Fairness of variation terms in UK financial services consumer contracts

This guide was last updated in January 2019.

The Financial Conduct Authority (FCA) published its finalised guidance on the fairness of variation terms in financial services consumer contracts in December 2018. This guidance provides welcome clarity for firms on the FCA's expectations when it comes to unfairness.

Now that the FCA has published its finalised guidance, firms will need to take this into account when drafting and reviewing consumer contracts. If you haven't already done so, you should begin to think about what changes are needed to your variation terms to ensure they are sufficiently transparent (see below).

Although the FCA indicated that it is not going to conduct a proactive review to assess the fairness of variation terms entered into before December 2018, or of any other terms, firms will need to be aware of how their existing terms might be challenged. This will be particularly relevant if you are contemplating a thematic review, or if the contract is otherwise likely to be put before a court in the near future.

You should also consider how the FCA's increased focus on transparency could impact the drafting of terms other than variation terms. This is likely to be particularly relevant when drafting 'grey list' clauses liable to be assessed for fairness under the 2015 Consumer Rights Act (CRA), such as fee disclosure terms or termination rights.

The FCA has also reminded those firms subject to the Senior Managers Regime (SMR) that responsibility for this role needs to be clear from statements of responsibilities.

Assessing whether a variation term is fair

Under the CRA, a term in a consumer contract is unfair "if, contrary to good faith requirements, a term causes a significant imbalance in the rights and obligations of the trader and the consumer to the detriment of the consumer".

In its consultation on draft guidance, published in May 2018, the FCA said that it was focusing on variation terms because, in its view, these terms are complex to assess, often give rise to consumer interest and have been the subject of a number of relatively recent decisions by the Court of Justice of the EU (CJEU). The FCA acknowledged the benefit of variation terms, but suggested that careful drafting is needed to ensure such terms are not unfair.

The finalised guidance sets out a non-exhaustive list of factors "relevant to determining whether or not a variation term is fair". The FCA says that financial services firms should consider these factors when drafting and reviewing variation terms in their consumer contracts. These factors have a common theme of 'transparency', and include:

• whether the firm has included the variation term "to achieve a legitimate objective";
• if the reasons the firm gives for amending the contract are "no wider than is reasonably necessary to achieve a legitimate objective";
• whether the reasons are objective and clearly expressed, and whether it is possible to verify that the reasons have arisen;
• whether the consumer understands the consequences of a future variation at the time the contract is concluded;
• what notice of any variation will be given;
• whether the customer will have "freedom to exit", contractually and practically; and
• whether the term "strikes a fair balance between the legitimate interests of the firm and the legitimate interests of the consumer".

The FCA has also reminded firms that treating customers fairly when making a change to a contract will not automatically "change an unfair variation term into a fair one", although this may be relevant to assessing notice periods and justifying variation terms in longer-term contracts. This is an important distinction to keep in mind: you may not be able to use a variation term if it does not meet the above criteria, even if the change you want to make benefits your customers.

An increased role for transparency of variation terms

One of the central themes of the finalised guidance is the FCA's increased focus on the role of "transparency" when assessing the fairness of terms in a consumer contract.

The transparency requirement under the CRA is that the terms must be written in plain and intelligible language to make grammatical sense to the average consumer, and drafted to ensure that consumers can make informed choices. However, the FCA has made it clear that, in its view, transparency is not just about making sure your drafting is grammatically correct. Transparency also means that customers are given all the information they need to understand how the contract they are about to enter into will work, as well as giving proper notice of any changes to be made.

The FCA expands on the transparency requirement in its finalised guidance. It suggests that firms should consider whether it is practical to give customers a simple explanation of how the variation term will operate. For example, in relation to changes to pricing, the FCA suggests including an explanation of:

• the circumstances in which prices may change;
• how the new price would be determined, in general terms; and
• the potential size of any price increases.

The FCA suggests that this could also be accompanied by examples or explanations of past variations where appropriate, subject to competition law considerations.

Although this offers welcome guidance, at least in relation to price changes, the FCA has stressed that including this information will not, in itself, mean that the clause is fair.

The FCA has also confirmed that transparency must be assessed not on a case by case basis, but from "the perspective of the 'average consumer' who is 'reasonably well-informed and reasonably observant and circumspect'".

Interestingly, the statement that "providing notice does not compensate for a lack of transparency" which appeared in the May draft has been removed from the finalised guidance. This suggests that proper notice periods still have an important role to play in the assessment of fairness.

A more limited role for variations 'for any reason'

In the FCA's view, legitimate reasons and long notice periods may no longer cure an unfair term if it is not transparent. Although the FCA notes in the guidance that "a term that fails to meet the CRA requirement for transparency is not necessarily unfair", it is difficult to see how a term that is not transparent would meet the FCA's fairness threshold.

One of the remaining areas of uncertainty and concern for firms following the consultation was whether the FCA would see clauses that allow variations "for any other reason" as automatically unfair on the basis that such a term is not transparent. In previous guidance, the FCA seemed to accept that such a term would not be unfair if changes were permitted for valid reasons only. The finalised guidance confirms a slight shift in the FCA's position, but firms will be relieved that this will not always be the case.

It appears that in contracts of determinate and shorter duration, the FCA considers that a variation clause will only be transparent, and therefore valid, if all the reasons are clearly expressed in the contract document. However, the FCA has acknowledged that the position is more difficult in respect of contracts of indeterminate duration, and those fixed term contracts of longer duration. The finalised guidance states that:

"We recognise that, depending on the circumstances, terms entitling the firm to vary for any reason may be justified in longer term contracts if, when the contract is made, the firm reasonably considers that it cannot foresee all the circumstances that could justify varying the term. In assessing the fairness of such a wide variation term all the circumstances bearing on the fairness of the term would have to be considered, including terms regarding notice, freedom to exit, practical barriers to termination and the information provided to the consumer about the variation term. Firms should carefully consider whether such a wide variation term strikes a fair balance between the legitimate interests of the firm and the consumer. Firms should also consider how they can satisfy themselves that the consumer has been treated fairly when making changes to contracts of determinate duration."

The FCA goes on to recognise that, in respect of contracts of indeterminate duration, "the category of potentially valid reasons may be wider" and, "depending on the circumstances, the power to vary 'for any reason' is less likely to be unfair than a term in a similar contract of determinate duration". Firms will therefore need to carefully consider the drafting of such clauses.

Lauren McCarthy and David Heffron are financial regulation experts at Pinsent Masons, the law firm behind Out-Law.com.