Consumer Rights Act may apply to Guarantors of Companies

The Consumer Rights Act 2015 (“CRA”) is an important piece of recent legislation which governs many contracts between traders and consumers, and implements the. EU Unfair Contract Terms Directive (93/13/EC) (“UTD”.) “Consumer” is defined in section 2 (3) of the Act as: –

“an individual acting for purposes that are wholly or mainly outside that individual’s trade, business, craft or profession.”

There is as yet no direct authority on how the definition of consumer applies in the context of security documentation, but the Court of Justice of the European Union (ECJ) has set out the test in the UTD for when it applies to personal Guarantees and security agreements given by an individual to secure debts of a company In Dumitru Tarcău, Ileana Tarcău v Banca Comercială Intesa Sanpaolo România SA (C-74/15) the court held that a personal Guarantee was to be subject to the UTD because it was given by a natural person, acting outside his trade or business, and who had no functional links to the guaranteed company.

The new test supersedes the previous test in English law, under which the rules on consumer unfair terms only applied where both the Guarantor and the borrower were individuals. Under the new test, the rules apply to individual Guarantors of facilities to corporates and other legal entities.

In the Tarcău case the ECJ considered a Romanian case where the credit agreement was between the bank and a company. The sole shareholder and director of the company later extended his line of credit. His parents guaranteed the whole loan via two contracts, a contract of Guarantee and a contract granting a mortgage over their own home, by way of security.

The ECJ had to consider two questions:

• Was the UTD limited to contracts for the sale of goods or supply of services, or could a Guarantee or security agreement from a consumer also fall within its scope?
• Could a natural person acting as guarantor/surety for a loan to a company be a “consumer” under the UTD if they were acting for private purposes and had no connection with the company’s activities?

The court held that the UTD can apply to personal Guarantees or security agreements. In a transaction where the loan is made to a legal entity (such as a company), a contract of Guarantee or a contract providing security made in order to secure contractual obligations under that loan would be subject to the UTD if all of the following three conditions are met:

• The Guarantee/security contract is made with a natural person (identity condition);
• The natural person is acting for purposes outside his trade, business or professional purposes (purpose condition); and
• The natural person has no link of a functional nature with that company (a new functional links condition).

The ECJ indicated by way of example that functional links include directorship or non-negligible shareholding. There is nothing in the decision to indicate what might amount to “negligible”.

Tarcău indicates that the correct approach for UTD purposes is to look at the parties to the Guarantee and their purpose for entering that contract (not the purpose of the Guarantee). From the perspective of its parties, a Guarantee/security is a distinct contract because it is concluded “with persons other than the parties to the loan”, and “therefore as parties to the contract providing security or contract of Guarantee that the capacity in which those parties acted must be assessed”. The ECJ also emphasised the particular importance of UTD protection in such cases, given the personal commitment to pay a contractual debt owed by a third party, a commitment which involves onerous obligations and which puts the guarantor/surety’s own property at risk.

The three-part test in Tarcău would also apply to personal Guarantees/security in respect of lending to other legal entities (for example, an LLP), and where a director is guaranteeing the liabilities of his own company. In the latter case, the purpose and now the additional functional links conditions would be likely to prevent the director (or partner) from relying on unfair terms protection in respect of a personal Guarantee or security agreement.

Requirements for fairness and transparency

If the CRA applies, what substantive rights does it confer on individuals? Under the CRA consumers are entitled to protection both in relation to fairness and transparency.

(a) Fairness

Section 62 (1) of the CRA provides that an unfair term is not binding on the consumer, and by section 62 (4): –

“A term is 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 detriment of the consumer”.

Section 62 (5) provides: –

“Whether a term is fair is to be determined—

(a) taking into account the nature of the subject matter of the contract, and

(b) by reference to all the circumstances existing when the term was agreed and to all of the other terms of the contract or of any other contract on which it depends”.

Section 64 (1) (a) excludes from the assessment of fairness a term which “specifies the main subject matter of the contract”, and in some circumstances this will exempt provisions of a Guarantee or Legal Charge from scrutiny. However, section 64 (2) excludes a term from an assessment for fairness “only if it is transparent and prominent”, which means that it is expressed in plain and intelligible language and “brought to the consumer’s attention in such a way that an average consumer would be aware of the term” (section 64 (3) and (4)).

As for the test for fairness, the court is to have regard to Schedule 2 of the CRA which indicates inter-alia in paragraph 10 of part 1: –

“A term which has the object or effect of irrevocably binding the consumer to terms with which the consumer has had no real opportunity of becoming acquainted before the conclusion of the contract”.

(b) Transparency

Section 68 (1) of the CRA also imposes a requirement of transparency, which as stated above requires a term to be expressed in plain and intelligible language. This will be judged in the context of the circumstances of the signatory.

Practical effect

The combined effect of the Tarcău decision and the substantive provisions of the CRA may give new rights to guarantors to seek to avoid liability under Guarantees and other security documents given to asset financiers in some circumstances.

However, asset financiers should already be aware of the desirability of ensuring that individuals providing security who are not “fully involved directors” of the relevant corporate entity actually receive legal advice from an independent solicitor as to the nature and effect of the obligations they are undertaking.

Surprisingly this requirement remains unknown to some asset financiers, notwithstanding that it is well established by a long line of cases going back to the 1980s and resulting in Royal Bank of Scotland plc v Etridge (No 2) [2002] 2 AC 773. In that case the House of Lords laid down authoritative guidance to the effect that misrepresentations, undue influence and duress will provide a defence to a signatory of a document who has been subject to such matters if the financier has not taken steps to ensure that the signatory received legal advice as to the nature and effect of the document.

The House of Lords made it perfectly clear that it is not sufficient for the signatory to sign a declaration to the effect that he or she has had an opportunity to seek legal advice, as often appears on security documentation presented to individuals: the position is that unless legal advice is actually taken then the financier is bound with notice of any misrepresentation or other malpractice which can be established by evidence from the signatory.

Asset financiers who ignore this requirement now run the risk not only of complaints arising from individuals based on misrepresentation or undue influence, but also in some circumstances of allegations that documentation was not sufficiently transparent and was unfair under the CRA.