38] UTCCR apply to a significantly wider range of terms, but only when those terms are in a consumer contract. Many of the terms to which UTCCR apply but UCTA does not, may be unfair not only in a consumer contract but also in a business-to-business contract, especially where the business against whose interests the term operates is small. The DTI received various complaints from business;[39] it is these which led to the second limb of the reference to the Law Commissions.

2.31                                      This part of the project is covered in Part V of this consultation paper. At this stage we note that to extend the controls in the way that we are asked to consider would involve a somewhat greater change in balance than would our provisional proposals for consumer contracts. The change would not be of balance in the same sense that we discussed in the previous section. Since by definition we are dealing not with consumer contracts but with business-to-business contracts, the balance between business and consumer would not be affected. Rather, the change in balance might be of two other kinds. First, were the extension to be in favour of small businesses only, there would be a change as between small businesses and larger concerns. Secondly, there would again be a change in balance between fairness and certainty.[40] Each of these points is discussed in more detail in Part V.

2.32                                      When we examine UCTA in more detail we will see that its definitions of the various kinds of exclusion and limitation clauses to which it applies, particularly the clauses that fall within section 3(2)(b) [s 17(1)(b)], are wide: the latter covers any clause which purports to allow a business to perform in a way that the other party will not reasonably expect, or not to perform at all. Thus clauses allowing a change in the goods to be delivered, or the services to be provided, are potentially within UCTA. So are clauses allowing the business to cancel the contract or any part of it. What are not covered are clauses which impose on the other party greater obligations than it might reasonably have expected; for example, to pay an increased price or to be bound to the contract for longer than it expected. It is our provisional view that, with UCTA covering so much already, to bring these clauses within the controls also would not be a major change.

2.33                                      Further, as part of our consideration of how the existing controls should be incorporated into the proposed new legislation, we raise the possibility of removing some of the controls that at present UCTA imposes over exclusions and limitations of liability in business-to-business contracts. We argue that the real problems in business-to-business contracts lie with terms that have not been negotiated and that the UCTA controls over terms of business-to-business contracts that have been negotiated might be removed. This would counterbalance any extension of control.

2.34                                      As with the first part of the project, it is our provisional conclusion that even though the changes we suggest would not be major, they would deal with types of unfair term that have caused very real problems to a number of businesses.

6. Making the new legislation “clearer and more accessible to the reader”

2.35                                      The Law Commissions are under a statutory duty to keep the law under review for a number of purposes, including its simplification.[41] We believe that an important aspect of our duty is to try to make the law more accessible. This means accessible not only to lawyers but, particularly where the law has an impact on the day to day life of individuals or the day to day operation of businesses, to the individuals or businesses concerned. Legislation on unfair terms is an example. It is relevant to businesses and consumers when contracts are being made, not just when a dispute has arisen and litigation is contemplated. That the legislation should be comprehensible to the business people and to the consumers affected is almost certainly unattainable in practice. However, we think that the legislation should at least be capable of being understood by consumer advisers, many of whom are not legally qualified, and by any person in business who has some knowledge of contracting.

2.36                                      The Law Commissions seek to make any draft legislation for which they are responsible as clear as possible. However, often there is a trade-off to be made between transparency of structure or language and conciseness. In this project we have provisionally decided to try to produce legislation that can readily be understood by consumer advisers and business people, even if this means that the new enactment is somewhat longer than the statute it is designed to replace. We have been inspired by the example of the Tax Law Rewrite project.[42] The third limb of the terms of the current reference:

Making any replacement legislation clearer and more accessible to the reader, so far as is possible without making the law significantly less certain, by using language which is non-technical with simple sentences, by setting out the law in a simple structure following a clear logic and by using presentation which is easy to follow

is taken from the published aims of that project. We refer to this part of our project as making the legislation “clearer and more accessible”.

2.37                                      This has called for a procedure which is different from our usual practice of appending draft legislation only to the final report. It is difficult to argue against the abstract idea of making legislation more easily understandable. The real question is whether it can be achieved without undue length and loss of precision. We know of no way of discovering this, and of allowing consultees to judge our efforts, other than to include some examples of the draft in the consultation paper. Therefore this consultation paper contains draft legislation prepared by Parliamentary Counsel. It is not a complete draft; it seemed sensible to do only part of the work and offer that as a sample, so that if consultees consider the new approach to be unacceptable or not worth pursuing, too much time and effort will not have been wasted. We have therefore drafted provisions dealing with the main points which arise in relation to consumer contracts and contracts between private persons (that is, where neither party is acting in the course of a business), and in relation to terms and notices excluding liability for negligence. Only part of the indicative list is covered,[43] and the draft does not deal with the powers of the OFT and others to prevent businesses using unfair terms.[44] Equally, the clauses dealing with terms in business-to-business contracts and various ancillary provisions have not been included, though obviously Counsel has kept in mind what would be needed as this affects the drafting of the clauses which are included.

2.38                                      In order to draft these clauses it was necessary to make assumptions about what the substance of the law should be. For this purpose, and this purpose only, we have treated our provisional proposals as if they were final. We must stress that this is completely without prejudice to our final recommendations. Inclusion of a particular approach or decision in the draft does not create any presumption that, at the end of the day, it will be adopted in the report. Moreover the inclusion of the “clear and accessible” draft does not create any presumption that our final recommendation will be to adopt this drafting technique.

2.39                                      As will be explained in more detail in Part VII, the principal change between the new draft and UCTA is in structure. The language used is changed less, if only because the legislation has to deal with technical legal terms. We have of course endeavoured to provide explanations. The draft also attempts to set out explicitly some of the hidden complexities of the existing legislation, particularly of UTCCR. As will be seen, we are sufficiently convinced that the draft is a significant improvement over both UCTA and UTCCR that we provisionally propose that the new approach should be adopted. We believe that improving the accessibility of the law in this way would enable businesses to comply with their obligations more easily and make it more straightforward for both consumers and businesses to understand and obtain recognition of their rights.

7. The impact of our proposals

2.40                                      We have indicated our provisional view that, in each of the three parts of this project, the changes we propose would (in terms of the substance of the law) be marginal or, in the case of the extension of controls in business-to-business contracts, modest; but that each part would produce changes that would satisfy real needs. In order to assist us in evaluating our provisional proposals before we make final recommendations, it would be very helpful to have, from consultees who are in a position to supply it, evidence about the costs and benefits of the proposals.

2.41                                      We invite comments on the practical and economic impact that our proposals would have on both consumers and businesses.