W. C. H. Ervine
*Abstract – This essay reviews the ineffective provisions of the United Kingdom’s original Consumer Credit Act 1974 designed to regulate what it termed extor-tionate credit bargains, and the reasons for their failure. It goes on to analyse the new rules which will shortly replace them when the Consumer Credit Bill 2005 becomes law and concludes that there are grounds for expecting that consumers will be much better protected by these new provisions.
The United Kingdom’s consumer credit legislation has been undergoing a thorough review for the past few years, culminating in the introduction of the Consumer Credit Bill into Parliament in May 2005.1This bill and the reforms effected by secondary legislation2represent a major overhaul of the system of regulation brought about by the Consumer Credit Act 1974. One of the most interesting aspects of the current reforms is the attempt to deal with socially harmful lending and it is with this issue that this paper is concerned.
As a number of reports3on this area in the UK have stressed, the vast majority of credit transactions do not result in any difficulties and most trad-ers act in a responsible manner. However, there is a minority of transactions which do give cause for concern. The DTI’s consultation paper,Tackling Loan Sharks – and More !, summed up the situation in this way :
Most credit, for most consumers, most of the time causes no problems.
However there is an ongoing concern about some activities mainly on the
* Senior Lecturer, University of Dundee.
1 A very similar bill was introduced in December 2004 during the previous parliament but did not complete all its stages before the general election in May 2005. For the background to these bills and an overview of the areas with which they deal see Lominicka, The Future of Consumer Credit Regulation, [2003/2004] CIL 184.
2 See the Consumer Credit (Advertisements) Regulations 2004, the Consumer Credit (Agreements) (Amendment) Regulations 2004, the Consumer Credit (Disclosure of Information) Regulations 2004 and the Consumer Credit (Early Settlement) Regulations 2004 in June 2004, the Consumer Credit (Miscellaneous Amendments) Regulations 2004 in October 2004 and the Consumer Credit Act 1974 (Electronic Communications) Order 2004.
3 Office of Fair Trading, Unjust Credit Transactions, London 1991, (hereafter OFT 1991), E. Kempson and C. Whyley, Extortionate Credit in the UK – A Report to the DTI, DTI, London 1999 (hereafter Kempson and Whyley), National Association of Citizens’ Advice Bureaux, Daylight Robbery – The CAB case for effective regulation of extortionate credit, London, 2000 (hereafter Daylight Robbery), Fair, Clear and Competitive, Cm. 6040 (2003) (the White Paper).
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margins of the market that can be described as socially harmful lending, i.e.
transactions where the costs of credit (in terms of price and associated terms and conditions) substantially exceed levels which would be generated by a fully competitive market and/or are so oppressive or exploitive that no sensible person, independently advised, would find them acceptable.4
The nature and scale of the problem are difficult to assess. The Crowther Committee in 1971 was troubled by the very burdensome nature of the com-mitments taken on by some consumers and devoted a chapter to the subject.
They concluded that there was “a level of cost above which it becomes socially harmful to make loans available at all” and that some potential borrowers were of such poor financial standing that they “ought not to be eligible for loans from the private sector.”5 The Office of Fair Trading, when it came to review the controls on socially harmful lending introduced by the Consumer Credit Act 1974, noted that “There is indeed no documented evidence about the extent of extortionate credit in the United Kingdom.”6The experience of the Office and the views of both consumer and industry sources led it to con-clude that “… credit transactions of the sort which so troubled the Crowther Committee, and at which the extortionate credit provisions of the Consumer Credit Act were targeted, continue to take place and, indeed, the concerns are now wider.”7Later research conducted on behalf of the DTI by Kempson and Whyley confirmed this view. Those most likely to be affected are among the most vulnerable consumers who, as the OFT’s 1991 report had put it, engaged in “necessitous borrowing for the management of poverty rather than the facilitation of affluence.”
Kempson and Whyley found that the types of lending institution that gave most cause for concern fell into two groups. The first was what they called the alternative credit industry. This part of the credit industry is of long standing and caters for low-income households that require small sums of money for relatively short periods of time and are not served by the main-stream credit market. This part of the market comprises companies who lend money and collect repayments in person from borrowers in their homes, pawnbrokers, mail order companies and, a more recent entrant to the mar-ket, cheque cashers. The other group is referred to as non-status lenders ; it comprises financial institutions that cater specifically for people who need the kind of credit services that mainstream lenders provide but do not have access to them because of their poor credit record.
4 Department of Trade and Industry, London, 2003, para. 2.1.
5 Consumer Credit : Report of the Committee (Cmnd 4596) 1971 (hereafter Crowther) para 6.6.6.
6 OFT 1991 para. 4.5.
7 Ibid. 4.14
Regulating Socially Harmful Lending : Reform in the United Kingdom The lending factors that are associated with potentially extortionate lending relate to both the substance of the transaction and lending practices.
Substantive factors involve high rates of interest and charges and onerous ditions. The onerous conditions include dual rates of interest involving con-cessionary rates which can easily be lost, often for trivial defaults, and never regained.8Lending practices that have caused concern are the targeting of vul-nerable people for whose problems credit may not be an appropriate solution, the use of high pressure sales tactics, failure to check the ability of borrowers to repay and even the falsification of income data on application forms.
Kempson and Whyley concluded that “Only a relatively small number of people use lenders who offer credit agreements that would be considered ex-tortionate in most people’s eyes – possibly no more than a hundred thousand people at any one time.” However, they went on to point out that :
… there are many more (indeed millions) who borrow in the alternative and non-status markets and are potentially at risk of extortionate terms on their loans. Consequently, the terms and conditions attached to credit from some lenders present a bigger problem in relation to extortionate credit than interest rates alone. This is exacerbated by the fact that terms and conditions are less transparent than the cost of a loan.9
This conclusion is corroborated by research carried out by the National Association of Credit Bureaux and its Scottish counterpart, Citizens’ Advice Scotland.10
Until the enactment of the Consumer Credit Act 1974, UK law made very limited attempts to deal with the problem. The most visible legislative provi-sion was to be found in the Moneylenders Acts which contained a proviprovi-sion for the reopening of agreements which were found to be harsh and uncon-scionable. Interest rates of over 48% were presumed to be unconuncon-scionable.
The Crowther Committee whose report provided the impetus for the Con-sumer Credit Act 1974 considered that “… the existing safeguards against the imposing of extortionate charges are altogether inadequate”11and recom-mended that much more wide-ranging protections be introduced. Following a perceptive analysis of the problems faced by those requiring credit, the committee observed that :
The basic problem is that the law protects least those whom it is designed to serve most. The low-income consumer is particularly open to oppression, yet he is usually unable – through ignorance, fear or sheer inability to manage
8 For a good example see Falco Finance Ltd v. Gough [1999] C.C.L.R. 16.
9 Kempson and Whyley p. 34.
10 Daylight Robbery Ch.3 and Cathy Sharp, On the Cards : The Debt Crisis facing Scottish CAB Clients, Citizens Advice Scotland, Edinburgh, 2004.
11 Crowther para. 6.6.9.
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his affairs – to avail himself of the protection which is offered to him by the process of litigation.12
They recommended that the presumption about interest rates contained in the Moneylenders Act should be extended to the whole field of consumer credit, but it is also important to note that they realised that this problem ne-cessitated a multi-facetted approach. They therefore also advocated the cre-ation of a licensing system for those engaged in the consumer credit industry.
The Commissioner, as they would have designated the official in charge of this system,13would have had power to initiate proceedings for a declaration that in any particular transaction the interest charged was harsh and uncon-scionable, and persistent overcharging would have been a ground for the suspension or revocation of a licence. In addition, those charging more than the 48% rate would have been required to send quarterly returns to the Com-missioner setting out the total number of loans which had exceeded that rate.
It is important to note, in the light of the extensive criticisms of the reforms in this area in the 1974 Act, that the Crowther Committee’s recommendations were only partially enacted.
The ensuing legislation took a significantly different approach to unfair credit bargains and it is this which is now about to be replaced. Potentially far-reaching powers were given to the courts in sections 137-140 of the Con-sumer Credit Act 1974 to reopen a credit bargain found to be extortionate so as to do justice between the parties. Unlike most of the other provisions of the Consumer Credit Act, it applied not only to regulated credit agreements but also to all credit agreements with individuals. The significance of this is that credit bargains for any amount were subject to these provisions, whereas the other provisions of the Act applied only to agreements where credit of up to
£ 25,000 was extended.14
Section 138(1) provides that a credit bargain will be extortionate if it : (a) requires the debtor … to make payments … which are grossly exorbitant, or (b) otherwise grossly contravenes ordinary principles of fair dealing.
In making a judgement on these matters courts are to have regard to evidence adduced on prevailing interest rates, the age, experience, business capacity and health of the debtor. They must also take account of the finan-cial pressure that he or she was under at the time the bargain was entered into, as well as any other relevant considerations. From the creditor’s point of
12 Crowther para. 6.1.19.
13 The task was added to the duties of the Director General of Fair Trading, an official created by the Fair Trading Act 1973. The post of Director General has now been abolished and the task is as-signed to the Office of Fair Trading by the Enterprise Act 2002.
14 The original financial limit had been much lower but has been increased over the years to take account of inflation.
Regulating Socially Harmful Lending : Reform in the United Kingdom view the court must consider the degree of risk taken, having regard to any security provided, the relationship to the debtor, and whether or not a “co-lourable,” i.e. inflated, cash price was quoted for any goods or services. This latter point is included to prevent a transaction being dressed up to seem as if the rate of interest is lower than it is by inflating the alleged purchase price.
Section 171(7) provides that the burden of proof is on the creditor to show that the transaction is not extortionate.
It is important to note that the test applies to the credit bargain, not just the credit agreement. If one or more other transactions are to be taken into account in computing the total charge for credit the test applies to the credit agreement and those other related transactions. These might include various fees such as arrangement fees.
If a credit bargain is found to be extortionate there are wide powers “for the purpose of relieving the debtor or a surety from payment of any sum in excess of that fairly due and reasonable.”15The whole, or any part, of any ob-ligation imposed by the credit bargain may be set aside and the creditor may be made to repay the whole, or any part, of a sum paid under the credit bar-gain or any related agreement by the debtor or a surety. In addition, a court has power to alter the terms of the credit agreement or any security instru-ment and direct the return to a surety of any property provided as security.
These are potentially wide-ranging powers but very little use has been made of them. The Consumer Credit White Paper16notes that they have been invoked in about 30 cases, in only ten of which was the debtor successful.
The number of reported cases is not necessarily an infallible guide to the effectiveness of legislation, especially where, as here, most of the litigation takes place in the English County Court or the Scottish Sheriff Court, whose decisions are not usually reported and do not provide binding precedents.
However, the Office of Fair Trading does not consider that the provision is having a hidden effect through its use as a negotiating tool and confirms that it has not been widely used.17
Some consumers have successfully invoked the provisions. What factors seem to have been important in these cases ? InBarcabe v. Edwards,18an Eng-lish county court decision, the debtors had borrowed £ 400 for the purchase of a car at a flat rate of almost 100 per cent, an APR of 319 per cent. The court substituted a flat rate of 40 per cent, which would have given an APR of
15 Section 139(2).
16 The White Paper para. 3.29. This is an underestimate, as a search on a legal database such as Westlaw or Lexis will confirm, but the point is still valid that remarkably little use has been made of these provisions.
17 OFT 1991 paras 4.2 and 4.3.
18 [1983] C.C.L.R. 11.
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92 per cent under the original terms of the loan. The fact that the debtors had little business capacity, that there was no unusual risk for the lender, and that one of the debtors could not read were taken into account, as was evidence that similar lenders were charging flat rates of 20 per cent.
InDevogate v. Jarvis19the debtors had borrowed £ 10,000, on security, to pay off existing debts at an APR of 39 per cent. An APR of 30 per cent was substituted, despite the fact that the original rate was not unusual for the type of loan, the court taking into account the fact that there was security justifying a lower rate. Also relevant was the inequality of bargaining power flowing from the desperate financial circumstances of the debtors. The rela-tively low risk and the fact that the loan was secured were also important in the judge reducing the flat rate of interest from 42 per cent to 21 per cent inPrestonwell Ltd v. Capon.20The fact that the debtors were under financial pressure, had little business acumen and did not have access to proper legal advice were also relevant. Another successful case isShahabinia v. Gyachi21 where loans with flat rates of interest of 78 per cent, 104 per cent and 156 per cent were considered extortionate and reduced to a flat rate of 30 per cent.
Falco Finance Ltd v. Michael Gough22is one of the few cases where the agree-ment was found to be extortionate under section 138(1)(b), on the ground that it grossly contravened ordinary principles of fair dealing rather than involv-ing grossly exorbitant payments. This involved a dual rate mortgage under which the “normal” interest payments of 13.99 per cent (flat rate) were initially discounted to 8.99 per cent, providing every monthly payment was made on time. This concession was lost permanently for the life of the mortgage if any payment was missed or was in any way deficient. The court viewed this as unacceptable because there was no genuine attempt to calculate the loss to the company from late payment, or conversely any gain received by prompt payment ; the conditions for retaining the concession were so harsh that it was almost impossible to comply with them for the whole period ; and there was no possibility of reclaiming the concession.
Some guidance can be obtained from unsuccessful cases. The OFT report23notes that the highest rate of interest not held to be extortionate has been 48 per cent. One such case wasKetley v. Scott,24 where the debtor had business experience and the risk was relatively high. The judge also observed that even if he had found the extortion test had been satisfied he would not
19 1987, county court, unreported.
20 1988, county court, unreported.
21 Court of Appeal (Civil Division) England unreported.
22 Op. cit. note 8.
23 OFT 1991
24 [1981] I.C.R. 243.
Regulating Socially Harmful Lending : Reform in the United Kingdom have given relief, on the ground that this would not have been just between the parties because the debtor had been deceitful in not disclosing the full extent of his financial commitments and had falsified the value of the house on the security of which the loan was given.
While it is not easy from case reports to assess the fairness of decisions, it is difficult to dispel the impression that in some cases the courts have been less than realistic and unwilling to make full use of the width of the defini-tion of extordefini-tionate. A good example isWills v. Wood.25An elderly lady with little business experience and no capital, except her cottage, borrowed £ 3,000 secured on the cottage at 12 per cent. The county court judge found the bar-gain extortionate on the second limb of the definition, observing that the debtor was in severe financial difficulties with no source of income or capital from which to meet her liabilities. He added that had “she received inde-pendent advice I am satisfied she would have been strongly advised against borrowing.” The Court of Appeal upheld the creditor’s appeal, stating that the debtor was of full age and capacity and no “unworldly recluse.” It was suggested that she could have sold her cottage to meet her debts. The Master of the Rolls noted that the word wasextortionate, notunwise, and that the situ-ation came nowhere near one in which the court could reopen the bargain.
Coldunell Ltd v. Gallon26is another case the result of which might occa-sion some surprise. The borrowers were a man of 86 and his wife of 91 who borrowed money on the security of their home which was their only capital asset. The creditor knew that the money was needed to help their son, who promptly ran off with it, and that they had not had independent legal advice.
In the English Court of Appeal Oliver L.J. said that a creditor could discharge the burden of proving that the bargain was not extortionate “by showing that the bargain was on its face a proper and not extortionate commercial bargain
In the English Court of Appeal Oliver L.J. said that a creditor could discharge the burden of proving that the bargain was not extortionate “by showing that the bargain was on its face a proper and not extortionate commercial bargain