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Birkinshaw, Christopher --- "Making disclosure meaningful: a proposal" [2005] CanterLawRw 2; (2005) 11 Canterbury Law Review 30


MAKING DISCLOSURE MEANINGFUL: A PROPOSAL

CHRISTOPHER BIRKINSHAW[*]

I. INTRODUCTION

Power rarely resides with the consumer. This has prompted various New Zealand governments to intervene in an attempt to rectify the power imbalance. The Consumer Guarantees Act 1993 and the Door to Door Sales Act 1967 are just two examples. Without intervention, there is a risk that traders will take advantage of unwary consumers. This risk is particularly acute in consumer credit markets in which a lack of intervention can lead to serious abuses by creditors. Various steps have been taken to protect debtors, including legislating to re-open credit contracts that were considered oppressive.[1] However, that approach only tackles oppressive behaviour by creditors once the contract is entered into. Another option adopted in New Zealand, and most of the common law world, is to implement measures that are intended to encourage competition on the basis that a competitive market minimises the risks of market failures and, therefore, the need to resort to reopening credit contracts. Disclosure to potential debtors of specific information regarding a credit contract is the key tool in encouraging competition. Consumers armed with such information should be able to ‘shop around’ for credit contracts, thereby directly encouraging greater competition amongst creditors. However, as this paper will show, persuading consumers to comparison shop for credit is not an easy task. Just like the old dog that cannot learn new tricks, there are significant barriers that prevent consumers from comparative shopping for credit, and the most recent New Zealand legislation, the Credit Contracts and Consumer Finance Act 2003 (‘the 2003 Act’), appears unlikely to be effective in breaking down those barriers. If encouraging competition amongst creditors is accepted as a valid method for protecting consumers, and if the 2003 Act’s initial disclosure regime is not effective, then other options for encouraging competition should be considered. The option put forward in this paper is to retain initial disclosure documents as a method for informing consumers of the terms of a contract, but also to provide disclosure by a third-party to consumers of the key indicators of the competitiveness of credit contracts offered by creditors. Internet technology has progressed to such an extent that it provides an adequate and sufficiently flexible medium for providing key information about potential credit contracts to consumers. This form of disclosure can encourage competition in two ways: indirectly, because it allows consumers to more easily engage in comparison shopping, which in turn encourages competition; or directly, in that it encourages creditors to offer more competitive contracts to prevent consumers viewing a creditor as overly expensive in comparison to others. Before the details of such a proposal are discussed, this paper first traces the development of the regulation of credit contracts. Regulation has moved towards providing consumers with information regarding the terms and conditions of the credit contract. Whilst initially the purpose was to make debtors aware of their obligations, the additional purpose of encouraging consumers to comparative shop was adopted from the late-1960s onwards. The paper then considers the inherent limitations of initial disclosure regimes that prevent them from encouraging comparative shopping. The paper moves on to consider whether the changes adopted in the 2003 Act have the ability to overcome these limitations. Finally, a new approach is considered and it is suggested that such an approach can encourage what consumer credit regulation has for the most part failed to achieve: more competitive consumer credit markets.

II. HISTORICAL ANALYSIS OF CREDIT CONTRACT REGULATION

Usury

Regulation of credit contracts started with the prohibition on usury: ‘the act of receiving more than the principal in a loan’.[2] Usury was prohibited absolutely by both the Church and the secular authorities during the medieval period,[3] on the basis of Exodus, xxii, 25:

On Mount Sinai, Moses was told: ‘[t]hou shalt not lend upon usury to thy brother; usury of money, usury of victuals, usury of anything that is lent; unto a stranger thou mayest lend upon usury’.[4]

Similar prohibitions are to be found in Leviticus, xxv, 36-37:

Take thou no usury of him, or increase; but fear thy God: that thy brother may live with thee. [T]hou shall not give him thy money upon usury, nor lend him thy victuals for increase.[5]

Despite the prohibition, devices developed to avoid its effects, and these became so numerous and potent that the prohibition became ‘an empty shell’.[6] As a result, any person in need of credit and willing to pay was never completely dispossessed of the possibility of borrowing money.[7] Any person in need of a loan was likely to need such a device later, and thereby ‘usury flourished, for no one who might want a further loan another day would invoke the law’.[8]

As commerce and trade developed, however, the laws prohibiting usury became impractical. Rather than removing the prohibition altogether, governments imposed limits on the rate at which interest could be charged. In 1545 Henry VIII legislated for a maximum interest rate of 10%,[9] although this only lasted seven years until usury was again absolutely prohibited by Edward VI.[10] However, the demand for credit did not disappear. In 1571 Elizabeth I reintroduced interest as lawful at 10%,[11] and, over the next century and a half, the ceiling on interest rates was gradually reduced to 5%.[12] A gradual change came about between the medieval period and the 19th century. Usury was no longer perceived as charging any interest, but as charging excessive interest.[13] This reflected a change that had already occurred in imperial Rome.[14] However, despite the gradual relaxation of the prohibition, it was not enough. Innovative techniques were still used to avoid the regulation of contracts for credit.[15] During this period a fault line developed between, on the one hand, the need for contracts of credit, and, on the other, the belief by some of the evils of credit. But, as is the case with physical fault lines, one side has to rise up whilst the other sinks beneath. Perhaps unsurprisingly, given the industrial revolution of the time, the need for credit prevailed. In 1854 the Usury Laws Repeal Act (UK) was passed and ‘swept away all controls on usury and interest.’[16]

Repeal of Usury Laws and the Moneylenders Act 1900 (UK)

With the removal of any remaining prohibitions on usury, money-lenders enjoyed an ‘unparalleled era of freedom and prosperity’,[17] which inevitably lead to serious abuses of the recently granted freedom to lend. In 1898 the House of Commons Select Committee on Money-lending published its report into the money-lending market.[18] The report noted that

one lender had admitted charging on occasion interest at rates as high as 3,000 per cent, while another confessed that to avoid notoriety likely to result from his activities he had traded under no less than 34 different aliases.[19]

The report resulted in the enactment of the Moneylenders Act 1900 (UK) (‘the 1900 Act’). The 1900 Act provided for a number of methods of regulating money-lending. First, it provided that a court could reopen a transaction if it was satisfied that the interest rate or charges were excessive and that, in either case, the transaction was harsh and unconscionable.[20] Secondly, it provided for the registration of money-lenders under ‘his own or usual trade name, and in no other name.’[21] Money-lenders were prohibited from carrying on the money-lending business in anything other than their registered name.[22] The period of 1854-1900 represents the only period in history where there was no regulation of the provision of credit in Britain. The practices of credit providers in that period provides an indication of why some regulation of those who provide credit remains necessary.

Early Credit Regulation in New Zealand

The English Laws Act 1858 provided that the laws of England as at 14 January 1840 were in force in New Zealand so far as they were applicable to New Zealand circumstances. However, this excluded the law against usury,[23] and as a result, there was no restriction on money-lending in New Zealand until 1901. The Moneylenders Act 1901 was based almost entirely on the 1900 Act, and was re-legislated as the Moneylenders Act 1908 (‘the 1908 Act’). The 1908 Act contained the same provisions regarding reopening transactions and registration of money-lenders. It was the first regulation of borrowing in New Zealand and, as with the 1900 Act, contained no provisions requiring disclosure of the terms and conditions of the credit contract. The 1908 Act was amended by the Money-lenders Amendment Act 1933 (‘the 1933 Act’) which replicated many of the provisions of the Moneylenders Act 1927 (UK). The 1933 Act replaced registration with annual licensing, placed restrictions on circulars and advertising and, for the first time, imposed disclosure requirements. Section 8 required that the contract be in writing and that a copy of it be delivered or sent to the borrower within seven days of the making of the contract. It also required that the document contain all of the terms of the contract, in particular the amount of the principal of the loan and the interest rate or the total amount of interest charged. The purpose of the initial disclosure requirements is not clear from the 1933 Act itself, but can be found in the comments of the Minster of Justice during the second reading of the Money-lenders Amendment Bill. The Minister, in explaining Clause 8, said:

Experience has shown the necessity for some such protection. People sometimes borrow money and do not seem to know what it is going to cost them. Anyhow, it is considered that there should be a regular contract and that definite terms and conditions should be set out in that contract so that the borrower may know what he has to pay for a loan of money obtained (emphasis added).[24]

The purpose of s 8, therefore, was to provide debtors with information that allowed them to become informed of the terms and conditions of the contract, and of the cost of the transaction.

Hire-Purchase Legislation

Up to this point, the law made a specific distinction between loan credit and sale credit.[25] The roots of this division extend as far back as the prohibition against usury.

Lending at interest has for hundreds, indeed thousands, of years carried overtones of moral disapproval … Selling on credit, however, while attracting moral disapproval as pandering to the weakness of the flesh, somehow avoided incurring the opprobrium of usury, and the law governing sales on credit developed along entirely different lines.[26]

The most dominant form of credit sale in the twentieth century was the hire-purchase agreement, although it had existed since the early 1800s.[27] Because of the nature of hire-purchase agreements as credit sales, such agreements were not subject to the money-lending legislation, and therefore initial disclosure as required by those statutes was not required. The distinction between sale credit and loan credit was devoid of logical or economic merit,[28] and it was inevitable that legislatures in common law countries would eventually intervene. The Hire Purchase Act 1938 (UK) (‘the 1938 Act’) provided that under a hire-purchase or credit-sale agreement, any right to recover the goods or security given was unenforceable against the hirer or guarantor unless the cash price, the hire-purchase price, and the amount and date of each instalment had been given or sent to the hirer by the owner within seven days of making the agreement.[29] It is possible to discern in s 2 the emergence of the need for some protection for the hirer (or debtor). Diamond suggested that the 1938 Act sought to protect the hirer in three main ways, one of which was through making the terms of the transaction clear through disclosure.[30] Hire-purchase legislation was introduced in New Zealand soon after in the form of the Hire-purchase Agreements Act 1939 (‘the 1939 Act’). Whilst providing protection for the owner, the 1939 Act did not provide for initial disclosure of specific information as required by the UK equivalent. The result was that in New Zealand, in terms of debtor protection through disclosure, a divide still existed between loan credit and sale credit. This divide continued for some time until ‘[b]y the early nineteen-sixties it had become apparent that New Zealand was lagging behind other common law countries in its statutory protection of purchasers.’[31] The law relating to hire-purchase agreements was finally the subject of substantial reform in the Hire Purchase Act 1971 (‘the 1971 Act’). Section 5 provided that the agreement had to be in writing, and s 6 provided for the disclosure of specific information. The most important requirement for the purposes of this paper is that the agreement contain financial details in substantially the same form as set out in Part 1 of the First Schedule of the 1971 Act. That information included the cash price of the goods, any other fees, the total amount financed under the agreement and the total cost of the transaction. Section 7 provided that a copy of the agreement be given to the purchaser within ten days of the date the agreement was made. Vendors were encouraged to supply this information by s 4, which provided that if the information was not disclosed, the liability of the purchaser for the cost of credit was extinguished.

When introducing the Hire Purchase Bill in 1970, the Minister of Justice stated that it was designed to protect the consumer and to inform the consumer ‘as fully and fairly as practicable of what he is agreeing to when he buys an article on hire purchase, and what it is costing him.’[32] The purpose of disclosure under the 1971 Act was, therefore, substantially the same as the purpose under the 1933 Act: to allow a consumer to become informed of the nature of his or her obligations under the agreement, and of the cost of the transaction. However, neither the 1933 Act nor the 1971 Act yet viewed initial disclosure as a means of encouraging competition in credit markets. Statutes regulating credit transactions in this period contained a number of unresolved problems. For example, there was still an illogical distinction between loan credit and sale credit. Regulation also depended on the nature of the lender or the nature of the transaction, with the consequence that it was possible to avoid regulation by developing innovative transactions or organisations that fell outside the legislative definitions. Further, and this issue went unresolved in New Zealand until the 2003 Act, whilst most statutes were intended as consumer protection instruments, they applied equally to credit transactions entered into by businesses. Legislation was introduced in the United States in the late 1960’s that made a major change to the purpose of disclosure and attempted to deal with some of these problems.

The United States’ Truth in Lending Act

On 29 May 1968 the Truth in Lending Act 1968 (US) (‘the 1968 Act’) was passed. It represented a watershed in terms of initial disclosure for credit contracts for a number of reasons. First, credit was defined as the right granted by a creditor to a debtor to defer payment of a debt, or to incur debt and defer its payment.[33] This represented the first step in recognising that the contracts that fell within the credit contract legislation be determined by the substance of the transaction. If credit was provided under the contract, it was subject to the 1968 Act irrespective of the nature of the transaction or the creditor. Whilst the 1968 Act continued the distinction between sale credit and loan credit, the problems experienced previously whereby such transactions attracted different disclosure requirements were reduced. The requirements were contained in the same legislation and were substantially similar.[34] Secondly, the 1968 Act brought about a wholesale change in the purpose of initial disclosure. It was recognised that the best method for protecting consumers was to encourage competition amongst creditors. Competitive markets benefit consumers because uncompetitive credit contracts with excessive interest rates or charges will not survive. Competitive markets encourage price competition amongst creditors which thereby benefits debtors. The declaration of purpose of the 1968 Act reflects this realisation.

The Congress finds that … competition among various financial institutions and other firms engaged in the extension of consumer credit would be strengthened by the informed use of credit. The informed use of credit results from an awareness of the cost thereof by consumers. It is the purpose of [this Act] to assure a meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available to him and avoid the uninformed use of credit (emphasis added).[35]

Thirdly, the 1968 Act required that the disclosure document issued to the debtor contain the finance charge (the total cost of credit in dollars and cents) and the annual percentage rate.[36] It was intended that, armed with these items of information, consumers would be able to compare competing arrangements. To ensure that consumers were comparing like with like, the 1968 Act also stipulated that the actuarial method be used to calculate the annual percentage rate. The 1968 Act thereby added a new purpose to initial disclosure: to provide enough information to potential debtors to allow them to comparative shop for credit, which in turn would promote competition, which in turn provides the best protection for consumers against excessive pricing. In theory, the 1968 Act had the potential to have a major impact on the way debtors shopped for credit. In the late-1960s, encouraging competition using the method proposed later in this paper was unlikely. It would have been difficult, if not impossible, to cheaply acquire up-to-date information about all the credit options offered by creditors, compile it in readable form and distribute it to a sufficient number of consumers to encourage competition. It is not surprising, therefore, that legislatures adopted initial disclosure, which was already required under previous statutes, as a tool for encouraging the new purpose of credit legislation. At the time it represented the best option for communicating to debtors the most important, yet almost infinitely variable, information that it was hoped would encourage comparison shopping for credit.

Developments in the UK, Australia and New Zealand

Following the 1968 Act, the United Kingdom, Australia and New Zealand all moved towards providing for pre-contractual disclosure (also called truth-in-lending disclosure) with the purpose of encouraging comparative shopping for credit by potential debtors, although at different speeds. The Consumer Credit Act 1974 (UK) overhauled credit contract law in the United Kingdom and is considered in depth elsewhere.[37] In Australia, the Molomby Report noted the emphasis in other reports and legislation on

the desirability of the consumer being able to ‘shop around’ for the cheapest credit available to finance his transaction … to encourage it, the law should ensure that consumers who desire to do so can make a realistic comparison of the price of credit available to them.[38]

Whilst the South Australia Government was quick to respond to the report’s recommendations,[39] other states were not so swift. It was not until 1984 that Victoria and New South Wales enacted their own legislation (‘the 1984 Acts’).[40] The 1984 Acts provided for disclosure of the credit charge and the annual percentage rate, both calculated as prescribed in the Acts.[41] Under the 1984 Acts, the credit charge was any amount payable by the debtor in excess of the amount financed.[42] As with the UK legislation, it would appear that the purpose of such disclosure was to encourage consumers to comparative shop. New Zealand also adopted the new purpose for pre-contractual disclosure in the Credit Contracts Act 1981 (‘the 1981 Act’). The purpose of disclosure, to ensure that a debtor knows his or her obligations, is retained but the long title also states that one purpose of disclosure is to ensure that the cost of credit is disclosed, on a uniform basis, to encourage competition. It is inherent within the latter purpose that the purpose of initial disclosure is to allow potential debtors to comparative shop, for competition is only encouraged by informed potential debtors ‘shopping around’ for the best deal. This is supported by the Report of the Contracts and Commercial Law Reform Committee (‘the Report’) that preceded the 1981 Act.[43] Amongst the purposes of disclosure listed in the Report were the need for persons to know the rights, obligations and powers of each party, and to ensure that debtors have information which enables them to compare the terms of the various sources of credit available.[44] Further, the Report also stated, whilst considering the issue of the information that should be disclosed, that one aspect of the question was ‘the provision to debtors of information to enable them to compare the terms of the various forms of credit available to them (emphasis added).’[45] Finally, the Report stated that:

In a nutshell, we believe that the disclosure of financial details is meaningful only if it furnishes a prospective borrower with such information as will enable him to compare the terms offered by one prospective financier with terms available from other sources. This information must be furnished in a manner that facilitates such a comparison and which eliminates any practical difficulties.[46]

There is further evidence in the Parliamentary Debates that preceded the Act that the purpose of disclosure in the 1981 Act was to encourage comparison shopping. When introducing the Consumer Credit Bill (‘the Bill’), the Minister of Justice commented that its objects were similar to the truth-in-lending legislation in the USA. The information to be disclosed would allow debtors to compare the cost of various credit options.[47] Debtors would then be able to make their own decisions about which of those options would be the most appropriate to their particular circumstances.[48] It is therefore evident that, whilst the purpose of the 1981 Act was explicitly to encourage competition, this includes the implicit purpose of encouraging and enabling comparative credit shopping.

To enable comparative shopping potential debtors need to be provided with information that allows them to do so and the 1981 Act provided for the initial disclosure of specific information for all controlled credit contracts.[49] The information to be disclosed is specified in Part 1 of the Second Schedule to the Act.[50] For the purposes of this paper, the information that is of importance is the financial information that was to be disclosed: the total cost of credit and the finance rate, which were respectively defined in ss 5 and 6. The total cost of credit was the cost to the debtor over and above the credit advanced, and the finance rate was the total cost of credit expressed as a percentage rate per annum of the amount of credit. The Contracts and Commercial Law Reform Committee believed that disclosure of such information had positive merits, as the finance rate provided ‘a uniform yardstick for comparison’.[51] Not only did the 1981 Act represent a major shift in the purpose of initial disclosure, it was also the first step towards regulation of credit contracts by their substance rather than form. If a contract provided credit, disclosure was required (unless the person providing credit was not usually in the business of providing credit).[52] This applied whether the creditor was a moneylender, a bank or even a seed merchant. Whilst New Zealand was slower than other countries in adopting the new purpose of initial disclosure, in 1981 initial disclosure documents still represented the best option for encouraging debtors to comparison shop for credit with the purpose of encouraging price competition. Including comparative annual finance rates in advertisements was also an option, but advertisements lacked sufficient flexibility to take account of all the variables that exist in credit contracts and had the potential to be misleading. The law in Australia was the subject of substantial reform in 1994. It was unsatisfactory to have different disclosure regimes in each state and in 1994 the Consumer Credit (Queensland) Act 1994 was enacted, to which the Consumer Credit Code (‘the Code’) was an appendix. The Code is important because it continues to emphasise the significance of competitive forces, as opposed to government regulation, in encouraging price competition between creditors long after the purpose of encouraging comparison shopping for credit was first adopted,[53] and the tool that continues to be used for that purpose is the initial disclosure document. It would appear that there was still no cheap and sufficiently flexible method available to allow a third party to acquire and distribute the information consumers would require to allow them to easily comparison shop for credit.

III. THE DIFFICULTIES WITH, AND EFFECTS OF, INITIAL DISCLOSURE

Despite the good intentions of the new purpose of truth-in-lending disclosure, things did not run as smoothly as planned. This part of the paper discusses some of the inherent problems with initial disclosure regimes. These problems often mean that consumers are either unable to effectively comparative shop for credit, or unwilling to, with the result that the truth-in-lending disclosure regimes may be unable to achieve their ultimate purpose of encouraging competition. Many of these problems are drawn from overseas jurisdictions, but are equally applicable to the 1981 Act. This part will then consider evidence that some consumers do use the information disclosed to comparative shop for credit, and evidence that there is price competition between creditors in some markets.

Inherent Difficulties With Initial Disclosure

Use of the annual finance rate

Disclosure of the annual finance rate was intended to assist consumers in comparing competing credit agreements. However, numerous problems exist with using the rate for comparison shopping, some of which are discussed by the Ministry of Consumer Affairs in the third part of its review of consumer credit law that preceded the 2003 Act.[54] A brief summary of some of those problems is given here. First, there was uncertainty about what charges were to be included in the total cost of credit from which the annual finance rate was to be calculated. Secondly, the annual finance rate has inherent limitations. For example, it is not the sole factor that determines whether a particular transaction is the best option for a debtor and consumers often do not have the skills to interpret and use the annual finance rate. Thirdly, the annual finance rate is not suitable for revolving credit contracts, as the total cost of credit is not known. Fourthly, ‘credit law is inherently complex’.[55] The number of different credit contracts available to consumers is large, and the annual finance rate cannot be an effective means of comparing competing credit agreements for all of them. Finally, ‘[r]esearch elsewhere … suggests that there is little consumer awareness and understanding of the concept and that it has little effect on the behaviour of consumers.’[56] It can be concluded from the Transparency Review that the annual finance rate as a tool for encouraging comparative shopping is too uncertain, too difficult for potential debtors to understand and make use of, and does not always reliably provide a guide to the best credit option.

Timing of disclosure

The 1981 Act required that initial disclosure be made either before, or by the end of the 15th working day after, the day the contract is made.[57] In reality, because of the time and cost involved in preparing disclosure documents, disclosures under truth-in-lending statutes tend to occur either at the time of, or very shortly before, the completion of the transaction.

However, at this point the debtor has become psychologically committed to the transaction, and thus comparison shopping for credit is unlikely.[58] This is related to a problem discussed below, that consumers tend to comparison shop for the features of the goods sought, not the features of the credit.[59] As a result, by the time disclosure is made, the consumer has done as much shopping as is intended, and hence disclosure is ineffective.[60] However, it must be borne in mind that Landers and Rohner’s conclusion that disclosure is ineffective because it is made too late, which has been cited numerous times,[61] was made a quarter of a century ago. Calculating the annual finance rate and total cost of credit was not as easy then as it is in 2005 where advanced computer software that can calculate such figures relatively easily and quickly exists. Consumers may ask for such information before they become committed to a transaction, and most mainstream credit providers would likely be able to provide such information without too much difficulty. Whether most consumers have the will or desire to make such requests remains doubtful because of the costs of comparative shopping. At least for home loans, acquiring comparable information from lending institutions involves time and expense that consumers may be unwilling to spend.[62] The same time and expense problems apply equally to less costly items or loans for smaller amounts and, if the costs are high and the benefits minimal, comparative shopping is even less likely in these credit markets. Whether consumers would ask for such information is even more questionable given the likelihood that a large number of consumers may not know what information is helpful, or how to ask for it.

Debtor illiteracy

Even if disclosure statements were provided before a potential debtor became committed to a transaction, many consumers may have insufficient literacy skills to understand the disclosure statements, and would thus be unable to comparison shop. Approximately 45% of New Zealanders are functionally illiterate, and 750,000 adults are unable to comprehend an every day document.[63] Given such high levels of illiteracy, disclosure statements may be ineffective in encouraging comparison shopping, irrespective of when disclosure is made, or what information is contained therein.

Cognitive overload

A further problem is that of cognitive overload.[64] Disclosure statements may contain too much information, with the result that the potential debtor cannot absorb all the information presented, and the consumer instead ignores the whole document, but for a cursory glance. In the USA as recently as 2001, 75% of consumers found truth-in-lending statements complicated.[65] Given the suggestion that the average consumer can absorb between six and eight ‘bits’ of information,[66] the same result is likely under the 1981 Act. Part I of the Second Schedule requires eight ‘bits’ of information to be disclosed. However, these ‘bits’ include all the terms of the contract not otherwise disclosed, and the lengthy (but necessary) Statement of Rights. The conclusion is that the average consumer may well suffer cognitive overload and ignore the parts of the disclosure document that are intended to allow comparative shopping. An associated problem is that the disclosure statement may include information that is irrelevant to the potential debtor’s decision,[67] and as a result he or she may be unable to assess the most important information.

The difficulties and cost of comparative shopping

Even given early disclosure, sufficient literary skills and a supply of sufficient but not excessive relevant information, consumers would probably still not use disclosure statements to comparative shop for credit. Schwartz and Wilde suggest that comparison shopping will occur if it is convenient, by which they mean that the costs of comparison shopping are low.[68] Under the 1981 Act, however, comparison shopping using the initial disclosure document is not convenient. Potential debtors must spend time and energy acquiring the information from creditors and subsequently analysing it. This analysis itself is difficult. Schwartz and Wilde also suggest that the costs of comparative shopping are lowered if the methods of quoting prices is standardised because it is easier to compare like with like.[69] Under the 1981 Act, there is uncertainty as to which fees and charges are included in the calculation of the annual finance rate,[70] and there is no standard form which creditors can use so that potential debtors can easily make a comparison. Potential debtors attempting to compare credit contracts are therefore faced with an inconvenient, difficult and costly task.

Conditions under which disclosure is made

The conditions under which the potential debtor is provided with the disclosure statement may be stressful so as to inhibit not only an effective comparison, but also the desire to shop around and make any comparison at all.[71] For example, disclosure is often made whilst in the presence of a credit salesperson and the salesperson often has a financial interest in completing the transaction. The consumer may feel under some pressure from the salesperson to complete the transaction. Whilst the 1981 Act does provide for a three day ‘cooling-off period’, the purpose of which is to allow consumers to exit unsuitable credit transactions, the Ministry of Consumer Affairs doubted whether the cooling-off period was used for extensive credit shopping.[72] Further, there may be other distractions that affect a consumer’s ability to process the information contained in the disclosure document, such as children or other consumers.

Consumers shop by features of the product or service

Consumers may well be motivated to shop around by the features of the product or service purchased as opposed to the features of the credit used to complete the purchase.[73] For example, a consumer in search of a new television may be more interested in the quality of the picture than in the terms of the credit offered to him or her. A consumer seeking a personal loan may be more interested in how easily the loan can be obtained rather than the interest rate or total cost of the loan. The consumer may also be influenced in making his or her decision by other factors, such as an existing relationship with the creditor.[74] This is typically the case where the consumer enters into a credit transaction with a bank. As a result, if the goods or services possess the features that the consumer desires, the consumer may well accept the credit terms offered instead of shopping around, even though a disclosure statement is provided.

Inability to obtain credit

Disclosure of information may be ineffective in promoting comparison shopping for consumers on low incomes because such consumers may be unable to obtain credit at lower rates.[75] Low income consumers are more likely to accept the credit offered because they know that credit providers offering lower interest rates or charges are unlikely to approve credit transactions for those with low disposable incomes or poor credit ratings. As a result, initial disclosure statements cannot encourage some consumers to comparative shop for credit.

Consumers Who Do Comparative Shop and Competitive Credit Markets

Despite the fact that significant barriers may prevent comparative shopping, this does not automatically allow the conclusion that initial disclosure cannot encourage competition in credit markets. Before this conclusion is reached, it is necessary to consider any evidence of comparative shopping and competition.

Evidence of comparative shopping

Schwartz and Wilde suggest that a substantial number of consumers shopping around for credit will encourage competition.[76] They put the threshold at one third of consumers. Despite the problems with truth-in-lending disclosure, there is evidence overseas to suggest that consumers do comparison shop for credit. In Australia, 58% of respondents to a survey shopped around for a housing loan, and 96% of those who did shop around stated that they compared interest rates on home loans.[77] Sixty one percent of respondents shopped around for personal loans with 95% comparing interest rates, but only 26% of respondents shopped around for credit cards with 80% comparing interest rates.[78] This suggests that there are sufficient numbers of consumers comparison shopping for credit to encourage competition in the housing and personal loans markets, but not in the credit card market. There is no reason to suggest that consumer behaviour would be any different in New Zealand.

Evidence of competitive markets

There is also evidence to suggest that some competitive credit markets do exist. Schwartz and Wilde suggest that competitive markets have several characteristics.[79] First, in a competitive market, prices tend to cluster. Secondly, price advertising is common. Thirdly, comparison shopping is convenient. Finally, sellers cannot distinguish between consumers who are shoppers and those who are not. Whilst Malbon used empirical data to assess the competitiveness of credit markets in Australia,[80] such data is not currently available in New Zealand. Therefore, to carry out a basic assessment of the competitiveness of credit markets in New Zealand, only the first two of Schwartz and Wilde’s characteristics will be discussed on the basis of easily obtainable information. First, consider the market for mortgages. In November 2004, variable rate mortgages varied between 8% and 8.6%, with a median of 8.4%.[81] A three-year fixed-rate mortgage varied between 7.5% and 8.05%, with a median of 7.75%.[82] Interest rates for mortgages, therefore, appear to cluster within a small range, suggesting a competitive market for mortgages. This is reinforced by the fact that advertising for mortgages is extremely common. A consumer can barely open a newspaper or watch a 30-minute television programme without coming across a number of advertisements for mortgages which compete on the basis of interest rates. Secondly, consider the market for credit cards. In November 2004, interest rates amongst 64 credit cards varied between 10.95% and 19.95%, with a median of 19.95%.[83] The cluster appears to be at 19%, except for nine that had an interest rate below 18%. This suggests less of a tendency to cluster, thereby suggesting a slightly less competitive market. This is reinforced by the relative lack of advertising of credit card interest rates in comparison to mortgage rates. Therefore, the market for mortgages can be said to be highly competitive, whereas the market for credit cards is slightly less so.

Does such evidence suggest that disclosure regimes are effective in achieving comparative shopping and competition?

The answer on both counts is ‘no’. There is reason to be sceptical about the results of Malbon’s survey that suggests a substantial proportion of consumers comparative shop. The nature of the questions asked in Malbon’s survey are not clear. A question similar to ‘Did you compare different credit products?’ carries the risk of what Durkin calls ‘yea saying’: giving the answer that is perceived to be correct.[84] A preferable option would be to ask consumers what use they would make of the information provided, rather than offering a simple yes/no type answer structure. Although there is no data available on such a question, given the inherent problems surrounding disclosure statements, this author suspects that the number of respondents using the disclosed information for comparative purposes would drop well below the figures quoted in Malbon’s survey, with the possible exception of large credit transactions such as mortgages. There is also no evidence that initial disclosure under the 1981 Act is causative of the competitive credit markets that do exist. Malbon’s work suggests the opposite. He asserts that, if initial disclosure was decisive in encouraging competition, the results of his survey would demonstrate equal competitiveness in different credit markets.[85] The results of his survey suggest that this is not the case. It appears, therefore, that some credit markets are competitive without the need for government intervention, and therefore initial disclosure is not necessarily causative of that competitiveness.

IV. THE CREDIT CONTACTS AND CONSUMER FINANCE ACT 2003

Part III showed some of the inherent problems with disclosure under the 1981 Act, that the evidence of comparison shopping for credit is questionable and that there is no evidence of a causative link between disclosure and competition in some credit markets. Evidently reform was needed, and the issue was considered by the Ministry of Consumer Affairs in its Transparency Review. After carrying out a critique of the disclosure requirements, the Ministry concluded that there were serious limitations in the 1981 Act in terms of initial disclosure.[86] The Ministry made a number of suggestions for reform, one of which was the synthesised approach eventually adopted in the 2003 Act. This approach incorporated five key features.[87] First, it was proposed that the annual finance rate be abandoned. Secondly, as is the case under the Code, the Ministry proposed prescribing the method for calculating interest. Whilst not dictating the method to be used to calculate interest, the effect would be that most creditors would use the same method. Thirdly, interest would be defined so as to clearly distinguish it from other fees and charges. Fourthly, some form of regulating fees and charges was proposed. Finally, the Ministry suggested that the disclosure requirements be reduced. The Ministry also suggested providing model disclosure forms for creditors to use. Creditors using such forms would be deemed to have complied with any statutory disclosure requirements.

The recommendations of the Ministry were substantially adopted in the 2003 Act. There is no longer a need to disclose the annual finance rate. This is replaced by disclosure of the annual interest rate,[88] as defined in s

2. Section 39 provides that an interest charge cannot be more than that calculated by using a specified method. An interest charge is defined in s 5. There is separate disclosure of credit fees and charges. The charging of fees is regulated in subpart 6 of Part 2 of the 2003 Act on the basis that a fee should not be ‘unreasonable’. The total cost of credit is retained, although the debtor must work this out him or herself by adding the total interest charges to the credit fees and charges. The initial disclosure requirements are set out in the First Schedule. Section 32(1)(c) provides that such information must be expressed clearly, concisely, and in a manner likely to bring the information to the attention of a reasonable person. Section 34 provides that a person who uses a model disclosure statement prescribed by the regulations is to be treated as having complied with s 32(1)(c). The Ministry has released the proposed model disclosure statements for consultation.89 Before considering the potential impact of these reforms, it is worth considering the purpose of initial disclosure under the 2003 Act. Any assessment of the changes made would be incomplete without knowing if the purpose of initial disclosure has changed or remained the same.

Purpose of the 2003 Act

There is some evidence that encouraging comparison shopping has been dropped as a purpose of disclosure under the 2003 Act, and that the sole purpose of disclosure under the 2003 Act is to inform consumers of their obligations before they become irrevocably committed to the credit contract. However, it is suggested that there is stronger evidence to support a conclusion that the purpose of promoting comparative shopping has in fact been retained.

Evidence that encouraging comparative shopping is no longer apurpose of the 2003 Act

The Transparency Review suggests that the Ministry considered encouraging competition amongst creditors by encouraging comparative shopping to be a difficult goal for initial disclosure. For example, the central feature of the proposed synthesised approach was said to be that it largely abandoned the goal of facilitating comparison shopping through direct creditor to borrower disclosure.[90] The Ministry also stated that:

Even if comparison shopping on the basis of comparability of documentation is an unrealistic goal for a disclosure regime, prescribed disclosures may be useful in bringing the key financial details to the attention of the borrower without imposing too much cost on the lender.[91]

The Ministry appears to suggest that initial disclosure, rather than promoting comparison shopping, should be retained solely as a tool for informing consumers of their obligations under a credit contract. Also, two of the Ministry’s senior advisers, in their summary of the functions of disclosure under the proposed new statute, concluded that ‘contractual disclosures are unlikely to form the basis for meaningful comparison shopping, even by a small number of consumers.’[92] All this evidence suggests that the Ministry believed the goal of comparative shopping through disclosure should be abandoned as a purpose under the 2003 Act. Furthermore, unlike the long title of the 1981 Act, the purposes of disclosure in s 3 of the 2003 Act make no reference to promoting competition which suggests that this purpose, following the Ministry’s advice, has been abandoned. This is supported by the comments, or lack thereof, made by the Minister of Consumer Affairs prior to introducing the Consumer Credit Bill (as it was then named) for its first reading. The Minister stated that the purpose of the Bill was to enable consumers to become informed at the time of entering a credit contract.[93] This is consistent with the purposes of disclosure in the early twentieth century legislation and which is explicitly set out in s 3(b)(ii): to enable consumers to be informed of the terms of consumer credit contracts before becoming irrevocably committed to them. However, unlike the discussions that preceded the 1981 Act, the Minister made no reference to the use of disclosure to promote comparative shopping or competition.

Evidence that encouraging comparative shopping is retained as apurpose of the 2003 Act

Despite all the inherent problems that accompany promoting comparative shopping through initial disclosure, there is ample evidence to suggest that the Government has in fact retained initial disclosure as a tool for encouraging comparative shopping. Whilst s 3 of the 2003 Act does not include promoting competition amongst the purposes of disclosure, it does include enabling consumers to distinguish between competing credit arrangements.[94] Back in 1977, the Contract and Commercial Law Reform Committee suggested that the purposes of disclosure in credit contracts legislation, which were adopted in the 1981 Act, were to allow debtors to know of the rights, obligations and powers of each party, and to ensure that the debtors had information which enabled them to compare the terms of the various sources of credit available.[95] Those purposes are remarkably similar to those contained in s 3(b)(i) and (ii) of the 2003 Act, which suggests that the purpose of disclosure under the 2003 Act mirrors its purpose under the 1981 Act. It may be argued that encouraging consumers to distinguish between credit contracts under the 2003 Act is not the same as encouraging consumers to compare credit contracts under the 1981 Act. It is not, however, a strong argument. The Concise Oxford Dictionary defines ‘to compare something to’ as: ‘to point out or describe the resemblances of something with, or to liken to’. To ‘distinguish between’ is: ‘to perceive or point out a difference between’. To this writer, these are different sides of the same coin. One requires a person to identify similarities, the other to identify differences. The result is effectively the same – some kind of comparison is intended to be made between alternative credit contracts. Again, this suggests that the purpose of disclosure under the 2003 Act is the same as the 1981 Act. Even the Transparency Review suggests that the Ministry did not propose abandoning comparative shopping as an aim under the 2003 Act. The Review stated that one of the benefits of transparency (the Ministry preferred that term over disclosure) was that it allowed consumers to receive information so that they could choose the most suitable product or service. If a consumer is to have a choice, there must be more than one available product to choose from, which thereby infers that, when making a choice, the consumer will be comparing two or more alternatives. Further, as noted above, the Transparency Review stated that a central part of the proposed synthesised approach to disclosure was that it largely abandoned the goal of encouraging comparative shopping based on disclosure. This suggests that it is not the promotion of comparative shopping that has been abandoned, but comparative shopping based solely on initial disclosure. Other measures adopted in the 2003 Act, such as regulation of the method used to calculate interest[96] and the regulations of fees,[97] appear to be intended to act in unison with disclosure to facilitate comparative shopping. Finally, there is indirect evidence from the Minister of Consumer Affairs that assisting comparative shopping is still intended under the 2003 Act. Prior to the Third Reading, the Minister stated that the purpose of protecting consumers was achieved by updating and strengthening the information disclosure requirements, thus enabling consumers to make informed decisions.[98] The making of informed decisions could mean one of two things. First, it could mean that, on the basis of the information disclosed, the consumer can decide whether or not to enter the proposed transaction. This may involve a consideration of such factors as whether he or she can afford the repayments and the nature of any security taken. Alternatively, it could mean that disclosure is intended to enable the consumer to make an informed decision regarding whether the proposed transaction is the best option when compared with other alternative credit contracts. In other words, an ‘informed decision’ cannot be made unless the consumer is aware of the possible alternatives, and once the alternatives are known, making the informed decision necessarily requires a comparison of competing credit contracts. Given the other evidence that encouraging comparative shopping and competition has been retained as a purpose of disclosure in the 2003 Act, the latter interpretation is to be preferred.

Are the Changes Made Under the 2003 Act Likely to be Effective in Encouraging Comparison Shopping?

It is suggested, therefore, that the weight of evidence points towards the retention in the 2003 Act of the purpose of encouraging comparative shopping and competition as a means of protecting consumers. The issue then becomes whether the new synthesised approach can overcome the problems with disclosure that were identified in Part III as plaguing disclosure under the 1981 Act. Before this is done, it should be pointed out that some of the problems that prevent comparative shopping may be impossible to solve. For example, it may be impossible to force consumers to shop by the nature of the credit offered instead of the features of the product sought. The tangible characteristics and benefits of a product purchased with credit may always receive greater consideration in a consumer’s thought patterns than the intangible characteristics of the credit agreement. Further, low-income or poor-credit-rated consumers may not have a choice of credit contracts, so no method of encouraging comparison shopping will allow such consumers to do so. The approach is then to look at whether the measures adopted under the 2003 Act can solve most of the problems previously identified in Part III. The 2003 Act has made some progress by removing the annual finance rate and replacing it with the annual interest rate as a comparative tool. Interest is clearly defined and the limitations on the amount of interest that may be charged should result in consumers comparing like with like if they choose to make their comparisons on the basis of the annual interest rate. The annual interest rate is also beneficial because it can be used to compare revolving credit contracts as well as fixed-term contracts. However, problems still exist. Whilst the annual interest rate may be a useful tool for comparing credit contracts, it is not necessarily the predominant consideration for the consumer seeking the best option. The total cost of credit, disclosure of which is no longer required in itself under the 2003 Act, may be a consideration for some consumers. Consider the following example. A consumer (C) is considering two credit contracts of the same term and principal: A and B. Contract A discloses an annual interest rate of 10%, total interest charges of $300 and credit fees and charges of $150. Contract B discloses an annual interest rate of 11%, total interest charges of $330 and credit fees and charges of $70. Assuming C seeks the cheapest option, if C’s decision is based on the annual interest rate, C would choose contract A, in which case the annual interest rate is misleading. C is better off choosing contract B. Yet to discover this, C must add the total interest charges and credit fees and charges for both contracts, and then compare the two. Given that consumers often do not have skills to interpret and use the annual finance rate under the 1981 Act, it is unlikely that many would have the skills to make the comparison made above where the total cost of credit is not disclosed. Undoubtedly the changes made to the definition of interest, and the adoption of the annual interest rate, are a step forward. However, the other changes made to the disclosure requirements make it hard to assess the total cost of credit, and comparisons based on the annual interest rate ignore any differences in the fees and charges associated with the credit contracts. The removal of the need to disclose the total cost of credit therefore appears to be a step backwards. Whilst the annual interest rate does go some way to assisting comparison shopping, it is submitted that the other changes have little or no impact on the problems that existed under the 1981 Act. The 2003 Act makes no attempt to deal with the major problem of the timing of disclosure. The three-day ‘cooling-off’ period has been retained from the 1981 Act,[99] despite the Ministry’s conclusion that it was doubtful whether the right to cancel was used for credit shopping.[100] The Ministry rejected two other options for resolving this problem: pre-contractual disclosure and the use of comparison rates in advertising. This means that the 2003 Act makes no attempt to deal with an associated problem: the conditions under which the consumer is presented with the disclosure statement. The Act also makes no attempt to reduce the stressful conditions under which a disclosure statement may be presented. The 2003 Act only makes a minimal attempt to tackle illiteracy problems by providing for the Commerce Commission to make available educational material for consumers.[101] However, any criticism of this is overly harsh, for the illiteracy of adult New Zealanders is a much wider social issue than the Act was intended to tackle, and the provision of educational material is perhaps the best that can be hoped for. The issue of cognitive overload, on the other hand, appears to be worse under the 2003 Act. Whilst the 1981 Act only required disclosure of eight ‘bits’ of information, the 2003 Act provides for disclosure of up to 21 ‘bits’. Whilst only the information that is relevant to the credit contract must be disclosed, the proposed model disclosure forms indicate that there is still a grave risk of information overload. The model disclosure statement for fixed credit contracts contains 16 ‘bits’ of information.[102] Twelve ‘bits’ must be disclosed in the case of revolving credit contracts.[103] This is contrary to the Ministry’s synthesised approach, which proposed reduced disclosure requirements. When all these considerations are combined, it appears unlikely that the changes made will encourage comparative shopping any more than the 1981 Act.

V. OPTIONS FOR FURTHER REFORM

Disclosure regimes add costs for creditors which are inevitably passed on to consumers. Because initial disclosure is unlikely to promote comparison shopping under the 2003 Act, and thus is unlikely to encourage competition, the legitimacy of this type of intervention in consumer credit markets is questionable. This part examines some options for reform and concludes that initial disclosure still has a purpose, but that alternative methods should be used to promote competitive consumer credit markets.

Remove Initial Disclosure Requirements from the Legislation

It has already been noted that the best option for protecting consumers is a competitive credit market. The first option, therefore, is to remove truth-in-lending disclosure from the legislation and rely on the free market to promote competition. Initial disclosure in previous legislation has been shown to be ineffective in achieving the purpose of encouraging competition, and this is likely to remain so under the 2003 Act. Further, some of the barriers to achieving comparative shopping, such as consumer illiteracy, and consumers who shop by features of the goods rather than the credit, may be insurmountable. As a result, ineffective disclosure requirements increase the costs of credit transactions, and those costs are passed onto consumers. Consumers would therefore benefit through reduced costs if the disclosure regime was removed altogether. Furthermore, as indicated above, whilst competition is beneficial to consumers in that it reduces prices, there is no evidence that initial disclosure encouraging comparative shopping is causative of the competitiveness that exists in some markets. Credit markets may be competitive without the need for disclosure, and so disclosure requirements again add an unnecessary cost to the transaction. Finally, although there is evidence of unconscionable practices in the only period in which there was no regulation of credit transactions (see Part II above), there are reasons to believe that an unregulated market may not be so problematic in the twenty-first century. The media has become a powerful tool in protecting consumers[104] and, in combination with advances in communication technology through the internet and e-mail, this may mean creditors charging excessive rates or fees may not be as prolific as they were in the nineteenth century if initial disclosure is removed. However, the free market approach has its problems. The late nineteenth century is indicative of the lengths to which some marginal lenders will go to take advantage of the unwary. The media does not have the ability to catch every unconscionable creditor before some unwary consumers have been disadvantaged. Further, while some markets may be competitive without disclosure statements, it is reasonable to suggest that such an assertion is restricted to mainstream creditors such as banks, credit cards and large finance firms. The market for marginal lenders, in which low-income debtors may not have a choice of creditors, is unlikely to be competitive if left unregulated, and may result in unconscionable practices.[105] A solution could be to legislate only for the regulation of marginal lenders, but such a proposal also has problems. It resorts to regulating by the nature of the creditor as opposed to the substance and form of the transaction, and creditors have in the past shown that they can be innovative in coming up with new types of transactions or organisations to avoid regulation.[106] Legislation will, as a result, always be playing ‘catch-up’, seeking to regulate the most recent method used to avoid regulation. It is likely, therefore, that if truth-in-lending disclosure statements were abandoned completely, there is not enough competitive pressure in all credit markets to avoid market failures and inefficiencies. McBride and Bowie reached the same conclusion.[107] Therefore, some regulation requiring information disclosure is preferable.

Initial Disclosure to Ensure Consumers are Informed of the Terms of the Transaction

The next option is to accept that initial disclosure in its current form will not encourage comparative shopping for credit, and that such a purpose should be abandoned. However, initial disclosure still has a purpose in that it allows consumers to become informed of the terms of the transaction, in particular the consumer’s obligations, before becoming irrevocably committed to it. To this extent, disclosure has a function as a ‘warning flag’ where the interest rate or cost of credit is excessive, or beyond that which the consumer is willing to pay.[108] Disclosure may therefore be effective in persuading a consumer not to enter a particularly onerous credit contract. For example, in Malbon’s research, 11 per cent of respondents who affirmed that the pre-contractual statement had affected their decision to take out the proposed loan stated that they had decided not to take out the loan on the basis of the statement.[109] Whilst Malbon’s conclusion that 11 percent is a ‘reasonably significant proportion’ is questionable,[110] his conclusion that initial disclosure documents as required by the Consumer Credit Code in Australia are ‘having some impact on consumer decision-making’ is more supportable.[111] Whilst some of the problems that inhibit comparative shopping also affect the consumer’s ability to understand his or her obligations under the contract (for example, illiteracy), using initial disclosure to inform consumers of their obligations is supportable and in most cases achievable. Whilst disclosure may not be able to inform all consumers of their obligations, disclosure that allows most consumers to know most of their key obligations (such as how much to pay and how often) and the consequences of default is a far better option than having a majority of consumers being unaware of such information.

Develop a Method that can Promote Comparative
Shopping and Competition

The third option is to accept that encouraging comparative shopping and competition is an option for protecting consumers, but that initial disclosure documents are not an appropriate tool for doing so. This involves three steps. The first is to abandon encouraging competition as a purpose of initial disclosure documents. Initial disclosure documents should still be retained, however, as they are possibly the only suitable method for attempting to inform consumers of the individual terms of a credit contract. The second step is to accept the assumption that a competitive marketplace is a more effective mechanism for attaining optimum consumer benefit than government-mandated price regulation.[112] A competitive market is the best way to ensure that consumers get the best deal without facing large search costs. It is also the best way to protect consumers from credit contracts that charge excessively, because competitive pressures will mean such products do not survive. The third step is to accept that comparative shopping for credit is a tool that can promote competition. Therefore, promoting comparative shopping is a legitimate purpose for consumer credit legislation. The writer suggests that it is this third option that represents the best option for protecting consumers. The challenge is then to develop a tool that either encourages competition directly, or indirectly, through comparative shopping. To be successful, any regime that is proposed must tackle most, if not all, of the problems identified in Part III, something which the 2003 Act fails to do.

VI. THE PROPOSAL

The tool that is best suited to solving most of the problems under the 1981 Act, a centralised third-party disclosure system, was rejected as an option by the Ministry of Consumer Affairs.[113] As far back as 1979, Schwartz and Wilde suggested that a promising method of promoting competition would be to provide consumers with comparative price information.[114] Since then, it has been suggested that advances in technology justify giving such a proposal serious thought.[115] Whilst such a proposal may not have been possible in the past, it is submitted that there is now sufficient technology available for such a measure to be adopted if Parliament is serious about encouraging comparative shopping and competitive consumer credit markets. With the advances in the use of the internet, the time may now have come for consumer credit disclosure legislation to take a major change in direction. It is important when considering the proposal put forward to bear in mind the distinction between initial disclosure documents and third-party disclosure, and what each is intended to achieve. The aim of third-party disclosure under this proposal is not to inform consumers of the exact terms and conditions of a consumer credit contract. In the ‘Potential Problems’ section below, it is acknowledged that there are too many variables in individual credit contracts for third-party disclosure to achieve that. Rather, such a purpose is better left to initial disclosure documents with the purposes of third-party disclosure being to encourage comparison shopping for credit and increased competition in credit markets. A brief description of the key features of the proposal follows together with a discussion of how it would encourage competition. This leads on to a consideration of whether such a proposal can tackle the problems inherent in initial disclosure documents. The potential problems with third-party disclosure identified by McBride and Bowie will then be considered along with other objections that may be raised.

Structure of the Proposed Scheme

The proposed system would operate as follows. Specified information regarding the terms of various credit products offered by credit providers is filed with a centralised agency. This would include, for example:

· the interest rate charged for a credit contract of a specified term and principal;
· other charges and fees that would be charged on such credit agreements; and
· the type of credit contract the rates and fees apply to, for example, a mortgage, personal loan or credit purchase.

Creditors file the information with the agency by filling in the required information on a web site (the creditor’s web site) which, once completed, is submitted to the agency via the internet. A programme would then process the information for use when a consumer accesses another web site (the consumer web site). The consumer inputs specific required information into the consumer web site, for example the contract term, the total amount sought to be financed and the type of credit contract.[116] The programme running the web site then produces a ‘league table’ of creditors offering the same type of credit contract for the same term and the same amount. The web site would offer to rank creditors by a number of factors. Malbon’s survey suggests that consumers found interest rates, and fees and charges, two of the easiest items to compare.[117] It is suggested that the total cost of credit may also be a factor which consumers would find useful when looking at the ranking of creditors in a table. Therefore, the consumer web site would rank creditors by those three indicators. One advantage of this system is that it can be used for both fixed-term and revolving credit contracts. This proposal for providing information to consumers can achieve its objective of encouraging competition in two ways. First, as Schwartz and Wilde have pointed out, the extent of comparison shopping varies inversely with the cost of comparing alternatives.[118] The above proposal reduces search costs significantly. There is no need to travel between creditors to make comparisons, thereby reducing time and transport costs. Additionally, there is no need for the consumer to perform the calculations required to compare alternative contracts. Those calculations are completed by the programme running the consumer web site. Therefore, as search costs are reduced, the likelihood of comparison shopping increases, and this in turn indirectly encourages competition. Secondly, even if the provision of such information does not promote comparative shopping, it is likely to encourage competition directly. It is difficult to imagine a reasonable credit provider that would be content to see itself significantly adrift from other creditors at the bottom of the league tables for each of the ranking criteria. Whilst a consumer may not actually comparative shop using the league tables, he or she is unlikely to choose a creditor at the bottom of the league tables as his or her first choice of creditor. The risk of this occurring would encourage creditors to be more competitive. There is data, albeit untested, that suggests that information easily provided on the internet can encourage comparison shopping for credit. Fundsource maintain the website www.cardwatch.co.nz which compares credit cards overall and by interest rates. When it was released, Fundsource carried out a survey of users as to whether they would use the information provided when deciding on a new credit card. Of 209 respondents, 90.43% agreed that they definitely would, or would use the information as a guide.[119] This can be compared to the data obtained by Malbon in Australia based on initial disclosure documents, in which only 26% of respondents shopped around for credit cards. This suggests that if obtaining the information needed for comparison shopping is easy to obtain and understand, more consumers will comparison shop, which will then encourage more competition.

Does the Proposal Solve the Problems that PlagueInitial Disclosure Documents?

The most significant problem with the truth-in-lending disclosure regimes is the timing of disclosure. The proposal put forward in this paper tackles the problem head on. With the ability to access the proposed consumer web site from home or at work, the consumer can either acquire the information just before he or she leaves to visit the creditor, or spend a number of weeks before entering a contract using the web site to search for the best option.[120] This gives the consumer more time than he or she has at present to consider the information provided. Accessing the information away from the creditor also reduces the stressfulness of the situation under which the information is provided. Whilst there may still be distractions such as children or work colleagues, the consumer is no longer faced with attempting to assess the information provided in the presence of the creditor. The proposal, if put into practice properly, may also be able to deal with the problem of debtor illiteracy. Whilst the numbers in the league tables may not mean a lot to many consumers, provided that most consumers are capable of concluding that those creditors at the top of the table represent the best or cheapest option and those at the bottom the worst or most expensive option, consumers should be able to identify how a creditor fits within the scale. The form of the league tables may also help solve the cognitive overload problems. Firstly, the information contained in the tables can be restricted to the three or four indicators that consumers consider to be the most relevant to their decision-making. Further research would be needed to identify these factors but, as discussed above, cost factors such as interest rate,[121] total cost of credit and additional compulsory charges and fees would be the most relevant. Secondly, whilst cognitive overload may prevent consumers from absorbing all the information in the league tables, the overall effect of ‘top of the table is good’ and ‘bottom of the table is bad’ should be easily understood.[122] The proposal may also encourage consumers to incorporate credit considerations into their shopping decisions. If the consumer web site is accessed before the consumer starts physically shopping for a product or service, the results provided in the league tables may influence where the consumer shops. Once the consumer has selected his or her preferred creditors, he or she may then search for the features of the goods or services within those pre-determined suppliers. It is acknowledged that not all consumers can be forced to abandon their desire to shop primarily by the features of the product or service sought. The above proposal, however, is intended to encourage competition, and if this occurs, then even those consumers who do not shop by the features of the credit contract should end up with better protection from excessive prices because of increased competition. It appears, therefore, that the proposal, if handled correctly, may be able to overcome most of the barriers that prevent initial disclosure documents from achieving the objectives of comparative shopping and encouraging competition.

Potential Problems

Undoubtedly a third-party disclosure regime faces obstacles to its implementation and success. McBride and Bowie identified five objections that have been raised with regard to third-party disclosure,[123] and these will be dealt with first. There are additional foreseeable problems and some of these are discussed subsequently.

Accumulating the required information at a justifiable cost

McBride and Bowie noted that concern was expressed during the review of consumer credit law that the Government would not be able to acquire the required information, or do so at a justifiable cost. Placing the onus on the creditor to file the required information on the creditor web site, initially and whenever their standard interest rates and fees change, goes some way to reducing this problem. This means that the burden of the cost is shifted to the creditor, which inevitably means that costs for consumers will increase. The challenge will be to design the creditor web site so that it requires the minimum time and effort to add or amend a creditor’s standard terms. It is accepted that creditors would be faced with substantial costs whilst initially filing the required information on the creditor’s web site when the proposed system is created. However, the ongoing costs may be minimal as a creditor would then only be required to amend its details when the interest rates or charges change, for example, when mortgage rates change, or a retailer has a 0% interest special offer. There is also an associated issue of how creditors can be encouraged to keep their details up to date. One possibility is to reintroduce registration for consumer creditors. Penalties could be imposed if a registered creditor’s information is not up to date, with the most severe penalty being suspension of the creditor’s registration and information from the consumer web site and league tables. If a transaction is unenforceable unless the creditor is registered at the time the contract is entered into, this presents a strong incentive to creditors to ensure that their information is correct.

Marginal lenders may not participate

There is a risk that marginal lenders may not participate because of increased costs. However, most costs are inevitably passed on to consumers, so marginal lenders are unlikely to be squeezed out of the market place. Instead, the risk is that the increased costs that are passed on to consumers will negative any reduced prices that are achieved through increased competition. Again, the challenge will be to design the system so that creditors’ costs are minimised.

An interactive system would not reflect the range of costs options

The proposal makes no allowance for other terms of the contract, such as whether any security is taken, default fees and interest, and the extent of any trade-off between, for example, credit insurance and interest rates. In other words, the system could not be flexible enough to cope with the wide range of possible terms. It may have to be accepted that the terms of an individual credit contract of a particular class may often vary from another issued by the same creditor because of the different characteristics of the consumer and other terms of the credit contract. It may be impossible for third-party disclosure to accurately reflect all those variations. However, what should be possible is for creditors to submit their information, such as interest rates, based on a hypothetical consumer with an average credit rating, and contract terms specified by the agency. For the latter, for example, the interest rate on a credit sale may be given on the basis that security is taken and credit insurance is not. Whilst these terms may not accurately reflect the exact terms of the contract into which the consumer eventually enters, the purpose of third-party disclosure is not to inform consumers of the cost of credit or interest rate on a particular credit contract. The purpose is to supply consumers with a guide to the cost of credit contracts with particular creditors, which thereby facilitates comparison shopping. The task of informing a consumer of the terms of the contract belongs to the initial disclosure documents.

The private sector is already beginning to fulfil this role

Whilst the private sector may be organising third-party disclosure for large credit transactions such as mortgages, it does not hold true for smaller credit transactions such as credit cards, overdrafts, sale credit and personal loans.

Such a system would not remove the need for disclosure of individual terms

Whilst third-party disclosure does not remove the need for disclosure of the terms of an individual credit contract, it must be recalled that the aim of third-party disclosure is to encourage competition, not to inform the consumer of the exact terms and conditions. That is the task of initial disclosure documents. The problem that arises, however, is again cost. The cost of third-party disclosure must be absorbed in addition to the costs of initial disclosure statements.

The system would not be sufficiently flexible

There is a risk that the proposed web sites would not be flexible enough to allow for all possible types of credit products that are offered to consumers. Creditors may be forced to fit themselves within the categories specified on the creditor’s web site, even though such categories do not truly reflect the nature of the creditor’s business. Resolving this issue would require extensive consultation with creditors to ensure that all suppliers of credit to consumers are able to be incorporated into the system. Whether this can in reality be achieved would need to be the subject of further research. This problem, along with the cost of initiating and maintaining the system, is likely to be one of the most significant barriers to adoption of third-party disclosure. There is further a risk that third-party disclosure would not be sufficiently flexible to accommodate new credit products. This in turn may prevent the development of new credit products that would benefit consumers. This problem can be solved by allowing creditors to request that the agency create a new category of credit product for incorporation into the creditor’s and consumer’s web sites, thereby removing any disincentives for innovative products that such a system may generate.

Other terms of the credit contract that affect a consumer’s decision are not incorporated into the web site

The cost of credit is not the only factor that affects a consumer’s choice of credit product. A consumer’s decision may also depend on such things as the type and extent of any security taken, default rates and default fees. Therefore, it may be argued that third-party disclosure does not, and cannot, incorporate the multitude of factors that may affect the consumer’s decision. But the purpose of this proposal must be recalled. The purpose is not to tell the consumer which credit contract is his or her best option. It is to encourage creditors to offer price competitive credit products on the basis that lower credit prices benefit the majority of consumers. Further, the consumers who are aware of other factors such as security and default charges, or even know what they mean, are likely to be those that are sufficiently knowledgeable about credit contracts to incorporate such factors into their decisions without the need for disclosure over the internet.

Problems of locality

A consumer in Gore is unlikely to be interested in the credit products offered by a retailer in Tauranga, so the consumer’s web site would need to be able to take account of the consumer’s locality. This can be easily achieved by including on the consumer’s web site an option for selecting the geographical region within which the consumer wishes to search. The hypothetical consumer in Gore, for example, could be offered the option of searching within a region such as Southland or Otago.

Inability of the consumer to obtain the credit offered

The proposal does not take account of the ability of consumers to obtain the credit options offered on the consumer’s web site. Again, the purpose of third-party disclosure must be recalled. It is intended to promote competition, not to tell a particular consumer which credit contracts he or she is able to obtain. It is unlikely that a system could be developed within sufficient cost restraints that would be able to provide consumers with this information.

Internet access

Not every consumer has access to the internet, so not all consumers will be able to comparative shop. This problem is exacerbated by the fact that those likely to benefit most by increased price competition, those on low incomes, are those least likely to have internet access. This issue is tackled by referral back to Schwartz and Wilde’s suggestion that not all consumers need to comparison shop to encourage competition.[124] Provided sufficient numbers use the proposed consumer web site, this would encourage competition for the benefit of all consumers, even those without internet access.

VII. CONCLUSION

This paper has shown that the 2003 Act is unlikely to be effective in overcoming the barriers that prevent initial disclosure from encouraging comparative shopping and increased competition in consumer credit markets. As competitive markets represent a better way of protecting consumers from excessive prices than government regulation of interest rates, it is suggested that the aim of encouraging competition amongst creditors should be retained. The challenge that lies ahead is to find a way in which a sufficient number of consumers can be provided with the relevant information that either allows them to comparative shop, or persuades creditors to offer more competitive products. The method presently used, initial disclosure documents, faces some almost insurmountable problems, and a new method must be considered. Previously it would have been difficult and expensive for a third party agency to acquire and distribute the information that would allow consumers to comparison shop. The internet, however, provides an ideal medium by which the required information can be compiled and dispersed. There are, undoubtedly, complications and difficulties that must be overcome before such a scheme can be accepted as viable. This paper has attempted to suggest solutions for some of those problems, but the major inhibitor will likely remain cost and the ability of any scheme to be flexible enough to cater for the wide variety of creditors and credit contracts that exist in the consumer market. Given that initial disclosure is almost certainly unable to fulfil its purpose of encouraging competition, governments may find themselves with no other sensible alternative other than finding a way to make third-party disclosure work if they continue to prefer market forces as a method for protecting consumers from excessive interest rates in consumer credit contracts.


[*] Christopher LLB(Hons), is currently working in the Corporate/Commercial department of Bell Gully in Wellington.

[1] Credit Contracts and Consumer Finance Act 2003, s 118, preceded by the Credit Contracts Act 1981, s 10(1).

[2] E Tan, ‘An Empty Shell? Rethinking the Usury Laws in Medieval Europe’ (2002) 23 Journal of Legal History 177.

[3] Ibid.

[4] A Duggan & E Lanyon, Consumer Credit Law (1999) 1.

[5] E Salin, ‘Usury’ in The Encyclopaedia of the Social Sciences Vol 15 (1915) 195, cited in J Henning, ‘The Origins of the Distinction Between Loan and Partnership Enshrined in the Partnership Act 1890’ (2001) 22 Company Law 75, 76.

[6] H Spiegel, ‘Usury’ in J Eatwell, M Milgate & P Newman (eds), The New Palgrave: a Dictionary of Economics (1987) 769-770, cited in Tan, above n 2.

[7] Henning, above n 5, 77.

[8] A Diamond, Commercial and Consumer Credit: An Introduction (1982) 4.

[9] 37 Hen VIII, c9.

[10] 5 & 6 Edw VI, c20.

[11] 13 Eliz I, c8.

[12] 21 Jac I, c17 (1623) reduced the rate to 8%. 12 Car II, c13 (1660) reduced the rate to 6%.12 Anne, Stat 2, c15 (1713) reduced the rate to 5%.

[13] ‘[I]n modern times the term [usury] was again narrowed down to refer only to excessive loan charges:’ Henning, above n 5, 76.

[14] Duggan & Lanyon, above n 4, 2.

[15] Ibid; Diamond, above n 8, 4.

[16] Diamond, above n 8, 5.

[17] R Goode, Introduction to the Consumer Credit Act 1974 (1974) 1.

[18] British Parliamentary Papers No. 260 (1898) X, 106

[19] Goode, above n 17, 1.

[20] Moneylenders Act 1900 (UK), s 1(1).

[21] Moneylenders Act 1900 (UK), s 2(1)(a).

[22] Moneylenders Act 1900 (UK), s 2(1)(b).

[23] P Spiller, J Finn & R Boast, A New Zealand Legal History (2nd ed, 2001) 76.

[24] 237 NZPD, 1933, 589.

[25] Goode, above n 17, 3.

[26] R Goode, ‘The Legal Regulation of Lending’ in A Diamond (ed), Instalment Credit (1970) 45

[27] Duggan & Lanyon, above n 4, 7.

[28] Goode, ‘The Legal Regulation of Lending’, above n 26, 45.

[29] Hire Purchase Act 1938 (UK), s 2.

[30] Diamond, above n 8, 13.

[31] D Dugdale, New Zealand Hire Purchase Law (3rd ed, 1978) 4.

[32] 367 NZPD, 1970, 2424.

[33] Truth in Lending Act 1968 (USA) 15 USCS § 1601, s 103.

[34] Truth in Lending Act 1968 (USA) 15 USCS § 1601, ss 128, 129.

[35] Truth in Lending Act 1968 (USA) 15 USCS § 1601, s 102.

[36] Truth in Lending Act 1968 (USA) 15 USCS § 1601, ss 106, 107.

[37] See R Goode, The Consumer Credit Act: A Students’ Guide (1979); P Dobson, Sale of Goods and Consumer Credit (6th ed, 2000).

[38] Law Council of Australia, Report on Fair Consumer Credit Laws (1972) [4.5.1].

[39] Consumer Credit Act 1972 (SA).

[40] Credit Act 1984 (NSW), Credit Act 1984 (Vic).

[41] Section 35 applied to sale credit contracts and s 36 applied to loan credit contracts.

[42] S Begg, ‘No Truth in Lending: the Cost of Credit Under the Code’ (1996) 70 Law Institute Journal 32. 43 Report of the Contracts and Commercial Law Reform Committee, Credit Contracts (1977).

[44] Ibid 97.

[45] Ibid 100.

[46] Ibid 134.

[47] 433 NZPD, 1980, 3687.

[48] NZPD Vol 433, 1980: 3689.

[49] Credit Contracts Act 1981, s 16. A controlled credit contract is defined in s 15. The definition essentially provides that where a credit contract is entered into by a person who provides credit in the course of his or her business, the contract is a controlled credit contract.

[50] Credit Contracts Act 1981, s 21(1)(a).

[51] Report of the Contracts and Commercial Law Reform Committee, above n 43, 140.

[52] Credit Contracts Act 1981, s 16.

[53] The explanatory notes of the Consumer Credit (Queensland) Bill 1994 state that ‘[t]he policy of the legislation is to rely generally on competitive forces to provide price restraint’, cited in J Malbon, ‘Shopping for Credit: An Empirical Study of Consumer Decision-making’ (2001) 29 Australian Business Law Review 44, 49.

[54] Ministry of Consumer Affairs, Consumer Credit Law Review Part 3: Transparency in Consumer Credit: Interest, Fees and Disclosure (2000) 24-36 (‘the Transparency Review’).

[55] Ibid 33.

[56] Ibid 34.

[57] Credit Contracts Act 1981, s 16.

[58] J Landers & R Rohner, ‘A Functional Analysis of Truth in Lending’ (1979) 26 UCLA Law Review 711, 715.

[59] Ibid 726.

[60] L Lawrence, ‘Toward a More Efficient and Just Economy: An Argument for Limited Enforcement of Consumer Promises’ (1987) 48 Ohio State Law Journal 815, 847.

[61] See for example, Malbon, above n 53, 45; R Bowes, ‘Annual Percentage Rate Disclosure in Canadian Cost of Credit Disclosure Laws’ (1997) 27 Canadian Business Law Journal 183, 207; Ministry of Consumer Affairs, above n 54, 31.

[62] ‘Now with sophisticated computer modelling available in the housing loan market, it may be that consumers can obtain timely disclosure for housing loans. However, to obtain this service, the consumer will need to make an appointment at the bank and the consequent investment of time and energy are unlikely to be repeated more than a few times:’ E Lanyon, ‘Cassandra’s Curse: Disclosure Under the Consumer Credit Code’ (1997) 5 Consumer Law Journal 178, 190.

[63] Ministry of Education, Adult Literacy in New Zealand: Results from the International Adult Literacy Survey (undated – survey conducted in March 1996), cited in Ministry of Consumer Affairs, above n 54, 13.

[64] Landers & Rohner, above n 58, 722-725.

[65] T Durkin, ‘Consumers and Credit Disclosures: Credit Cards and Credit Insurance’ [2002] Federal Reserve Bulletin 201, 208.

[66] Landers & Rohner, above n 58, 722-723.

[67] Ibid 711.

[68] A Schwartz & L Wilde, ‘Intervening in Markets on the Basis of Imperfect Information: A Legal and Economic Analysis’ (1979) 127 University of Pennsylvania Law Review 630, 656.

[69] Ibid.

[70] Ministry of Consumer Affairs, above n 54, 24.

[71] Landers & Rohner, above n 58, 725-727.

[72] Ministry of Consumer Affairs, above n 54, 59.

[73] W Brandt & G Day, ‘Information Disclosure and Consumer Behaviour: An Empirical Evaluation of Truth-In-Lending’ (1974) 7 University of Michigan Journal of Law Reform 297, 326.

[74] Malbon, above n 53, 55.

[75] H Kripke, ‘Gesture and Reality in Consumer Credit Reform’ (1969) 44 New York University Law Review 1, 6.

[76] Schwartz & Wilde, above n 68, 655-656.

[77] Malbon, above n 53, 53-54.

[78] Ibid.

[79] Schwartz & Wilde, above n 68, 655-656.

[80] Malbon, above n 53, 44.

[81] The National Business Review, 29 October 2004, 46.

[82] Ibid.

[83] <http://www.fundsource.co.nz/cardwatch_rates.asp> at 4 November 2004.

[84] Durkin, above n 65, 208.

[85] Malbon, above n 53, 58.

[86] Ministry of Consumer Affairs, above n 54, 48.

[87] Ibid 51-56.

[88] Credit Contracts and Consumer Finance Act 2003, s 17 and First Schedule.

[89] The proposed model disclosure statements are available at <http://www.consumeraffairs.govt.nz/policyandlaw/pdfpapers/CCCFA-Disclosure-Stmt2.pdf> and <http://www.consumeraffairs.govt.nz/policyandlaw/pdfpapers/CCCFA%20disclosure%20Stmt%201.pdf> .

[90] Ministry of Consumer Affairs, above n 54, 5.

[91] Ibid 56.

[92] N McBride & R Bowie, ‘The Goals of Consumer Credit Law: The Approach of the Ministry of Consumer Affairs to its Consumer Credit Law Review’ (2001) 7 New Zealand Business Law Quarterly 329, 337.

[93] 606 NZPD, 2003, 3511.

[94] Credit Contracts and Consumer Finance Act 2003, s 3(b)(i).

[95] Report of the Contracts and Commercial Law Reform Committee, above n 43, 97.

[96] Credit Contracts and Consumer Finance Act 2003, s 39.

[97] Credit Contracts and Consumer Finance Act 2003, ss 41-44.

[98] 612 NZPD, 2003, 8887.

[99] Credit Contract and Consumer Finance Act 2003, s 27.

[100] Ministry of Consumer Affairs, above n 54, 59.

[101] Credit Contracts and Consumer Finance Act 2003, s 111(2)(d).

[102] See above n 89.

[103] Ibid.

[104] This includes not only the television news and newspapers, but also consumer watchdog programmes such as Target and Fair Go.

[105] For example, see the discussion of pay-day lenders in C Field, ‘Pay-day Lending – an exploitative market practice’ [2002] AltLawJl 12; (2002) 27 Alternative Law Journal 36. For a New Zealand example, consider home buy-back schemes: see I Haynes, ‘Home buy-back schemes’ (2002) 594 Lawtalk 7. Home buy-back schemes are now regulated by the Credit Contracts and Consumer Finance Act 2003, ss 71-83.

[106] For example, see Goode, above n 17, 2.

[107] McBride & Bowie, above n 92, 333.

[108] Ministry of Consumer Affairs, above n 54, 23, citing Landers & Rohner, above n 58, 711.

[109] Malbon, above n 53, 59.

[110] Ibid.

[111] Ibid.

[112] Ibid 49.

[113] McBride & Bowie, above n 92, 337-8.

[114] Schwartz & Wilde, above n 68, 673.

[115] A Schwartz & L Wilde, ‘Imperfect Information in Markets for Contract Terms: The Examples of Warranties and Security Interests’ (1983) 69 Virginia Law Review 1387, 1461; R Bowes, ‘Annual Percentage Rate Disclosure in Canadian Cost of Credit Disclosure Laws’ (1997) 27 Canadian Business Law Journal 183, 217.

[116] For an example of such web site, see the various calculators that exist on <www.sorted.org.nz>.

[117] Malbon, above n 53, 63. Loan conditions were also said to be ‘easy to compare’.

[118] Schwartz & Wilde, ‘Imperfect Information in Markets for Contract Terms’, above n 115, 1460.

[119] Information provided in a personal e-mail from Fundsource following a request for the responses to the survey.

[120] This will pose problems for those without any access to the internet. See the ‘Potential Problems’ part of this section for a discussion of this issue.

[121] The method of calculating the interest rate would still need to be regulated as it is under the 2003 Act to ensure that the comparisons are valid.

[122] See ‘Potential Problems’ section below on the validity of price factors as indicating best and worst options.

[123] McBride & Bowie, above n 92, 338.

[124] Schwartz & Wilde, ‘Intervening in Markets’, above n 68, 655-656.


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