|
|
Home
| Databases
| WorldLII
| Search
| Feedback
New Zealand Ad Hoc Government Discussion Papers |
Last Updated: 18 April 2020
CONSUMER CREDIT LAW REVIEW
PART 2: APPLICATION:
WHAT TRANSACTIONS SHOULD CONSUMER CREDIT
LEGISLATION APPLY TO?
April 2000
CONSUMER CREDIT LAW REVIEW
PART 2: APPLICATION:
WHAT TRANSACTIONS SHOULD CONSUMER CREDIT
LEGISLATION APPLY TO?
April 2000
ISBN 0-478-23468-6
33 Bowen Street, PO Box 1473
Wellington, New Zealand
Phone: 64 (4) 474-2750
Fax: 64 (4) 473-9400
Email: mcainfo@moc.govt.nz
CONTENTS
EXECUTIVE SUMMARY
This is the second
public consultation document to be released by the Ministry of Consumer Affairs
as part of the Consumer Credit
Law Review. It discusses the issue of the
application of consumer credit law, or what transactions the legislation
should apply to. In particular, it considers what classes of transaction
should be regulated as consumer credit contracts.
The paper also raises
the issue of whether some forms of transaction should be regulated separately.
Specifically, it questions whether
there is still the need for a separate Act to
regulate hire purchase. Since the passing of the Credit Contracts Act 1981, the
Consumer
Guarantees Act 1993, the Credit (Repossession) Act 1997, and the
Personal Property Securities Act 1999, the justification for the
Hire Purchase
Act 1971 is less obvious. Views are sought on whether it is necessary to retain
the Act. There is also a brief discussion
on long-term consumer leases and
whether they should be treated as a distinct form of transaction.
The
paper discusses the current test used to apply consumer credit protection. The
focus is on the monetary ceiling of $250,000 which
is the primary means used to
define a “controlled credit contract”. Disclosure provisions and the
three day cooling-off
period are mandatory only for controlled credit contracts.
Because the monetary ceiling has become outdated through price inflation,
leaving significant consumer credit contracts unprotected, the Ministry believes
that it may no longer be the appropriate application
test.
The document
also discusses whether a monetary ceiling of $250,000 might be having the effect
of regulating – inappropriately
– a large number of commercial
credit contracts. Reasons why commercial credit is distinct from consumer credit
include:
The
Ministry also argues that inappropriate regulation of commercial credit can lead
to:
Lastly, business borrowers would still have
protection if not covered by consumer credit legislation. In particular, the
Fair Trading
Act 1986 offers protection, and remedies may be found in both the
common law and the law of equity. It is also notable that the banking
industry
has in place well-regarded self-regulatory mechanisms.
The document
finishes by outlining various alternatives to the current monetary ceiling in
the Credit Contracts Act, examining their
respective advantages and
disadvantages. These are:
Raising the monetary ceiling –
however, this would result in increased coverage of commercial credit contracts.
Lowering the monetary ceiling – this test is based on the
premise that consumers most often borrow small amounts. An issue is whether home
finance contracts
should be excluded from a ceiling, as a ceiling that excluded
most commercial credit contracts would also exclude most home finance.
A natural persons test – this test would regulate all
credit contracts via natural persons (as opposed to legal persons). The test is
arbitrary in
its treatment of commercial borrowers. Additionally, without a
monetary ceiling it would regulate many commercial credit contracts.
A
test to include small business – it would be possible to define small
business entities in legislation, in order to provide protection for them.
However,
matters of definition would be complex.
A contracting out
provision – commercial borrowers could be permitted to contract out of
credit legislation. Because lenders would likely seek to always
contract out
when lending to commercial borrowers, it would have little, if any, advantage
over blanket exclusion of commercial credit.
The Ministry’s
preferred option is for a purpose test, which would restrict regulation
to credit provided to a “natural person” primarily for
“personal, domestic or
household” use. The test, and variations of
it, are coming into more widespread use internationally. Australian evidence
shows
the test is workable for lenders and borrowers. Advantages include its
flexibility and consistency with market practice. However,
it may result in
uncertainty in limited situations. On balance, it appears to offer a favourable
approach.
CALL FOR SUBMISSIONS
The
Ministry encourages written submissions from interested parties on the content
of this document. The purpose of the submissions
will be to inform the Ministry
as it proceeds with the review of consumer credit law. Ultimately, the
submissions will inform the
government on any decisions it chooses to take with
respect to the reform of consumer credit law.
Questions for submitters
Final date for submissions and contact details
Final
date for receipt of submissions is Friday, 14 July, 2000.
Comments and
submissions should be addressed to:
Consumer Credit Law Review Team
Policy
Unit
Ministry of Consumer Affairs
PO Box 1473
WELLINGTON
Contact
details:
Rob Bowie 64 4 474-2927 rob.bowie@moc.govt.nz
Bob Hillier 64 4
474-2944 bob.hillier@moc.govt.nz
Nick McBride 64 4
474-2818 nick.mcbride@moc.govt.nz
Fax: 64 4 473-9400
OFFICIAL INFORMATION ACT 1982
In providing your submission, please advise us if you have any objections to the release of your submission. If this is the case, please advise us of the parts of your submission that you would wish withheld, and the grounds for withholding. In preparing and releasing any summary, and in considering any formal Official Information Act requests that might be received, the Ministry will carefully review any representations that you make in this regard.
PRIVACY ACT 1993
Any
personal information that you supply to the Ministry in the course of making a
submission will be used by the Ministry in conjunction
with consideration of
matters covered by this discussion paper only.
When preparing any summary
of submissions for public circulation, it is the Ministry’s normal
practice to set out the names
of parties making submissions. Your name will be
included in any such summary unless you inform the Ministry that you do not wish
your name to be included. In order to indicate your wishes, or to view personal
information held about you in respect of the matters
covered by this discussion
paper, or to request correction of that information, please contact the Ministry
of Consumer Affairs,
ph (04) 474 2750.
1. INTRODUCTION
1.1 The review of consumer credit law
The Ministry of Consumer Affairs is reviewing consumer credit law to see whether it is appropriate for today’s credit market. The Ministry’s core purpose is to promote a fair and informed marketplace, so it has a strong interest in ensuring that consumer credit law meets the needs of both consumers and lenders.
Consumer credit can contribute to the welfare of consumers and the prosperity of business – but only if certain conditions are met. The current system of consumer credit law has a number of perceived inadequacies:
To deal with this range of issues, the review is concerned with:
This discussion paper is the second in a series of five papers being released by the Ministry of Consumer Affairs. A paper dealing with transparency in consumer credit has been published at the same time as this one. Two further papers dealing with redress and enforcement, and other issues (such as insurance and electronic commerce) will be released on 30 June 2000. The first paper in the series, entitled Setting the Scene was released on 1 July 1999.
1.2 The purpose of this public consultation paper
This paper discusses the application of consumer credit legislation – that is, what transactions the legislation should apply to.
It does this principally by looking at what classes of transaction should be regulated. There are two fundamental classes:
Whether both classes should be included in the same legislation is discussed in depth in section 3.3 – and outlined below, in section 1.3.
This paper also briefly comments on some forms of transactions – in particular, hire purchase and long-term consumer leases (see pages 9-11). The Ministry considers all forms of credit transactions between consumers and lenders[1] should be regulated – but it is possible that long-term consumer leases need to be treated separately from other credit sales. These leases are discussed at the end of section 2.
1.3 Main issues
The Credit Contracts Act
1981 regulates all credit transactions and in particular requires the
disclosure of certain information in nearly all credit transactions involving
amounts
under $250,000.
This has given rise to two major issues.
The first is that the ceiling of $250,000 (set in 1981 when the Act was passed) is now too low to cover many consumer credit transactions. Increasing numbers of housing loans, for example, are now above the ceiling.
The
second issue is whether it is appropriate to regulate commercial transactions.
The Credit Contracts Act makes no distinction between
consumer and commercial
transactions. But there are significant differences between the two types of
credit, and the Ministry believes
they should be treated differently.
Failure to account for these differences in regulation may produce undesirable results. For instance, including commercial transactions in consumer credit legislation can lead – and in some cases has led – to:
1.4 Options for reform
For these reasons, the
Ministry considers it is time to re-examine the application of existing credit
legislation. It has identified
a number of alternatives to the status quo.
The Ministry’s own preferred alternative is to limit the legislation to credit (of any amount) provided “primarily for personal, domestic, or household purposes”. This is called a “purpose test”. There would be no monetary ceiling. The Ministry’s preferred option is discussed in section 5.
Other alternatives identified by the Ministry are:
These alternatives are discussed in section 4.
Issues for discussion
The Ministry welcomes your views on the ideas in
this discussion paper.
There are some specific questions listed at the
end of each section. The Ministry would like your responses to these – and
also
your views on other issues you see as being important in deciding what
transactions should be protected by consumer credit law.
2. EXISTING LEGISLATION
The key Acts that regulate consumer credit are:
This section looks at these Acts. It
also discusses the transactions covered by each of them, as the Acts are not
uniform in how they
distinguish between commercial and consumer transactions.
2.1 Credit Contracts Act 1981
The Credit Contracts Act is central to the consumer credit legal framework in New Zealand. Its two most important parts are:
2.1.1 Reopening provisions
Reopening provisions
give the Courts a wide power to examine (that is, “reopen”) any
credit contract or any actions taken
under that contract. The Courts have the
power to grant certain remedies if a credit transaction, or any term or
condition of a credit
contract, or any action undertaken by a lender under a
credit contract, is found to be oppressive.
These reopening provisions
apply to all credit contracts, regardless of the amount involved or the status
of the borrower or lender.
A “credit contract” is defined broadly in
section 3 of the Act, in order to give the protection of the reopening
provisions
to as many different classes of borrower as possible.
2.1.2 Disclosure provisions
Disclosure provisions make it compulsory for a lender to disclose certain information. The most important information is:
The Act provides for penalties against lenders
who fail to disclose the total cost of credit and the finance rate, or who fail
to
disclose it correctly. There is also a three day “cooling-off”
period for borrowers after disclosure has been made. This
allows them to cancel
the credit contract within that period without penalty (and without having to
give a reason).
These disclosure provisions are intended to provide
consumer protection and to enhance competition. In particular, they provide a
means of comparison between the price of credit offered by different lenders.
The disclosure provisions apply only to controlled credit contracts.
These are defined in section 15 of the Act (see Appendix One),
and twelve
exceptions to them are also listed there. One of the main exceptions is where
“the total amount of credit ... is
or will be not less than
$250,000” [s.15(1)(f)]. This is known as the “monetary
ceiling”.
2.1.3 The background to the Credit Contracts Act’s monetary ceiling
The original
recommendations of the Contracts and Commercial Law Reform
Committee[2] were for disclosure
provisions that covered virtually all credit contracts. The Committee’s
conception of the Credit Contracts
Act was that this would be a basic contract
statute (like the Contractual Remedies Act 1979, for example). Its
recommendations reflected
a primary desire for the Act’s principles to
have a widespread and general application, with as few exceptions as possible.
When the Act was passed, however, it included a monetary ceiling that
limited disclosure to credit transactions below a certain amount.
The monetary
ceiling was the “bright line” that made it clear to lenders and
borrowers when a transaction was subject
to disclosure and when it was not.
In this, the Act followed overseas legislation of the time – all
of which employed monetary ceilings.
The approach in overseas Acts,
however, was to set the ceiling low enough to cover small-scale transactions,
such as personal loans
and hire purchase – and this usually meant that
home finance contracts were excluded. In the United States, the Truth in Lending
Act has an exception to the ceiling to cover home finance, but in other
jurisdictions home finance was largely outside the legislation.
In New Zealand
it was considered that home finance should be covered, and the monetary
ceiling was set at a level that would largely achieve this.
2.2 Hire Purchase Act 1971
Hire purchase is a
particular type of credit transaction, in which the sale of a good is financed
by the seller or an associated financier.
Title does not pass to the consumer
until the good has been fully paid for.
The Act covers both
business[3] and consumer transactions,
but its consumer coverage has been significantly eroded in the following
ways:
This “erosion” raises the
question of whether the Hire Purchase Act could be repealed. Very little remains
in the Act
that is of compelling importance. It does still contain some specific
consumer protection measures relating to early repayment rights,
statutory
rebates, voluntary return of goods, and assignment of the hire purchase
contract. These would need to be re-enacted in
consumer credit legislation or
other legislation. Any other relevant provisions, such as insurance, could also
be re-enacted.
2.3 Credit (Repossession) Act 1997
The Credit Repossession
Act applies where a lender has a right to take possession of goods under a
credit agreement. It gives consumer
protection in the event of repossession, and
sets out a process that a lender must follow before and after repossessing.
Once the Personal Property Securities Act is passed, the Act will apply
only when the goods are to be used primarily for personal,
domestic, or
household purposes at the time the security is given. So it will not apply to
goods obtained for commercial or business
purposes. These will be regulated by
Part 9 of the Personal Property Securities Act.
Issues for discussion
What should happen to the Hire Purchase Act? If you
think it should be repealed, are there any provisions that should be re-enacted?
In what legislation should they be re-enacted?
Is there any reason to
recognise long-term consumer leases as a specific form of consumer credit
transaction? Are specific types
of disclosure or other types of consumer
protections needed for these types of leases?
3. CRITICISMS OF THE STATUS QUO
This section
describes the major problems that have become apparent with the application of
the Credit Contracts Act.
3.1 The monetary ceiling
3.1.1 The ceiling has become outdated
A
major problem with monetary ceilings is that they become outdated when prices
change – and so they fail to capture their intended
range of transactions.
The ceiling of $250,000 specified in the Credit Contracts Act has not
been adjusted since the Act was passed in 1981. In December
1982 (the Act became
law in June 1982) the average house price in Auckland
City[4] was $68,358. By December 1999
this had increased to $316,561. Other localities where the average house sale
price currently exceeds
$250,000 include Wellington City ($266,687) and North
Shore City ($302,359).
This indicates that increasing numbers of home
finance loans, which the Act was intended to cover, are falling outside of it.
If the
monetary ceiling had been adjusted to take account of movements in the
consumer price index, it would now be about
$700,000.[5]
In practice,
where a loan is above the monetary ceiling, home finance lenders will often
disclose the information required by the
Act.[6] However, if disclosure is
made incorrectly, a borrower cannot make use of the Act’s penalties
against the lender; nor can
they prevent the lender from enforcing the contract.
These remedies are only available when disclosure is required to be made.
Furthermore, a borrower who takes out a loan of $250,000 or more is not entitled
to the three day cooling-off period.
Borrowers with loans of $250,000 or
more can still use the Act’s reopening provisions: the ceiling affects
only their rights
to disclosure.
3.1.2 The ceiling is not suited to modern credit products
There are potential
problems with “new generation” credit products (such as flexible
mortgages) that often attach revolving
credit accounts to mortgage accounts to
make a single product.[7] Such
innovations did not exist in 1981 when the monetary ceiling under the Credit
Contracts Act was set.
Attaching a revolving credit account to a mortgage
can have the effect of pushing the total amount of credit above the $250,000
ceiling,
and excluding the entire contract from the Act’s disclosure
provisions. For example, a consumer purchases a family home and
$265,000 is
outstanding on the mortgage account, including a $25,000 revolving credit
account and $240,000 as a fixed sum for the
house. Both accounts are part of the
same contract and secured against the real estate. The revolving credit
component can be used
to purchase other goods and services from time to time and
be repaid as circumstances dictate.
In this case, “the total amount of credit outstanding under that contract and under all other contracts is ... not less than $250,000”.[8] So no part of the arrangement is covered by the Act’s disclosure provisions. There is no requirement to disclose, no cooling-off period, and no penalties for incorrect disclosure by the lender.
When the Act was passed, revolving
credit accounts were an entirely separate credit product. Now, as in the
scenario above, purchases
on a revolving credit account can be secured against
the borrower’s home – which should make a more compelling case for
disclosure, rather than removing it entirely.
The absence of a monetary
ceiling, or the exclusion of home finance contracts from the monetary ceiling,
would avoid the problems
raised in this scenario.
3.2 Inappropriate regulation of commercial transactions
3.2.1 Consumer credit is functionally different from commercial credit
Consumer
credit is credit provided to an individual who uses it predominantly for
personal, domestic, or household purposes. Examples include a television
bought
on hire purchase, a loan to purchase a residential home, and a secured or
unsecured loan used for a holiday. Consumer credit
helps to finance the
satisfaction of immediate personal desires and needs out of future income.
Essentially, consumer credit is concerned
with consumption.
Commercial credit has a different function. It can be broadly
divided into:
Commercial credit, therefore, concerns production and
underpins business activity.
3.2.2 Consumer borrowers are intrinsically different from business borrowers
One of the main reasons
for regulating consumer credit is to “even up” the imbalance of
powers between consumer borrowers and lenders.
Consumers may be
inhibited by lack of information. There is typically an imbalance of knowledge
between the lender and borrower. Many
consumers lack the ability to obtain and
process information about credit deals. One survey found that 500,000 New
Zealand adults
have minimal or nil reading capability and a further 750,000
cannot comprehend an everyday
document.[9] Consumers are not easily
able to comprehend the detailed and complex terms and conditions of a credit
contract, in comparison with
lenders.
Consumers are often in a position
of weak bargaining power vis-à-vis a lending institution. The consumer
credit market is generally
based on standard form contracts, which further
lessen the scope for negotiation between borrower and lender. Also, because of
their
risk profile, some consumers are limited in their choice of potential
lenders.
In contrast, large and medium-sized business borrowers
are usually considered not to need consumer protection. For instance, as a
business grows, it will inevitably engage accounting or
financial expertise to
manage its credit dealings. Furthermore, such businesses are often of similar
bargaining power to financial
institutions (or at least in a better position
than consumers), thus negating the need for regulation. When financial
institutions
lend to businesses, there is less emphasis on standard form
contracts and more negotiation of prices and terms.
However, small
business borrowers may appear to be in a similar position to consumer
borrowers for the following reasons:
So there are arguments for and against
including small business borrowing under consumer credit legislation –
and, in drawing
up the Credit Contracts Act, the Contracts and Commercial Law
Reform Committee decided they should be regulated. Two decades later,
however,
there appears to be a strengthening view that the legislation should focus on
protecting consumer borrowers, rather than
all
borrowers. Protection is now commonly deemed inappropriate for businesses. What is seen as being more appropriate is:
3.2.3 Consumers and businesses have different sources of credit
While many lenders,
especially large financial institutions, lend to both businesses and consumers,
the credit products offered are
largely based on whether the credit is offered
for business or consumer purposes. In other words, consumers and businesses do
not
approach the same division of an institution – and often do not
approach the same institution – to access
credit.[11]
Most
importantly, businesses do not normally borrow from “marginal
lenders” (the “lender of last resort” market),
which is a
major area of concern for consumer borrowers. (In fact, much consumer credit
regulation is aimed at providing consumer
protection for problems in the
marginal lender market segment – in particular, the practices of some cash
loan and hire purchase
financiers.)
By contrast, businesses tend to
borrow from banks and mainstream finance
companies.[12] The important
differences between these and marginal lenders are:
The existence of these factors reduces the need for protection of
business borrowers.
3.2.4 Business borrowers have a different relationship with their lender
One feature of the
relationship between a business borrower and their lender is that the lender has
a strong incentive to monitor
the borrower’s business. In fact, the
regular provision of financial information by the borrower is commonly a
condition of
commercial loan contracts. This allows the borrower to
“signal” its ability and intention to repay the
loan.
“Bonding” refers to the investment made by each party
towards building an ongoing business relationship and the establishment
of
“reputation”. These signalling and bonding processes effectively
regulate the commercial relationship between borrower
and lender. Consumer
transactions do not give rise to these same
processes[13] – in particular,
reputational checks and balances are more difficult to establish and implement.
3.2.5 Businesses can offer more attractive security for their loans
In consumer lending
situations, with the exception of loans secured by real property, assets taken
as security will not necessarily
cover the debt if the borrower defaults.
By contrast, assets purchased for a commercial purpose usually have a
much higher value on realisation, for example, livestock, machinery,
and
equipment. There are also a wide range of security arrangements that business
borrowers can enter into, either to obtain more
favourable terms or as risk
management strategies to control the consequences of default. Examples are
security in goods acquired
after the contract has been entered into, and
proceeds from the sale of goods that are secured. These arrangements are not
possible
for consumers (nor are they always possible for all
businesses).
3.3 Implications of regulating commercial transactions
3.3.1 Legislation being ineffective
Clearly, many business borrowers are well-informed and experienced in matters of credit and are therefore unlikely to need measures designed primarily for the protection of more vulnerable consumers. Furthermore, consumer protection provisions will tend to limit business borrowers’ freedom of contract, and to restrict their flexibility in business dealings.
Conversely, credit legislation that meets the needs of
business borrowers – for example, through having minimal disclosure
requirements
– may have adverse effects on consumers, by reducing their
basic protections.
3.3.2 Increased compliance costs
When loans have complex
terms and conditions, lenders will face additional compliance costs in providing
disclosure information. These
costs will invariably be passed on to borrowers
– but if the borrower does not value or need the disclosed information,
then
these compliance costs are an unnecessary and inefficient imposition. This
is likely to be the case when commercial credit is regulated
to the same
standards as consumer credit.
3.3.3 Restrictions on credit flexibility and innovation
Flexibility of terms and
conditions – which can benefit both borrower and lender – are
hampered by provisions designed
to protect consumers.
This is
particularly the case where a loan has special features – for example, a
fixed-term loan in which a lender trades-off
a below market rate of interest in
return for a share of potential profits. The requirement to disclose an annual
finance rate on
such a loan may complicate and therefore discourage such
innovations.
Finance leases provide another example. These are
predominantly a business transaction, and are regulated as a credit contract
under
the Credit Contracts Act on the basis that they are “deferred
payment dispositions” equivalent to hire purchase. However,
leases often
have features that make them different from standard hire purchase (such as
balloon payments and “agreed residual
values”). They fit awkwardly
under the Credit Contracts Act, particularly when it comes to calculating the
annual finance rate
and total cost of credit. They may, as a result, be less
used as a financing option for businesses than they would otherwise be.
A final example where the Credit Contracts Act restricts flexibility in
commercial transactions is the three day cooling-off period
in which a borrower
can cancel a loan. This increases uncertainty for lenders. Cancellation can
involve considerable transaction
costs for them – for example, if they
have registered debentures as a security for a loan (and it can be important to
register
such securities quickly), then they must deregister them if the loan is
subsequently cancelled. So one result of allowing business
borrowers a
cooling-off period can be that lenders delay the provision of finance, to
minimise their costs if the loan is cancelled.
This in turn inconveniences the
borrower, because they get their financing later than they otherwise would
have.
3.3.4 Opportunistic use of the Act by defaulting borrowers
Defaulting borrowers can
use the provisions of the Act to avoid contractual obligations, at great expense
to the lender and other
third parties.
Many reported judgements on the
Credit Contracts Act involve non-consumer transactions. Borrowers often are
experienced traders who
received professional advice before entering into the
transaction. Not uncommonly, they later invoke the reopening or the disclosure
provisions of the Credit Contracts Act to avoid performance of obligations which
were apparent to them at the time of
agreement.[14]
3.4 Adequate protection may already exist for commercial transactions
If commercial credit
transactions were to be excluded from credit regulation, it is necessary to
consider whether other laws would
be adequate.
The Fair Trading Act
1986 prohibits misleading conduct in trade generally. It covers the
presentation of the terms of a credit contract, and any statements
or
representations made by the lender. The Act provides a strong incentive for
lenders not to disguise fees or charges, or to make
misleading interest rate
quotations. Beyond its broad protection against misleading conduct, the Act is
non-prescriptive and therefore
allows considerable contractual flexibility.
However, a borrower taking action under the Act cannot invoke specific
penalties; they
can only seek more general damages or criminal penalties.
Business borrowers alleging unfair or unconscionable conduct would, in
the absence of provisions under the Credit Contracts Act, have
to rely on the
common law doctrine of duress, and on the doctrines of undue influence
and unconscionable bargain in the law of
equity.[15] However, these
doctrines may not give the Court the same discretion to intervene in contracts
that the Credit Contracts Act does
– and so there may be some argument for
including business borrowing in the reopening provisions of consumer credit
legislation.
There are some additional protections for businesses that
borrow from banks, through the banking industry’s self-regulation.
The Code of Banking Practice and the Bankers’ Association Statement of
Principles for working with small and medium-sized
businesses has procedures to
resolve disputes. Businesses can obtain redress from the Office of the Banking
Ombudsman, which can
hear complaints about the conduct of banks that belong to
the Banking Ombudsman scheme. The Banking Ombudsman’s jurisdiction
limit
is $100,000.
3.5 Conclusion
The Ministry believes
that the differences between consumer credit and business credit are sufficient
to consider separating consumer
credit law from credit law generally. This will
mean that it is easier to introduce specific consumer protections where these
are
required. Compliance costs to business lenders – and also ultimately
to business borrowers – are likely to be reduced
if lenders do not have to
observe inappropriate disclosure provisions.
Businesses have other forms
of protection through the Fair Trading Act, the law of contract and other common
law, signalling and bonding
processes, and the self-regulation of the banking
industry. Removing businesses from credit legislation and making that
legislation
consumer specific will allow it to respond more effectively to
modern consumer credit products. It will ensure that the most vulnerable
groups
of consumers can be protected without imposing unnecessary costs on the whole
credit system.
Issues for discussion
Are consumer and commercial borrowers
sufficiently different to justify separate treatment in legislation?
Should commercial borrowing be covered by consumer credit regulation?
What are your reasons for and/or against?
Should small businesses be
provided with the same legislative protection as consumers?
Is it
appropriate for businesses to be covered by the reopening provisions but not the
disclosure provisions?
4. ALTERNATIVES TO THE STATUS QUO
This section considers a
range of alternatives to the status quo under the Credit Contracts Act. It
briefly describes each alternative,
along with its advantages and disadvantages.
The Ministry of Consumer Affairs’ preferred option – a
“purpose test”
– is discussed in section 5. A chart
summarising all the alternatives can be found at the end of this section.
The alternatives are not mutually exclusive – for example, a
monetary ceiling can be combined with other tests. The monetary
ceilings
currently used in consumer credit legislation in the United Kingdom and the
United States are combined with a “natural
persons test” and a
purpose test respectively.
4.1 A revised monetary ceiling
A monetary ceiling has
the advantage of clarity for all parties to a credit contract. It would
eliminate most disputes[16] about
whether a transaction was protected.
If the current shape of the
legislation was retained, this would mean that all transactions below the
ceiling would be subject to
disclosure. But all transactions of any amount would
be subject to reopening.
There are two alternatives within a revised
monetary ceiling:
4.1.1 Revise monetary ceiling to a higher level
The monetary ceiling could be raised so that it would cover the range of transactions initially contemplated by Parliament when the current limit was set. This would mean a ceiling of about $700,000.
The advantage of raising the ceiling is that the vast majority of consumer credit transactions would be subject to disclosure requirements, including most mortgage contracts and flexible mortgage products.
The
disadvantage is that this would capture a large number of commercial
transactions for which disclosure is not currently required.
While
raising the monetary limit might be justifiable in terms of increased protection
for consumer contracts, it would be much less
plausible in the case of
commercial credit.
4.1.2 Revise monetary ceiling to a lower level
When the Ministry of
Consumer Affairs undertook the 1988 review of consumer credit, it suggested a
monetary ceiling of $50,000 for
consumer credit contracts.
This limit
would have covered borrowing from marginal lenders, excluded many commercial
transactions, and been simple to apply. It
would also have been consistent with
consumer credit legislation in the United States, the United Kingdom, and
Australia.
If the monetary ceiling is lowered, then it raises the
question of what to do about home finance.
Home finance could be exempted
from the ceiling. This is what the Ministry of Consumer Affairs recommended in
1988, on the basis that
home finance is often the most significant financial
transaction that consumers engage in, justifying additional (disclosure)
protections.
United States consumer credit legislation also exempts home finance
from its monetary ceiling.
The alternative is to leave most home finance
contracts (that is, for amounts above the ceiling) unprotected by disclosure
provisions.[17]
The main
argument here is that consumers who borrow to purchase real estate almost
invariably use a solicitor to do so – and
so the solicitor can advise them
on the credit aspects of the transaction. However, much conveyancing work is of
a paralegal nature
– that is, it is provided by persons who are not
qualified solicitors and who do not advise on financial aspects of the
arrangement.
As well, solicitors who are experienced in conveyancing do not
necessarily have expertise in finance.
A secondary argument in favour of leaving home finance unprotected – that consumers who borrow high amounts are likely to be more financially sophisticated – is weak in this particular context. With a ceiling as low as $50,000, home finance of relatively modest amounts borrowed by financially unsophisticated consumers would be unprotected. Also, even sophisticated consumers stand to benefit from the standardisation of certain terms (such as the calculation of interest) that disclosure would require.
4.1.3 Difficulties in revising the monetary ceiling
A major disadvantage
with having a monetary ceiling – regardless of whether it is set high or
low – is the difficulty
in ensuring the ceiling is kept up-to-date. As
mentioned earlier, the current ceiling has not been updated since 1981.
Any new consumer credit legislation that used a monetary ceiling would have
to include a mechanism for regularly reviewing the ceiling.
For example, there
could be some method of annual indexation, or the administering government
department could be required to adjust
the monetary limit, at regular intervals,
through regulations.
4.2 A “natural persons” test
A “natural
person” is an individual. It includes people in business partnerships, but
does not include “legal persons”
(such as companies and incorporated
societies).
A natural persons
test[18] would treat all lending to
natural persons as consumer credit. It would, therefore, exclude many commercial
loans – those taken
out by companies and other incorporated bodies. At the
same time, sole traders and other unincorporated businesses (who are often
regarded as vulnerable) would be protected.
However, the dividing line
between incorporated and unincorporated businesses, while straightforward in
legal terms, makes little
sense in economic terms and may result in anomalies.
Many incorporated small businesses operate in similar environments and face
similar problems to those of unincorporated businesses of the same size. As
well, some unincorporated bodies are businesses of considerable
size and stature
– for example, law firms and accounting firms are organised as
partnerships or sole traders. Such businesses
do not need consumer
protection.
A natural persons test would need to be combined with a
monetary ceiling, to exclude very large commercial loans that were being
undertaken
by unincorporated businesses.
4.3 A test to include small businesses
In effect, this is
already used under the Credit Contracts Act – business borrowers with a
paid-up capital of more than $1m
are excluded from disclosure provisions.
However, legislation could go further and define “small business”
for the purpose
of including these businesses in the legislation.
A test
that includes small business would need to:
The test would also need to define
a small business. The definition could include limits on:
The main justification for this test is that it would
extend protection to smaller businesses.
Its main disadvantage is that
it would make complying with the legislation more complex and less certain. It
would be difficult for
a lender to establish the status of a business borrower.
But it would be important to do so. Any error in applying the test is likely
to
result in an agreement that the lender could not enforce. One way around this
type of uncertainty is to require small businesses
to make a “good
faith” declaration of their status to the lender, much like insurance
contracts
require from people taking out insurance. (A similar difficulty
occurs in the purpose test – see section 5.4.1.)
Another
disadvantage is that defining a small business in terms of monetary values has
the same problem as a monetary ceiling –
that is, ensuring that the values
are kept up-to-date.
Like the natural persons test, a test to include
small businesses would need to be combined with a monetary ceiling to exclude
very
large commercial loans.
4.4 Contracting out
Credit legislation could
apply to all transactions, but for commercial credit transactions the
parties could be permitted to contract out.
This is similar to what
happens in the Consumer Guarantees Act. Some commercial transactions are
included under the Consumer Guarantees
Act – but not if the “person
who acquires ... the goods or services for the purpose of a business”
agrees in writing
that the transaction will be excluded from the Act.
Without restrictions, the capacity to contract out is likely to mean
that lenders will seek to contract out of all transactions. Situations
similar
to this have arisen in Queensland, under the Australian purpose test – see
section 5.4.2. To be workable, the contracting
out provisions would need to
safeguard against consumers being pressured to describe their credit contract as
being for business
purposes.
It is also unclear whether contracting out
has any advantages over a test that would exclude commercial transactions
altogether.
4.5 Summary chart
The chart on page 25
summarises the alternatives discussed in this section. It also includes the
purpose test, which is discussed
in section 5.
Some of the alternatives
are combined in various ways – so it is possible to mix and match
different monetary ceilings with
different tests.
Issues for discussion
What general comments do you have on each of the
options discussed in this chapter?
Is a monetary ceiling still relevant?
If so, at what level should it be set?
Should all home finance
contracts be covered in consumer credit law?
Is the small business test
appropriate? If so, what criteria should be used in defining a small
business?
Is the natural persons test adequate for the purposes of
application?
|
Test
|
Key features
|
Consumer transactions
|
Commercial transactions
|
Advantages
|
Disadvantages |
|
Status quo |
Monetary ceiling of $250,000.
|
Some mortgages excluded.
|
Significant coverage.
|
Easy to apply.
|
Now out-of-date.
Unnecessary commercial coverage. |
|
Higher monetary ceiling
|
$700,000 (for example).
|
Comprehensive coverage.
|
More coverage than now.
|
Easy to apply. Comprehensive coverage of consumer transactions.
|
Reduced flexibility in commercial credit. Ceiling needs regular
revision.
|
|
Lower monetary ceiling (no exception for home finance)
|
$50,000 (for example).
|
Comprehensive coverage except for home finance, flexi-mortgages, and
loans for very expensive consumer items.
|
Coverage of smaller loans only.
|
Easy to apply.
Reduced regulation of commercial credit. |
Would reduce consumer protection overall.
Ceiling may need regular revision. |
|
Lower monetary ceiling (with exception for home finance)
|
$50,000 (for example) except for home finance credit.
|
Comprehensive coverage except for loans for very expensive consumer
items.
|
Coverage of smaller loans only.
|
Easy to apply.
Reduced regulation of commercial credit. Maintains comprehensive consumer protection. |
Ceiling may need regular revision.
No clear justification for regulating small commercial transactions. |
|
Natural persons test
|
All lending to natural persons regulated.
Test used in combination with monetary ceiling. |
Comprehensive coverage.
|
All lending to corporations excluded. Only sole traders and partnerships
covered.
|
Easy to apply.
Limits coverage of commercial transactions. |
Distinction between incorporated and unincorporated is artificial for many
businesses.
|
|
Test to include small business
|
Small business would be defined in legislation.
Test used in combination with monetary ceiling. |
Comprehensive coverage.
|
Only loans to small business covered.
|
Would protect small and vulnerable traders.
|
Very difficult to define “small business”.
|
|
Contracting out |
Businesses can contract out of legislation.
|
Comprehensive coverage.
|
Covered unless borrower contracts out (lender likely to want this).
|
No real advantage over totally excluding commercial transactions.
|
Some lenders likely to pressure consumers into contracting out.
|
|
Purpose test (covers entire Act)
|
Lending regulated if it is provided primarily for personal, domestic or
household purposes.
|
Comprehensive coverage.
|
Excluded where purpose is more than 50% commercial.
|
Consistent with market practice in New Zealand, and with overseas
legislation.
Gives flexibility in commercial lending. |
Possible uncertainty in some scenarios.
Scope for abuse by some lenders. |
|
Purpose test
(covers disclosure provisions only) |
Reopening provisions apply to all lending.
|
Comprehensive coverage.
|
Commercial borrowers can apply to Court to reopen contracts.
|
Has all the advantages of the purpose test, while providing redress for
commercial borrowers.
|
Possible uncertainty in some scenarios.
Scope for abuse by some lenders and misuse by some business borrowers. |
5. THE MINISTRY’S PREFERRED ALTERNATIVE: THE PURPOSE TEST
This section describes
the operation of the purpose test. It also sets out the advantages and
disadvantages of this test and describes
how some of the disadvantages could be
overcome. The increasing use of this test in other countries is briefly
summarised in a box
at the end of this section.
The purpose test could be
used in conjunction with a monetary ceiling, as it is currently in the United
States. The Ministry, however,
envisages the test as standing alone in defining
which transactions are subject to the legislation (or in defining which
transactions
are subject to particular provisions within the
legislation).
5.1 Definition of “purpose test”
The purpose test aims to
restrict credit regulation to consumer transactions by covering only those
transactions where the credit
is to be used by a natural person wholly
or primarily for personal, domestic or household purposes.
This test
is based on the positive wording used in Australian, Canadian and United States
consumer credit legislation. But it could
instead be framed in negative terms
– that is, by excluding loans that are wholly or primarily for a business
purpose.
Some further clarification of the purpose test is likely to be
needed to limit uncertainty:
5.2 How the test would work
The purpose test is
applied at the time that the contract is entered into. So it usually requires
the lender to actively inquire about
the purpose for which the borrower intends
to use the credit.
In most cases, this is not likely to be an onerous
task. It is already usual for banks and finance companies to find out the
borrower’s
purpose – and most of these lenders have separate lending
arrangements which depend on the loan’s purpose (for example,
“home
lending”, “personal lending”, “commercial
lending”).
Other lenders – such as those in the hire
purchase market – will find it impractical to distinguish between purposes
because
virtually all their lending is for consumer purposes. Lenders in these
markets could adopt standard credit contracts that meet the
legislation’s
requirements, and use these for all loans regardless of purpose. However, the
legislation would still apply only
to contracts entered into for consumer
purposes. The contracts could also be worded to include a disclaimer stating
that the legislation
does not apply to contracts entered into for a business
purpose.
5.3 Advantages
The purpose test has a number of advantages:
5.4 Disadvantages
The purpose test has two potential disadvantages:
5.4.1 Uncertainty
The most common
objection to a purpose test is that it may create uncertainty for lenders. This
is because the lender may not know
the precise purposes of the
borrower.[20]
Sometimes a borrower takes out a loan for “mixed” purposes and deciding which is the primary purpose may be difficult. For example: [21]
Modern flexible mortgage products may
also cause problems in clearly identifying a primary purpose. For
instance[23] an individual borrower
seeks a loan of $100,000. Of this, $60,000 is to be used to purchase a
house and $40,000 is to be used in the borrower’s business as working
capital. One-sixth of the house is to be used as an office for the business
– which means that 50 percent of the loan is for
business purposes.
These examples demonstrate that for certain transactions there will be a
grey area. This uncertainty is a potential cost for lenders,
and it may
occasionally result in litigation.
There are, however, two possible ways
for lenders to minimise this uncertainty.
The first is to seek a
formal declaration from the borrower as to the purpose of the loan. This
could require the borrower to estimate the expected use of the credit, or the
goods purchased on credit. The lender can then
rely on the declaration in good
faith to determine whether or not the loan is
regulated.[24] (For some possible
problems with declarations, see section 5.4.2 below.)
The second is to
document the credit contract as if it were regulated. This has already been
mentioned in section 5.2 as a practical strategy for lenders in the hire
purchase market, where a requirement
to differentiate between consumer and
business purpose is unrealistic. It is also an obvious risk management strategy
for any lender
faced with a situation of uncertainty. If it turns out that the
contract is regulated, this approach will avoid problems. As well,
incorporating a notice in the contract to the effect that credit for business
purposes is unregulated should avoid problems if it turns out that the contract
was indeed unregulated.
5.4.2 Possible scope for abuse
The Queensland Office of
Fair Trading has reported that “fringe” lenders sometimes obtain
false declarations from
consumers.[25] The consumer is
pressured into declaring that the credit they have applied for is to be used for
business purposes, and this allows
the lender to (try to) avoid the provisions
of the Uniform Consumer Credit Code. Other states in Australia have not reported
such
findings.
Any such attempt to avoid the Code’s provisions will
depend on the lender not being found out: the Code states that its provisions
will still apply, despite a false declaration, if the lender knows that the
credit is to be used for consumer purposes. However,
the Australian government
is now considering whether the Code needs further amendment to establish
“procuring a false declaration”
as an offence.
5.5 Australia’s experience with the purpose test
Ministry of Consumer
Affairs officials recently investigated the impact of the purpose test in
Australia, where it has been in force
since 1 November 1996.
Representatives of the Australian lending industry, as well as lawyers
practising in the area of consumer credit, were unanimous that
the purpose test
had been successful. The test has not created undesirable levels of uncertainty
for lenders or borrowers, and the
lender’s right to seek a declaration of
purpose from borrowers has (despite the Queensland experience) resolved many
potential
problems.
Issues for discussion
What general comments do you have on a purpose test
for consumer credit legislation? What are the specific advantages and
disadvantages?
APPENDIX ONE
Credit Contracts Act 1981
15 Meaning of “CONTROLLED CREDIT CONTRACT”—
(1) In this Act the term "controlled credit contract" means a credit contract—
(a) Where the creditor, or one of the creditors, for the time being is a financier acting in the course of his business; or
(b) Which results from an introduction of one of the parties to the contract to another such party by a paid adviser; or
(c) That has been prepared by a paid adviser;—
but does not include--
(d) A contract where every debtor for the time being is—
(i) A financier by virtue of either paragraph (a) or paragraph (c) of the definition of that term; or
(ii) The Crown, a local authority, or a Government agency; or
(iii) A body corporate that has a paid up capital of not less than $1,000,000; or a body corporate that is related to such a body; or
(e) A contract where every party to the contract for the time being is a body corporate that is related to every other such party to the contract; or
(f) A contract if the total amount of credit outstanding under that contract and under all other contracts between the same creditor and debtor is or will be not less than $250,000; or
(g) A contract that results from an offer of securities to the public within the meaning of sections 2 and 3 of the Securities Act 1978; or
(h) A contract the only effect of which is to modify the terms of a controlled credit contract; or
(i) A contract entered into pursuant to a revolving credit contract; or
(j) A contract entered into pursuant to [a registered superannuation scheme]; or
(k) A contract that forms part of a transaction involving the export from New Zealand, or the import into New Zealand, of goods or services and that is entered into for the purpose of facilitating the export or import of those goods or services; or
(l) An agreement to which sections 5 and 7 of the Door to Door Sales Act 1967 apply; or
(m) A contract of a kind specified in regulations made under section 47 (1) (d) of this Act.
(2) For the avoidance of doubt, it is hereby declared that where a person's account with a bank is debited and—
(a) The effect of the debit is to put the account into overdraft, or to increase the amount of an overdraft beyond an agreed limit; and
(b) The creation of the overdraft, or the increase in the limit, has not been agreed between the bank and the person before the debit of the account,—
neither the debiting of the account nor the creation, or increase, of the overdraft shall constitute a controlled credit contract, whether or not the bank knows at the time the account is debited that the debit would have that effect and whether or not the bank makes a charge (whether interest or otherwise) relating to the creation or increase of the overdraft.
APPENDIX TWO
Australian Uniform Consumer Credit Code
Provision of credit to which this Code applies
6 (1) [Key elements] This code applies to the provision of credit (and to the credit contract and related matters) if when the credit contract is entered into or (in the case of pre-contractual obligations) is proposed to be entered into—
(a) the debtor is a natural person ordinarily resident in this jurisdiction or a strata corporation formed in this jurisdiction; and
(b) the credit is provided or intended to be provided wholly or predominantly for personal, domestic or household purposes; and
(c) a charge is or may be made for providing the credit; and
(d) the credit provider provides the credit in the course of a business of providing credit or as part of or incidentally to any other business of the credit provider.
[...]
6 (4) [“Personal, domestic or household” purpose] For the purposes of this section, investment by the debtor is not a personal, domestic, or household purpose.
6 (5) [“Predominant purpose”] For the purposes of this section, the predominant purpose for which credit is provided is—
(a) the purpose for which more than half of the credit is intended to be used;
or
(b) if the credit is intended to be used to obtain goods or services for use for different purposes, the purpose for which the goods or services are intended to be most used.
Presumptions relating to application of Code
11 (1) [Code presumed to apply] In any proceedings (whether brought under this Code or not) in which a party claims that a credit contract, mortgage or guarantee is one to which this Code applies, it is presumed to be such unless the contrary is established.
11 (2) [Debtor’s declaration as to purpose] Credit is presumed conclusively for the purposes of this Code not to be provided wholly or predominantly for personal, domestic or household purposes if the debtor declares, before entering into the credit contract, that the credit is to be applied wholly or predominantly for business or investment purposes (or for both purposes).
11 (3) [Credit provider’s knowledge as to purpose] However, such a declaration is ineffective for the purposes of this section if the credit provider (or any other person who obtained the declaration from the debtor) knew, or had reason to believe, at the time the declaration was made that the credit was in fact to be applied wholly or predominantly for personal, domestic or household purposes.
11 (4) [Form of declaration] A declaration under this section is to be
substantially in the form (if any) required by the regulations and is
ineffective for the
purposes of this section if it is not.
[1] Any other forms of credit not specifically discussed in this document – such as informal borrowing arrangements between private individuals, short term (less than two months) credit or unconditionally free credit – which are currently subject to “reopening” but not to disclosure requirements should continue to be treated as they are now.
[2] Contracts and Commercial Law Reform Committee (February 1977) Credit Contracts Wellington.
[3] Parties may contract out of the provisions governing early repayment and statutory rebates if the cash price of the purchased goods exceeds $15,000.
[4] Defined by territorial authority; Source: Quotable New Zealand Ltd.
[6] This commitment is made in the Banking Code of Practice para 3.10.
[7] These products generally have the features of either overdraft or redraw facilities.
[8] This is the wording used for the monetary ceiling [Credit Contracts Act s.15(1)(f)].
[9] Ministry of Education (undated – survey conducted March 1996) Adult Literacy in New Zealand: Results from the International Adult Literacy Survey.
[10] New Zealand Bankers’ Association (June 1999) Banks & Small, Medium Size, and Farming Businesses Working Together: A Statement of Principles.
[12] See for example the list contained in the Ministry of Commerce publication Sources of Capital Available to Small and Medium Enterprises 2000, January 2000.
[13] On the role of bonding and signalling and the contrasts between consumer and commercial transactions see especially R Scott “Rethinking the Regulation of Coercive Creditor Remedies” (1989) 89 Columbia Law Review 730-788, at 744-45.
[14] For instance, see R. Burt “The Credit Contracts Act and the Reluctant Judge” (1990) New Zealand Law Journal, 240-242 and the cases cited therein, which are concerned with strategic use of disclosure provisions.
[15] See J. Burrows, J. Finn and S. Todd, (1997) Law of Contract Wellington: Butterworths.
[16] However, at least in one judgement the monetary ceiling has been in issue: Buckland v Landbase Securities (in liq) 11/4/91, Anderson J, HC Auckland CP 2604/89.
[17] In England and most of Europe, mortgage and home finance credit is largely unregulated.
[18] The natural persons test is used in the United Kingdom’s Consumer Credit Act 1974 [section 8(1)]. The Act regulates credit provided to “individuals”, and individuals are defined as “persons acting in their private capacity or as sole traders, a partnership or other unincorporated body of persons not consisting entirely of bodies corporate”. This test is used in conjunction with a monetary ceiling of £25,000.
[19] This is the definition used in Australia’s Consumer Credit Code [s.6(5)].
[20] This is the basis on which both the United Kingdom’s Crowther Committee (1971) and New Zealand’s Contracts and Commercial Law Reform Committee (1977) rejected a purpose test.
[21] These examples are taken from A. Duggan and E. Lanyon (1999) Consumer Credit Law Sydney: Butterworths.
[22] A contract under which the buyer pays the seller back in instalments.
[23] This example is taken directly from the Australian Consumer Credit Law Reporter (Volume One), CCH Australia, at 8,502.
[24] This is provided for in Australian law [Consumer Credit Code s.11] See Appendix Two.
[25] Office of Fair Trading (May 1999) “Fringe” Credit Provider – A Report and Issues Paper Queensland.
NZLII:
Copyright Policy
|
Disclaimers
|
Privacy Policy
|
Feedback
URL: http://www.nzlii.org/nz/other/NZAHGovDP/2000/1.html