UK: Proposed Changes to The Consumer Credit Regime, Including Reforms Concerning Consumer Credit On-Line

On 8th December 2003, the DTI published a White Paper entitled "Fair, Clear and Competitive--The Consumer Credit Market in the 21st Century" (the White Paper) as part of its review of the Consumer Credit Act 1974 (CCA), including proposed changes to regulate the conclusion of on-line consumer credit agreements.

The White Paper outlines the Government’s proposals for reform of consumer credit under a number of headings including: (i) establishing a more transparent regime by (a) changing the advertising regulations to make credit advertisements clearer and simpler for consumers to understand, (b) providing consumers with clearer information before and after agreements are signed, (c) changing the law to prevent those who settle loans early from being penalised and (d) enabling consumers to enter into and conclude agreements on-line; (ii) creating a fairer framework that encourages competition while stamping out irresponsible and unfair lending practices by (a) strengthening the credit licensing regime to target rogue and unfair practices, (b) changing the law to end unfair selling practices, including replacing a limited extortionate test with a wider unfairness test and providing an effective dispute resolution mechanism and (c) removing the £25,000 financial limit that creates a two tier lending framework and impedes consumer protection; (iii) shaping the European agenda, particularly in the context of two draft Commission Directives in the consumer credit sector (mentioned below); and (iv) minimising over indebtedness (although we do not focus on this proposal below).

Separate consultations on the proposed draft regulations giving effect to the changes proposed on consumer credit advertising, early settlement of credit agreements, credit agreements’ form and content and also on the alternative dispute resolution mechanism regarding consumer credit related disputes were published in conjunction with the White Paper. Whilst as part of these consultations, proposals on consumer credit online were put forward, no draft legislation has been published as yet.

In September 2002, the European Commission published a draft Directive on consumer credit (COM (2001) 443 final), (Consumer Credit Directive). This aims to fully harmonise the laws on consumer credit in the Member States. The White Paper indicates the issues that the Consumer Credit Directive will need to address, such as fair and equal cross border data access and exchange, the adoption of an EU wide approach to regulation of consumer credit information, advertising and unfair practices, common rules on APR calculations, barriers to cross border debt collection and recovery practices, an effective out of court redress mechanism and an effective passporting regime for lenders wishing to market and sell credit products cross border.

Additionally, on 18th June 2003 the Commission published a draft Directive as a harmonisation measure, on Unfair Commercial Practices in the field of consumer protection (COM (2003) 356 final). This draft Directive contains a prohibition on Unfair Commercial Practices and highlights two principal categories of Unfair Commercial Practices: misleading commercial practices (actions as well as omissions) and aggressive commercial practices. In each case, the Directive sets out criteria to establish whether a practice is misleading or aggressive and includes an annex containing a non-exhaustive list of examples of unfair commercial practices intended to demonstrate further application of the criteria. The DTI have concerns about the possible impact of this "cross cutting measure" as they describe it, on highly regulated sectors such as financial services and are consulting separately on it.

Of particular concern to lenders and regulated firms, will be the impact of the new regulations on existing agreements. New regulations relating to advertising, form and content rules, on-line facilitation (including cancellation/withdrawal rights), early settlement and unfair credit test rules will probably be effective from October 2004 for agreements entered into after that date. New regulations enabling consumer credit on-line will probably be implemented by an order under the Electronic Communications Act 2000. The early settlement rules will probably apply to existing loans from October 2006. Whether to apply the unfair credit test rules (indicated below) to existing agreements is also being considered. The Treasury implementation of the Directive on the Distance Marketing of Consumer Financial Services (the DMCFS), (Directive 2002/65/EC) should also be noted.

The consumer credit market broadly comprises secured lending (other than those first mortgages to be regulated by the FSA from 31 October 2004), credit cards, loans, mail order, hire purchase, store cards and credit unions.

Subject to certain exceptions, the CCA currently regulates consumer credit, consumer hire and related agreements for amounts up to £25,000. Credit includes any form of financial accommodation. Its protections apply to agreements with individuals (defined to include partnerships and other unincorporated bodies, unless all the members are corporate bodies). Additionally agreements for the bailment of goods are regulated consumer hire agreements under the CCA, subject to certain conditions. The CCA lays down rules covering: the form and content of credit agreements; credit advertising; the method of calculating the Annual Percentage Rate (APR) of the Total Charge for Credit; the procedures to be adopted in the event of default, termination, or early settlement; and the provision of remedies in cases of extortionate credit bargains.

A short summary of the key provisions of the White Paper is set out below.

The White Paper’s proposals relating to consumer credit advertising will apply to all forms of media used to advertise credit. The new regulations will apply where financial information is included in the advertisement, or certain statements are made regarding the credit itself or to whom it is targeted. The existing categories of simple, intermediate and full credit advertisements in the 1989 Regulations (Consumer Credit (Advertisements) Regulations 1989 SI 1989/1125, as amended) will be replaced with new requirements clarifying and simplifying credit advertisements for consumers and making the regulations easier for authorities to enforce.

Various changes are proposed in respect of provision of basic information to consumers, including the fact that the lender’s name must be included in all advertisements. Advertisements including no financial information will only have to comply with the overall requirements that advertisements be clear, fair and not misleading. However, where the company/web-site name quoted makes any subjective claim about the nature of the products offered there will be a requirement for the APR to be shown.

There are also various proposed changes relating to the requirement to show APR, e.g., where any interest rate is quoted in the advertisement, the APR must also be displayed. Where the APR is displayed this may be done without the requirement to include any other financial information. However, where other financial information is included, APRs must always be located with, more prominent than and double the size of any other financial information in the advertisement. Where advertisements advertise multiple products with different APRs, all APRs must be given identical prominence. APRs must also be quoted in other circumstances, e.g. where the credit amount/range is described.

Where a credit advertisement includes any of the items of information listed in Schedule 2 to the draft regulations (page 57 of the Consultation on proposals for regulations), apart from the amount of credit, the advertisement must include every other item of information listed in that Schedule. All those indicators must be shown together and be given equal prominence. Such indicators include (among other things) the deposit (if required), the advance payment (if required) and the total amount payable. Whenever the key indicators are required to be included, the APR (as defined) will also have to be displayed in the same place as the other information and twice the size and more prominent. The same approach will apply to hire agreements with a separate set of key financial indicators.

APRs quoted in advertisements, must be representative of the business they are expected to generate. Advertisements must quote the highest APR that at least 66 per cent of the eventual number of consumers formally accepting a credit agreement in response to the advertisement are expected to be given. This accords with the FSA’s proposed approach on mortgage regulation.

Where interest rates for products will vary according to the applicant’s credit-worthiness (personal pricing) lenders may quote a typical APR. Again, this will have to be the highest rate reasonably expected to be given to at least 66 per cent of the eventual number of consumers who accept a credit agreement in response to the advertisement.

Advertisers may also quote from APR. This must be based on 10 per cent of business written and be accompanied by the corresponding "to APR" based on 90 per cent of business written. The 66 per cent typical APR must always be shown twice the size and more prominently than the upper and lower figures.

A single method of calculating APRs based on a single set of assumptions, for running account credit so consumers can easily compare different advertisements is to be introduced and the relevant regulations will be amended accordingly. In respect of credit cards, one of the assumptions proposed is that the rate used to calculate the APR must be the standard rate for purchases because this is a credit card’s primary purpose.

Secured lending advertisements stating that offered products will be secured by a charge over the borrower’s home must include a wealth warning.

Certain essential information must be given to consumers prior to entry into credit agreements to allow them to consider the information before deciding whether to enter into the Agreement. This includes certain information concerning the creditor, credit (e.g., information relating to interest rate, repayments, early settlement information, security etc.), the agreement itself and redress. The precontractual information must be provided in a form that does not form part of the credit agreement and must precede it. The draft regulations set out specific precontractual information requirements in the case of voice telephone communications.

These pre-contractual information requirements will incorporate the pre-contractual information requirements set out in the DMCFS and extend them to all consumer credit agreements, regardless of whether they have been concluded at a distance.

Sometimes the interest rate charged will depend on the lender’s assessment of the individual applicant’s credit worthiness. Whether it is feasible for consumers to be made aware in the precontractual information of the rate they will pay before committing to a credit agreement is being considered. The pre contractual information must also include a statutory wealth warning for any loans secured on homes.

For fixed sum variable rate credit agreements an illustration of how interest rates rises will increase payments will be required and the overall amount paid tailored to the individual loan.

The FSA proposed rules and guidance on the DMCFS raised the issue of whether for successive operations, the pre-contract information requirements must be continually adhered to. Article 1.2 of the DMCFS provides that for contracts for financial services comprising an initial service agreement followed by successive operations or a series of operations of the same nature, performed over time, the provisions of the DMCFS shall only apply to the initial agreement. Where there is no initial service agreement, but there are further operations of the same nature between the two parties, the pre-contract information requirements apply only when the first operation is performed, provided there is less than a year between operations. It will be interesting to see how this is implemented by the DTI and the Treasury.

Regulated credit and consumer hire agreements will have to contain certain core information comprising main financial details and key statements as to the consumer’s rights and responsibilities immediately following the parties’ names and agreement description. The new statutory wealth warning for unsecured lending stating that "missing payments will have severe consequences and may make obtaining credit more difficult in the future" is also being introduced. Where applicable, information will also be required relating to "Your Home", "Your Responsibilities", early settlement, cancellation, Hire Purchase, lost/misused cards, exchange-rate/cross border charges and pawned goods. The Consumer Credit (Agreements) Regulations of 1983 will be amended accordingly.

A "summary box" has been proposed to ensure consumers are fully aware of all charges in a standard format to aid making comparisons.

Payment protection insurance (PPI) and similar policies sold in conjunction with credit agreements which are also funded by credit, will have to be sold in the same clear and transparent manner as the credit product. Products like PPI can remain within one document with the credit product, however separate sets of main financial details for the credit product and each insurance product purchased on credit, statements of combined total charges for credit and separate signatures for each product will be required.

Under consideration is the issue of "consent indicators". Signatures will be required for paper agreements or possibly another consent indicator for electronic agreements at the end of the agreement and by any separate product purchase. Terms and conditions of credit agreements must be no less prominent than the rest of the Agreement.

It is proposed that consumers will regularly be made aware of the outstanding amount they owe and be informed if they fall into arrears or incur additional charges attracting interest. Other post contractual information requirements will include warnings regarding the implications of only making minimum payments on credit card debts and the consequences of defaulting. The possibility of introducing repayment scenarios into regular credit card statements is also under discussion.

The changes here will encompass the relevant requirements of the Electronic Commerce Directive (ECD) (Directive 2000/31/EC, Article 9) and the DMCFS. The Government wishes it to be possible, but not mandatory to contract electronically. The CCA was conceived with paper in mind and there is currently no clear provision for facilitating or regulating the conclusion of electronic contracts.

The CCA (s61(1)(c)) requires that when regulated agreements are presented to the consumer for signature, all their terms must be readily legible. This will be retained, although in an online environment it is unclear what this means as it is acknowledged that it is not necessarily appropriate to prescribe a minimum font size for computer screen text, which can easily be altered by the consumer. However, at page 75 of the Consultation on proposals for regulations, the draft regulations provide "None of the lettering in an agreement shall be less prominent than the rest, except that headings may be afforded more prominence whether by capital letters, underlining, larger or bold print or otherwise".

The regulations implementing the ECD require that the terms and conditions of the contract be provided to the recipient in a form that enables the recipient to store and reproduce them. The DMCFS contains a similar requirement employing the durable medium terminology. There will be a requirement for consumers contracting on line, to receive copies of the documentation received from the lender, in a form which can be stored on a durable medium, however lenders will not have to determine, in advance of agreeing to contract electronically, whether the consumer has the capability to be able to store and reproduce them electronically.

Termination and default notices will still require to be sent in paper format to protect consumers’ interests. However, lenders may send such notices in both electronic and paper versions if they wish.

Generally, the medium for contract conclusion should determine the way notices should be delivered to the consumer. Accordingly, where consumers agree to conclude credit agreements electronically, future communications should also be electronic, subject to the termination and default notice requirements. However, Article 5.3 of the DMCFS will require that Member States ensure "the consumer is entitled to change the means of distance communication used unless this is incompatible with the contract concluded or the nature of the financial service provided" and it is proposed that lenders/consumers will be able to amend the means of communication. Lenders will be entitled to charge ‘reasonable’ fees, should the change in communicating method be at the consumer’s request and be more costly to the lender.

The issue of whether delivery should be deemed to have been effected 48 hours after transmission of electronic communications is being considered.

The Consumer Credit (Agreements) Regulations 1983 1983/1553, as amended, will be amended to ensure the adoption of a technology neutral approach so the prescribed information and layout of agreements will be the same regardless of the method of contracting.

One particular form of digital signature is unlikely to be mandated to conclude agreements on-line. Regulations will determine how the consumer’s consent is to be indicated.

Copies of documents may be provided electronically including the original executed copy of the agreement, provided the consumer has agreed he will communicate electronically and the lender ensures the copy he retains can be stored in a durable medium and reproduced any time. As already provided in the CCA (s77-78), consumers will be able upon payment of a prescribed fee to request a copy of the executed agreement at any time during the course of the agreement.

With regard to the right to cancel, or withdraw without penalty, or rescind a consumer credit agreement, the CCA provides detailed rules on cancellation/withdrawal, regulation 15 of the Electronic Commerce (EC Directive) Regulations 2002/2013 provide a right of rescission in certain circumstances, the DMCFS in Article 6 provides for a right of withdrawal and the proposed revised Consumer Credit Directive also provides for a consumer right of withdrawal in certain circumstances.

More particularly, the draft revised Consumer Credit Directive at Article 11 states that, the consumer should have a period of 14 calendar days to withdraw his acceptance of the credit agreement, without reason. The DTI are of the view that the opportunity should be taken to make all credit agreements subject to a cancellation/withdrawal period of 14 days, although no draft regulations have been published as yet. However, the extension of the right to non-distance agreements in the case of products regulated by the FSA is unlikely to be mandated. Note that Article 6.2(c) of the DMCFS provides that the right of withdrawal will not apply to "contracts whose performance has been fully completed by both parties at the consumer’s express request before the consumer exercises his right of withdrawal."

Proposals regarding early settlement of credit agreements include replacement of the Rule of 78 (set out in the Consumer Credit (Rebate on Early Settlement) Regulations 1983) with a new early settlement formula. Generally, this formula has been criticised as providing an insufficient discount for early settlement in the context of long term loans secured on property. Although these criticisms are directed specifically to unregulated secured lending, Paget points out that the underlying reasoning is equally applicable to any long term loan (see Paget’s Law of Banking, Twelfth Edition, page 52). The White Paper takes the position that this rule can result in substantial benefits to the lender as the settlement fee is not necessarily in proportion with the actual "breakage" costs associated with repaying the loan early. The new regulations will prescribe a formula based on actuarial principles to determine the maximum amount payable on any particular loan.

Lenders will be required to respond to early settlement quotation requests within seven working days from the date of the request as opposed to 12 working days as currently allowed.

Lenders rights to postpone the settlement date of a loan will be limited to 28 days from the date of the consumer’s request. Consumers may request longer deferments if they wish.

Lenders will be permitted to recover an additional one month’s interest only above the settlement figure for loans of more than one year, towards their costs. This will not generally apply to loans under 366 days.

Lenders must provide three examples (tailored to the specific loan) of early settlement in the precontract information (representing the costs of settlement at the quarter, half and three quarters stages of the repayment period) as part of the key financial particulars to be provided pre-contract.

A licence is required for the carrying on of a consumer credit, or consumer hire business (s21(1) CCA) and ancillary credit businesses (see CCA s145(1) for types of ancillary credit business). Applicants must satisfy the Office of Fair Trading (OFT) they are "fit" to carry on the relevant business. The relevant tests focus on past failings as evidence that traders are unfit to hold licences, but do not expressly consider traders’ abilities to conduct their credit businesses in a fit manner in future. The Government wants to strengthen the current fitness test to hold a licence so the OFT can look back at applicants’ past conduct and forward in assessing their competence to run their credit business. The OFT will produce initial guidance on the fitness standards required for the conduct of credit businesses.

The Government proposes to move from a system where licences are renewable every five years to one where the OFT can grant licences for indefinite periods with periodic licence maintenance payments.

The licensing system will be updated to include development of new categories of licensable activity such as credit repair, which are currently not covered. The Secretary of State for Trade and Industry will be allowed to vary the activities for which a licence is required for ancillary activities.

The OFT will be able to seek additional information from licensees and third parties including e.g. the requirement to produce books, documents and records. Licensees will be required to notify the OFT on an ongoing basis of any material changes in circumstances relating to their fitness to hold a licence.

The OFT will also be able to impose special conditions on or take undertakings from licence holders. Breaching such conditions or undertakings could result in a financial penalty or ultimately result in a revocation of the licence. Decisions to impose conditions or financial penalties would be subject to the same procedural safeguards and rights as decisions to refuse, revoke or vary a licence.

The Appeals process against the OFT’s licensing decisions will be made more transparent and there will be a revised licence fees structure reflecting the new regime.

The limited extortionate credit bargain test in the CCA will be replaced with a wider unfairness test (see below) making credit agreements easier to challenge. Currently a credit bargain is deemed to be extortionate if it requires a borrower to make payments which are grossly exorbitant or otherwise grossly contravene ordinary principles of fair dealing (see CCA ss138). The CCA already allows the court to re-open a credit agreement in these cases so as to do justice between the parties. The present definition has resulted in few successful court cases and the current test is regarded as unsatisfactory in various ways, including because of the fact that the courts have not tended to examine events which post date the agreement.

The Government intends to make it easier for consumers to challenge unfair agreements and for individual consumers to seek redress through an accessible ADR system. A new test in respect of "unfair credit transactions" will be introduced which will widen the current "extortionate bargain" definition and will allow account to be taken of unfair practices, e.g. whether the lender/any broker has misled, coerced or otherwise unduly influenced the borrower regarding the transaction and also of unfair credit costs (whether credit payments substantially exceed market levels). It is intended that the legislation and OFT guidance will provide clear guidance to businesses, the courts and ADR adjudicators in determining the fairness of credit transactions.

The concept of responsible lending, setting out certain lender obligations in providing credit may also be introduced, including requiring that reasonable steps be taken to ensure a consumer’s credit worthiness and ability to meet the full terms of the agreement at the time it was concluded. This concept is proposed by the Commission at Article 9 of the draft Consumer Credit Directive. The White Paper suggests that creditors should be expected to undertake proportionate enquiries, having regard to the type of agreement, their relationship with the customer and the costs and risks involved.

Designated bodies will be allowed to bring actions on behalf of the collective interests of consumers requiring a trader to refrain from engaging in conduct which constitutes an unfair credit practice.

The Government believes industry codes of conduct can help effect change within the lending sector and that all creditors should be covered by and comply with principle based codes of practice.

The Government intends to remove the £25,000 financial limit in respect of credit agreements and reexamine current exemptions under the CCA, but retain the limit for all business lending to unincorporated bodies (sole traders, partnerships up to and including three partners and other unincorporated bodies not consisting of bodies corporate). Because the personal and business affairs of people running small business may be intermingled, the DTI argue, they should receive the same protection in their business capacity as is afforded to them as consumers.

Many lenders offering secured loans are exempted from the CCA under generic exemptions. The most important exemptions for banks and building societies are certain mortgage loan agreements (s16 CCA) and agreements where the payments to be made by the debtor do not exceed a specified number (s16(5)(a) CCA), or the rate of total charge for credit does not exceed a specified rate (s16(5)(b) CCA). However, provisions dictate that some lenders, but not others, must be named in an order under s16 of the CCA for their loans to be exempt. Retention of such exemptions is being considered.

Abolition of the financial limit must be considered alongside s127 CCA. S127 CCA governs the enforceability of agreements and sets out powers a court has to enforce a regulated agreement. Under the CCA (s127), the court cannot make an enforcement order if the agreement is improperly executed and certain other formalities have not been complied with, such as where it is a cancellable agreement, but the duty to give notice of cancellation rights under s64(1) CCA was not complied with. With the £25,000 ceiling being removed lenders could be exposed to greater liability where agreements are held to be unenforceable. Proportionate proposals to balance the need to ensure the statutory requirements are met against the financial consequences of unenforceability for lenders will be introduced.

Abolition of the financial limit has concerned the lending industry regarding their increased exposure to liability when varying /supplementing existing credit or hire purchase agreements. Because the formal requirements which must be followed if the new agreement is to be enforceable with regard to modifying consumer credit and consumer hire agreements (s82 CCA) are regarded as overly complex leaving lenders exposed to arguments on unenforceability, the DTI is consulting on whether reform is needed in this area. A consensual variation of a credit agreement gives rise to a modifying agreement. If a modifying agreement varies or supplements an earlier agreement it is treated as revoking it and reproducing the combined effect of both agreements (s82(2)). Accordingly, it must if regulated, comply with all the provisions concerning the entry into agreements (see Paget’s Law of Banking. Twelfth Edition, page 53).

Consideration is ongoing regarding clarifying how transparency for consumers and legal certainty for lenders can be achieved in respect of agreements packaging together different credit products which fall within more than one statutory category, as such agreements must comply with the relevant statutory requirements for each category.

Clearly the regulations resulting from the White Paper’s proposals will have far reaching implications for all providers of consumer credit products and services. Those lenders subject to the CCA and those firms to which the Treasury implementation of the DMCFS will apply must carefully monitor the developments and not delay (as the final regulations are published) in reviewing their advertisements and terms and conditions to ensure that they comply with the new regulations.