Part V

Extending the protection against unfair terms to businesses

1. Introduction

5.1                                      In Part III we examined the differences between UCTA and UTCCR, and we noted that UTCCR affect a wider range of potentially unfair clauses than UCTA, but that UTCCR apply only to consumer contracts. We also noted that UTCCR provide mechanisms designed to prevent the use of unfair terms, which UCTA does not. In this Part we consider whether (or to what extent) the protection given by UTCCR to consumers should be extended beyond consumer contracts to contracts between businesses, especially small businesses. We also consider whether, if this extension were made, some of the existing controls over exclusion and restrictions of liability under UCTA – which apply whether or not the clause was negotiated – could be removed; and how the rest of the existing controls of UCTA should be brought within the proposed new legislation.

2. Existing protection in business-to-business contracts

5.2                                      In Part III we pointed out that many of the controls against unfair terms contained in UCTA apply to contracts between one business and another (“business-to-business” contracts). Thus section 2 [s 16] applies to any exclusion or restriction of “business liability”[1] for negligence[2] whether the victim was acting in the course of business or not. Sections 6 and 7 [ss 20, 21] apply to the exclusion or restriction of various implied terms in contracts of sale, hire-purchase, barter, hire and work and materials.[3] While any exception or restriction on the obligation to give good title is automatically void, where the buyer or person to whom the goods were supplied is not dealing as a consumer, the exclusion or restriction of liabilities for breach of the other implied terms may be valid if it satisfies the requirement of reasonableness. These provisions apply to business-to-business contracts even if they were negotiated between the parties. Section 3 [s 17] applies in favour of a party who is dealing on the other’s “written standard terms of business”.[4]

5.3                                      We also saw that the controls of UCTA are largely restricted to exclusions or limitations of liability. Even section 3 [s 17] applies only to terms which purport to allow the party whose terms they are to perform in a way which is substantially different from what was reasonably expected, or not to perform at all.

5.4                                      Thus under the existing legislation a party who is acting in the course of a business is not protected against unfair terms which, for example, relate to his own performance rather than that of the other party. Some protection is provided by the common law, for example in relation to penalty clauses, but this is narrow and to some degree uncertain in its scope of application.[5]

5.5                                      The terms in consumer contracts which are regulated by UTCCR are significantly wider in scope than exclusion of liability clauses. UTCCR subject all the terms of the contract other than the “core terms” to a fairness test. Examples of potentially unfair clauses against which businesses, unlike consumers, are not protected include:

                                                     (1)           deposits and forfeiture of money paid clauses;

                                                     (2)           default rates of interest (unless these can be shown to be penalties);

                                                     (3)           automatic extension of contract clauses;

                                                     (4)           price variation clauses;

                                                     (5)           entire agreement clauses;

                                                     (6)           arbitration clauses;

                                                     (7)           jurisdiction clauses; and

                                                     (8)           termination clauses.

5.6                                      Consumer contracts are also subject to another layer of control under UTCCR which has no equivalent under UCTA. UTCCR give the DGFT and other authorised bodies the power to prevent the use or recommendation of unfair terms. The OFT has made wide and very effective use of these powers and, though it states that the use of unfair terms is still widespread, the impact of these controls on the market is far greater than would ever be achieved by individual consumers challenging the terms in their particular contracts. This is clearly demonstrated by the large numbers of terms which have been removed after intervention by the OFT when the term in question was either of no effect under UCTA, or almost certainly would be ineffective because it could not satisfy the statutory reasonableness test.

3. The case for “individual” controls over business-to-business contracts

5.7                                      In passing UCTA, Parliament accepted that there is a case for “individual” control over some types of term in business-to-business contracts. (We use the word “individual” to distinguish these controls from the “preventive” controls referred to in the previous paragraph. “Preventive” controls will be discussed in Section 11 of this Part.) As we explained in Part II,[6] unfairness may occur simply because one party may “agree” to terms without being aware of what they contain or of their impact (obviously this is a particular risk when the first party “agrees” to the other’s standard terms); or one party may find it has no choice but to agree because all suppliers offer similar terms and it lacks sufficient bargaining power to get the terms altered. This may then leave it exposed. For example, a retailer might be advised that in its contracts with consumers it cannot use a clause allowing it to increase the price of goods, at least without giving the consumer the opportunity to cancel the contract, but find that the manufacturer or distributor which supplies him insists on his placing an order which is at a price to be fixed at the date of delivery and which cannot be cancelled. The plight of retailers was the main example given by the Law Commissions in discussing whether business sellers should be able to exclude or limit their liability under the SGA 1979 only if the clause was fair and reasonable.[7] However, in cases decided under UCTA and its predecessor, SOGITA, the courts have also found exemption clauses in individual business-to-business contracts to be unreasonable in a wide range of other circumstances.[8]

4. Terms which are of no effect in business-to-business contracts

5.8                                      Under the existing law, certain terms are simply of no effect in business-to-business contracts. Clauses which purport to exclude business liability for death or personal injury caused by negligence or breach of duty fall into this group, and this should continue under the new legislation.[9] There are two further situations in which clauses in business contracts may be of no effect under UCTA. Before we consider extending the “fairness” test to other terms, this section considers whether terms should continue to be of no effect in these two situations.

(1) Business purchasers as consumers

5.9                                      We saw in Part III that in the R & B Customs case the Court of Appeal held that a company may “deal as consumer” within UCTA if it enters a transaction which is only incidental to its business activity and which is not of a kind it makes with any degree of regularity.[10] The effect is that any clause excluding or restricting the other party’s liability for breach of sections 13–15 of the SGA 1979, or for breach of other equivalent legislation, is of no effect. There is a question whether a company or even a natural person making a contract to obtain goods or services “related to” but not “in the course of” business should continue to be treated as a consumer.[11]

5.10                                      We note that a number of Commonwealth jurisdictions do treat some business purchases as if they were consumer transactions so that any exclusion or restriction of liability under sale of goods and similar legislation will be ineffective.[12] Usually this applies only to buyers that are not corporations and if the goods were bought by the business for use, rather than for re-sale or manufacture into other goods.[13] The result is probably somewhat similar to the result in the R & B Customs case, in that purchases of goods bought regularly as materials or stock-in-trade will fall outside the controls.

5.11                                      We are not convinced, however, that clauses in business-to-business contracts should ever be treated as automatically ineffective, even if the contract was not a regular one for the business. We think it would be sufficient that they be subject to a fair and reasonable test. Although in the R & B Customs case the goods supplied may not have been either an item bought regularly by the company or integral to its business, the form of the transaction[14] may have been perfectly familiar to it and there seems little reason to hold the clause absolutely ineffective rather than subject to a reasonableness test. A second point is that the supplier will find it difficult to know whether the buying company is “dealing as consumer” without quite detailed enquiry as to the nature of its business. The same arguments apply, we believe, when the buyer is a natural person making the contract for purposes related to his business.

5.12                                      It is our provisional view that a person who makes a contract to obtain goods or services “related to”, even if not “in the course of”, his business should be treated as dealing as a business and not as a consumer.[15]

(2) Obligations as to title in the sale of goods

5.13                                      Section 6(1) [s 20(1)] of UCTA prevents any seller from excluding or restricting his obligations under the SGA 1979 section 12 (seller’s implied undertakings as to title), irrespective of whether he is a business or a purely private seller and irrespective of whether the buyer is buying for business or private purposes. Section 7(3A) [s 21(3A)] does the equivalent in relation to implied terms as to title in other contracts for the transfer of goods under the Supply of Goods and Services Act 1982, section 2. It seems to us that the implied obligations in the respective sections reflect a fundamental principle of the law of moveable property, namely, that a seller or supplier of goods should have a good title to pass to the purchaser. At least in the business-to-business contracts with which this Part is concerned, no seller or supplier should be able to exclude this obligation.[16] Moreover, we are not aware of any difficulties over these provisions.

5.14                                      We provisionally propose that the substance of UCTA sections 6(1) and 7(3A) [ss 20(1), 21(3A)] should be incorporated into the new legislation.

5. The case for extending the range of terms subject to a “fairness” test in individual business-to-business contracts

5.15                                      There are two issues that arise in relation to extending the range of terms subject to a “fairness” test: the extent to which the arguments, discussed earlier,[17] relating to unfair terms in standard form contracts apply to business-to-business contracts; and the extent to which terms that do not exclude or restrict liability should be subject to a fairness test in business-to-business contracts.

(1) Unfair terms in standard form contracts

5.16                                      We have argued earlier that standard form contracts present particular problems of unfair surprise and lack of choice,[18] especially in the consumer context. We identified the main reason as a market failure caused by the cost of acquiring information. However, unfair terms, and particularly unfair terms in standard form contracts, are regularly to be found in business-to-business contracts. Standard forms are used in transactions between all types of business because the cost of customising each transaction can be prohibitive for both sides.[19] The use of standard terms is not in itself a sign that one of the parties is in a weak bargaining position. Indeed, the terms of many standard forms are entirely fair and reasonable. Unfortunately, this is not always the case.

5.17                                      We believe that in the business-to-business context standard form contracts cause problems which are similar to, if not so severe as, those affecting consumer contracts. First, while in an ideal world a contracting party should read and ascertain the impact of the terms on offer, in the real world this involves costs to a business. Simply to have someone read through the terms is time-consuming. This is particularly the case if the terms are hard to understand. But even when the clause is in clear terms it may be difficult to know how it will affect the customer, especially if to evaluate its impact requires information (such as the other party’s reliability) which the customer will not have readily available.[20] Secondly, a business customer may have very little more bargaining power as against a supplier than would a consumer.[21] For example, a business supplier that sells all its output to a single purchaser (as in the case of a manufacturer of components for a major car maker) will not be in a strong negotiating position. However the problem is not confined to this case. It may exist whenever the proposed purchase is of relatively low volume or value.

5.18                                      It is probable that the problems for business customers in general are less severe than they are for consumers. The business customer is more likely to have the expertise to understand the terms or the resources to seek legal advice; it is more likely to have some influence over a supplier if it intends to make similar purchases in future; and it may be able to call on a trade association to negotiate better terms on its behalf. Even if it is obliged to accept unfavourable terms, it may be able to insure against the risk. But the cases that come before the courts suggest that unfair terms are still a real problem in business-to-business contracts.

(2) Terms that do not exclude or restrict liability

5.19                                      In business-to-business contracts UCTA affects only various forms of exemption clauses, though this is defined broadly by UCTA, especially section 3 [s 17]. As we have said, the effect of that section is that a term which purports to allow the business whose standard terms are used to perform in a way which is “substantially different from that which was reasonably expected”, or not to perform at all, is subject to control. In contrast, a term which affects the other party’s obligations, such as a term requiring the other to pay an increased price, is not. This made sense when the focus was on exclusion and limitation of liability; but, looked at from the perspective of potentially unfair terms in general, the justification for this restriction is far from evident. The terms listed earlier as not being caught by UCTA[22] have an equal potential for unfairness as do many of the clauses which UCTA requires to be fair and reasonable. It does not seem to us that, for instance, the clause purporting to allow the seller to charge an increased price (which, as we have said, is not caught by UCTA) is any less likely to be unfair than a clause allowing the seller to vary the specification of the goods or services to be provided (which is within UCTA). Our provisional view is that both should be subject to control.

5.20                                      Further arguments might be made. First, on a purely practical level, it is sometimes difficult to draw a clear dividing line between the consumer and the businessman. Under the current law it is not always obvious whether a person is acting “in the course of a business” (UCTA, s 12 [s 25(1)]) or “for purposes relating to … trade” (UTCCR, reg 3(1)).[23] One commentator, when considering the International Air Transport Association’s (IATA) general conditions of carriage, has wondered which regime applies to a traveller whose primary purpose is to go on holiday but who takes the opportunity of having a business meeting abroad.[24] Or if a solicitor buys a vehicle for use both in his business and for domestic use, how is the transaction to be categorised? Though in many cases it may be clear whether the transaction in question is a consumer transaction or a commercial transaction, there are clearly a number of cases which could with equal accuracy be characterised either way. It would be simpler to have a single regime for most cases,all terms being subject to the fairness test.[25] The court can apply the test in a flexible way to take account of the facts of the particular situation.

5.21                                      Secondly, the “overlap” makes the continuing existence of two different, exclusive, regulatory regimes questionable. As we will explain in this Part, we do not accept that terms in consumer and in business-to-business contracts should be treated in the same way in all respects, because we believe that the needs of the parties differ in the two situations; but we think that in general terms it is not desirable for the two sets of rules to differ without good reason.

5.22                                      A third argument is that an extension of the existing controls would bring our law into line with that of several of our competitors. As can be seen from the more detailed account in Appendix A to this consultation paper, a number of countries have controls over unfair terms in business-to-business contracts that go beyond what is provided in the UK. These further controls take three basic forms (a single country often having more than one form of control):

                                                     (1)           Some countries treat small businesses, or some small businesses such as artisans and farmers, simply as if they were consumers. This may apply only for certain types of contract such as sales, as in some Canadian provinces,[26] and render exclusion clauses of no effect. More usually it means that a very wide range of unfair terms are subject to a test of fairness. The Netherlands is an example. The French courts at one time held that a business buying goods or services outside its field of professional expertise is to be treated like a consumer (“non-professionel”). More recent cases have held that this does not apply to purchases directly related to the business (for example if a printing company purchases electricity) but the possibility remains that it will apply in other cases.[27]

                                                     (2)           Some countries have wide-ranging controls over unfair terms of all types in individual business-to-business contracts. This may be a general power to strike down harsh contracts or clauses, as under the American doctrine of unconscionability[28] and section 36 of Sweden’s Contracts Act,[29] or it may be that legislation aimed primarily at consumers can be applied by analogy, or at the court’s discretion, to business-to-business contracts also. Thus the German BGB[30]has lists of clauses which are always of no effect and which are presumed to be unfair unless shown otherwise;[31] and while these lists are stated to apply to consumer contracts,[32] the German courts apply them to business-to-business contracts relying on the “general clause” of BGB art 307.[33] This provides that clauses which are contrary to good faith are not valid. The position in the Netherlands is similar.[34]

                                                     (3)           A number of countries, including the Netherlands and Sweden, have preventive controls over the use of clauses in business-to-business contracts. This is discussed further later in this Part.[35]

5.23                                      Lastly, in the European context it has been argued that the Directive should be extended to business contracts in order to promote the objectives of the Treaty of Rome[36] – the harmonisation of consumer protection law across Europe, thus increasing the movement of trade and competition and thereby raising the standard of living.[37] An extension of our law would go some way to achieving the same result. It is difficult to gauge the strength of this argument but it is not inconceivable that overseas firms would be readier to do business in the UK if they knew that under UK law they would have protection from any unfair terms used by their UK counterparts, particularly if they are used to having such protection under their own domestic law.

5.24                                      We should emphasise a point made in Part II. So many terms in business-to-business contracts are already subject to control under UCTA section 3 [s 17][38] that to subject all terms to control as under UTCCR, as we will provisionally propose, would not be such a great change as it might at first sight appear to be. (It may also be noted that we do not intend to extend the controls over terms in business-to-business contracts to clauses that were negotiated.[39]) Nonetheless our proposal would deal with a number of types of clause that have caused justified complaints, such as clauses locking businesses into long-term contracts for photocopiers and similar equipment at escalating prices.

5.25                                      Our provisional view is that a good case can be made for extending the power to challenge unfair terms in at least some individual business-to-business contracts from the types of term subject to the reasonableness test of UCTA to the wider range covered (for consumer contracts) by UTCCR.

6. The range of businesses to be protected

5.26                                      We now go on to consider whether this extension should apply to all, or only to a limited type of, business-to-business contracts. We consider first whether any extension should be limited to protecting small businesses. Secondly we consider an alternative, which would be to limit the extension to transactions which are not of a kind the business disadvantaged by the term makes on a regular basis (so that it is an “occasional business customer”); and thirdly we consider whether the controls should apply to all business contracts.

(1) Small businesses

5.27                                      Our terms of reference ask us to consider whether extended protection is particularly necessary for small businesses. It must be the case that problems are more likely where the party affected by a term is a sole trader or small business. A sole trader or small business is less likely than a larger business to have staff with the knowledge and skills to understand the impact of the other party’s clauses, especially if they are not in readily understandable language;[40] and is unlikely to have the bargaining power to persuade the other party to modify its terms. In many ways the position of a small business is closely analogous to that of a consumer. We have seen that several countries simply treat small businesses, or certain types of small business, as if they were consumers.[41] Thus the small business is given protection identical to that of consumers, including in some cases rules which render certain types of clause of no effect at all.

5.28                                      However, though the problems posed by unfair terms may be worse for small businesses, they are not confined to them. This may be demonstrated simply by the number of cases in which the courts have found clauses in business-to-business contracts to be unreasonable under UCTA even though the party affected was not a small business. There have been some cases in which a clause was held to be unreasonable and the business in whose favour the decision was reached was said to be a small business.[42] But there have been more in which it was said that the parties were of unequal bargaining power without mentioning the size of the “weaker” business.[43] This suggests that the courts do not necessarily consider bargaining power to be a function of size.

5.29                                      A factor that seems to be more critical than whether the complaining party is a small business is whether or not it has dealt on the other party’s standard form of contract. There seems to have been only one reported case in England in which a clause which had been negotiated was held to be unreasonable.[44]

5.30                                      It seems likely that the factors listed in paragraph 5.18, as mitigating the problems caused by standard form contracts for businesses, are much less relevant for a small business than for a medium-sized or large one. As we suggested earlier,[45] in many ways small businesses seem to be in a similar position to consumers. Thus there appears to be a case for extending the controls so that they at least protect small businesses. However, the justification for extending the protection given to businesses may be wider than this.

(2) Occasional business customers

5.31                                      An alternative argument is that what matters is not so much the size of the customer’s business but the balance of bargaining expertise and bargaining power. This is borne out by the reported cases under UCTA, insofar as one can rely on these as a guide. As we have said, in cases in which a clause was held to be unreasonable there has been more emphasis on the unequal bargaining power of the parties than on their relative size.

5.32                                      A major determinant of bargaining power is whether the transaction a business is entering is of a kind it makes regularly or, conversely, is an unusual one for it to enter. When the transaction is of a kind which the business enters regularly, it is less likely to be at a disadvantage vis-à-vis the other party. It is more likely to have relevant expertise; the cost of finding out the meaning of the terms on offer can be spread over a larger number of transactions; and, as it can hold out to the other party the prospect of regular repeat orders, it may have some bargaining power. Conversely, if the transaction is not one it enters regularly, for example if a business buys equipment for use or contracts for occasional services rather than inventory or routine services, it is likely to be in a weaker position. This is true whatever the size of the business: a large business making the occasional purchase of goods or services which are outside its field of expertise may not be in a much better position than a small business in the same situation.[46]

5.33                                      Therefore it can be argued that, while business customers do not need protection in their routine transactions, since for these they can be expected to develop or buy in the necessary expertise and are likely to have more bargaining power, protection may still be justified in transactions which are not part of the routine business of the customer – when, in other words, the business is an “occasional business customer”.

5.34                                      However, we do not believe that the fact that a particular transaction is routine for the business is alone sufficient to ensure fairness. For example, the supplier whose entire output is usually bought by a car manufacturer or a supermarket chain lacks any real bargaining power, and a farmer buying seed[47] may face unfair terms, though all these are “routine” transactions for the weaker party. Thus we believe that it would not be sufficient to give protection to “occasional business customers”; it would be necessary to protect at least small businesses also.

(3) General protection for business

5.35                                      A third argument is that the new legislation should follow the pattern of UCTA. The protection provided by the requirement of reasonableness under UCTA is not formally limited to small or occasional business customers.[48] The size of the business, and whether or not the transaction is of a kind the business makes regularly, are factors (and probably important factors) which can be taken into account in assessing reasonableness, but in principle any business can claim the protection of UCTA.[49]

5.36                                      There would be advantages in this approach. To provide a separate regime for small businesses, or for small businesses and occasional transactions, would create even more complexity; it has not proved necessary in relation to the broad range of terms already controlled by UCTA; and it would cause difficulties for business. It seems likely that businesses wish to have a fairly good idea of which regime governs their terms. Were controls to be applied only to protect small businesses and “occasional business customers”, the other business might not be able to tell which regime would apply.

5.37                                      First, how is a business to know whether it is dealing with a small or a large business? It is true that there is legislation which distinguishes between “small” and other businesses. The Late Payment of Commercial Debts (Interest) Act 1998 provides for a term to be implied into contracts that interest shall be payable on debts paid late. This has been brought into force progressively. At first it applied only where the supplier was a small business (under 50 employees) and the purchaser a large business (over 50 employees) or a public authority.[50] It was then extended to the case where a small business was purchasing from a public authority,[51] and most recently it has been applied as between small businesses.[52] The burden of proving that a business is small rests on the business but there is no requirement that the small business warn its contracting partner in advance. It would be useful to know whether this has caused practical problems. It will be possible for the supplier to discover from industry sources the approximate size of a potential customer.

5.38                                      Equally, particularly where there has been no previous dealing between them, how is a business to know whether a transaction is or is not a regular one for its customer? The very difficulty for a supplier of distinguishing between its various customers could be a factor which the court can take into account in assessing the reasonableness of the term in question. Moreover, apart from the isolated decision in the R & B Customs case,[53] this distinction is not one normally used in contract law and, even if it can be justified in theory, it is not clear that it is workable in practice: detailed factual investigations are likely to be involved in order to determine which regime applies.

5.39                                      Thus in relation to the question of extending the range of clauses which must satisfy the fairness test to protect business customers, we are not convinced that the extension should be made only to small businesses or only to “occasional business customers”.

5.40                                      Our provisional view is that it would be better to treat all businesses alike in being able to benefit from the protection, allowing the courts to take into account the size of the business, and whether it makes transactions of the kind in question regularly or only occasionally, in assessing the fairness of the terms complained of. We ask consultees whether they agree. If not, how would they prefer to see the protection limited?

7. “Standard” or “non-negotiated” terms, or all terms?

(1) Should any controls apply to negotiated contracts?

5.41                                      In 1975, when considering what the scope of control should be in relation to business contracts, the Law Commissions concluded that control was most necessary where, even though both parties are acting in the course of a business,

one party requires the other to accept terms which the former has decided upon in advance as being generally advantageous to him, and the customer must either accept those terms or not enter into the contract: that is, where there is a standard form contract.[54]

The Second Report rejected more general controls on the ground that this would constitute too great an interference with freedom of contract, noting that “injustice is unlikely where the parties have been able to negotiate the provisions of the contract on equal terms”.[55]

5.42                                      On the other hand, we have seen that the “reasonableness” requirement imposed by UCTA sections 2(2) [s 16(1)(b)], 6(3) [s 20(2)(ii)] and 7(3) [s 21(1), (3)] in business-to-business contracts applies to terms in contracts which have been fully negotiated. We have also made the provisional proposal that, in consumer contracts, controls over unfair terms should not be limited to “non-negotiated” terms.[56] If the new legislation is to extend the controls to cover a wider range of clauses in business-to-business contracts, what approach should it take to this question? Should the controls apply to all “unfair” terms, whether negotiated or not? Or should the existing controls over negotiated terms in UCTA be retained, but the wider controls apply only to terms that are standard terms of business (the test under UCTA) or have not been individually negotiated (the test under UTCCR)?[57] Or should all the existing controls be replaced by a “fairness test” applicable only to standard or non-negotiated terms?

(a) Extended controls

5.43                                      Our provisional view is that it is not necessary to extend the general controls to terms which have been negotiated between businesses. We accept that there may be cases where, even though a business negotiated over a clause and thus was aware of the nature of the terms being offered to it and their possible consequences, it was obliged to accept those terms and the consequent risk, which could not be passed on to a third party. For example, a farmer who supplies a supermarket chain will in practice have very little influence over the terms on which his product is purchased. The fact that a negotiating process has taken place may not change the position that the contract contains terms which are unfair to one of the parties.[58] It may be argued that unless the negotiation has resulted in an amendment of the clause in question in favour of the weaker party, the clause should remain subject to the control of the court.[59] However, where the business concerned has been given the opportunity to negotiate a particular term in its contract, it will at least be aware of the term, and so have had the chance to consider the possible consequences of entering into a contract on that basis. Even if it does not have the bargaining power to ensure that the term is not included in the contract, it may be able to safeguard its position by ensuring that other terms of the contract are more favourable, or, alternatively, by accepting the risk and insuring against it. It can be argued to be an unreasonable interference with freedom of contract to allow the business to object to the term when, with hindsight, it appears that it is not advantageous. In particular, it is important that a business should not be encouraged to embark on litigation, or to threaten to embark on litigation, to challenge the fairness of a term, when its primary reason for doing so is to delay having to implement the contractual obligations which it has undertaken.

5.44                                      We provisionally propose that, for business-to-business contracts, the “fairness test” be extended to cover the same range of terms as would be subject to the fairness test under our proposals for consumer contracts, but only where the term in question “has not been negotiated” or is “standard”.[60]

(b) Existing controls

5.45                                      Should the provisions in UCTA that in business-to-business contracts[61] require even negotiated exclusion clauses to be reasonable be retained? It would not be illogical to say that the kinds of exclusion clauses covered by UCTA sections 2(2) [s 16(1)(b)], 6(3) [s 20(2)] and 7(3) [s 21(1), (3)] are so risky, or so anti-social, that they should be the subject of control even when they were negotiated, but that other terms should only be challenged if they were “standard” or “non-negotiated”. We think that the substance of UCTA section 2(2) [s 16(1)(b)], which of course applies to non-contractual notices as well as contract terms, should be retained, but we are not convinced that those in sections 6(3) and 7(3) [ss 20(2)(ii), 21(1)(ii)] are still needed. To maintain them would add to the complexity of the legislation; and we suspect that it would in practice affect the outcome in very few cases. We have already said that there seems to have been only one reported case in England and Wales in which a clause which had been negotiated was held to be unreasonable.[62]

5.46                                      Limiting the exclusion in this way to “individually negotiated terms” or “standard terms of business” (and thus following the approach of the current section 3 [s 17] of UCTA) would ensure that businesses are not deprived of protection from unfair terms in an area where it is needed, while preserving freedom of contract as far as possible.[63] At the same time it would simplify the law, as with only a few exceptions all terms in business contracts would be subject to a single regime.[64]

5.47                                      We would welcome evidence from consultees on whether in practice there are significant numbers of terms which were not standard, or which were negotiated, and which are seen as unfair. Our provisional conclusion is that the controls over negotiated exclusion clauses in UCTA sections 6 and 7 [ss 20(2)(ii), 21(1)(ii)] are not needed and that it would suffice to have the general fairness test over “standard” or “non-negotiated” terms.

(2) “Standard terms” or “not individually negotiated terms”?

5.48                                      There remains the question of whether the controls should be over “standard terms” as under UCTA section 3 [s 17] or “not individually negotiated terms” as under UTCCR. We need to define what is meant by each of these phrases.

5.49                                      UCTA refers to “written standard terms of business” (or, in the case of Scotland, “standard form contract”, but section 17(2) limits this to written standard terms of business). When considering whether or not to define “standard terms of business”, the Law Commissions rejected the lack of negotiation as a defining feature, noting that there are cases in which some, but not all, terms of the contract may be negotiated.[65] In the event it was decided to leave the phrase undefined. It has been interpreted flexibly by the courts.

5.50                                      First, it has been held that a term may be a “written standard term of business” even though other parts of the contract, including other standard terms, have been negotiated by the parties, provided the terms remain “standard”. In St Albans City and District Council v International Computers Ltd[66]Nourse LJ (with whom the other members of the court agreed) said that to “deal” on the other’s standard terms means simply to make the final contract on those terms. The question was one of fact: had any negotiations left the standard terms “effectively untouched”?[67]

5.51                                      Secondly, it is possible that one term may be treated as a “written standard term” within section 3 [s 17] even though some of the other standard terms have been altered as the result of negotiation: in other words, that the question whether a term is standard will be treated “term by term”. However, such authority as exists seems divided. In Pegler Ltd v Wang (UK) Ltd (No 1)[68] the evidence showed that Wang was prepared to negotiate on clauses defining the moments of delivery, performance, passing of risk and other matters but not on its standard exclusion clauses. Peter Bowsher QC, sitting as a High Court judge, found that the exclusion clause in question was still a standard term, even though Wang was prepared to accept a small variation of the term limiting its liability to losses of a certain amount: “A standard term is nonetheless a standard term even though the party putting forward that term is willing to negotiate some small variations of that term.”[69] In The Salvage Association v CAP Financial Services Ltd,[70] however, Thayne Forbes J held that the second contract in that case was not on CAP written standard terms as they had been the subject of negotiation, although they were “closely based on and followed” those terms.[71]

5.52                                      It is necessary that the term in question is one that is used with some regularity. Lord Dunpark in McCrone v Boots Farm Sales Ltd[72] said that the phrase “standard form contract” (the Scottish counterpart of “written standard terms”[73])

is, in my opinion, wide enough to include any contract, whether wholly written or partly oral, which includes a set of fixed terms or conditions which the proponer applies, without material variation, to contracts of the kind in question.

5.53                                      Other judges have been less demanding. Thus in British Fermentation Products v Compair Reavell,[74] it was said that it might be enough that the term was “at least usually used”.[75] Nonetheless, it is probable that the terms in question must be used for a large proportion of contracts of the relevant type before the criterion of being “standard” written terms is met.

5.54                                      In this respect UTCCR are different. A term is not individually negotiated “where it has been drafted in advance and the consumer has therefore not been able to influence the substance of the term”.[76] Thus it appears not to matter whether the term has been used before or was drafted in advance for use in the particular contract. It seems that the question must be taken “term by term”.

5.55                                      If controls over unfair terms in business-to-business contracts are to be extended, but the controls are to be restricted to “standard” or “non-negotiated” terms, should the legislation follow the UCTA or the UTCCR approach? We suggest that a “term by term” approach is better, simply because a party will often concentrate its attention on some terms but not others.[77] For instance, the “standard terms” may well include provisions dealing with the amounts payable under the contract; for example, standard scale fees. A party might well consider these in some detail and attempt to negotiate them while having no understanding of other terms in the standard form.

5.56                                      We provisionally propose that, if controls are to be limited to standard terms, the question should be whether the particular term is standard rather than whether any of the standard terms have been subject to negotiation.

5.57                                      We have not found it easy to decide whether the controls should be extended to a clause merely because it has been drafted in advance by one party and not subsequently negotiated. On the one hand we suspect that most clauses are drafted by one party or the other “in advance” of the contract being agreed – save in very high value transactions, it must be unusual for the parties to sit down together to draft the clauses. If the clause was drawn up for the particular contract, rather than being standard, the party who drafted it is less likely to refuse to alter it. On the other hand it is quite difficult to distinguish “standard terms” from those merely drafted in advance, particularly when the “standard form” may in fact be an electronic document and the clauses are printed out for each transaction.

5.58                                      In the end we have reached the provisional conclusion that the controls should apply to clauses that have been drafted in advance by one party and not subsequently negotiated, because this is the test which we think will be the easier one to apply when, as we think will be more and more often the case, the “standard form” will not be a printed document but an electronic one.[78]

5.59                                      We provisionally propose that, if controls are to be limited to terms that are in some way standard, they should apply to any term which has been drafted in advance and has not been negotiated, whether or not the term is one regularly used by the proponent.

8. Exemptions from the new regime

(1) “Core” terms

5.60                                      In Part III we considered the exemption from UTCCR’s fairness test of the “core terms” (more accurately, the definition of the main subject matter and the adequacy of the price), and proposed a reformulated version which should make these exemptions rather clearer.[79]

5.61                                      We provisionally propose that the same formulation of the “core terms” should apply to business-to-business contracts as to consumer contracts.

(2) Mandatory and permitted terms

5.62                                      In Part III we considered the question of terms which either are required by law or which are in substance the same as those which would apply in the absence of an express term (the “default” rules). We considered that both are exempt under the existing law and should remain so under the new legislation, provided however that they are “transparent”. As to terms required or approved by industry regulators, only terms required by regulators should be exempt from the new “reasonableness” regime.[80]

5.63                                      We provisionally propose that the same rules on mandatory and permitted terms should apply to business-to-business contracts as to consumer contracts.

(3) Excluded contracts

(a) Terms not subject to UCTA in business-to-business contracts

5.64                                      In Part II we noted that certain contracts are excluded from the operation of UCTA, even when they are consumer contracts. They are:

                                                     (1)           contracts of insurance; [81]

                                                     (2)           any contract so far as it relates to the creation or transfer of any interest in land,or the termination of such an interest; [82]

                                                     (3)           any contract so far as it relates to the creation or transfer of securities or of any right or interest in securities;and[83]

                                                     (4)           (for Scotland) contracts of guarantee.[84]

5.65                                      There are other exclusions which in practice affect only business-to-business contracts:

                                                     (1)           any contract so far as it relates to the creation or transfer of a right or interest in any patent, trade mark, copyright or design right, registered design, technical or commercial information or other intellectual property, or relates to the termination of any such right or interest;[85]

                                                     (2)           any contract so far as it relates

                                                                               (i)           to the formation or dissolution of a company (which means any body corporate or unincorporated association, and includes a partnership), or

                                                                             (ii)           to its constitution or the rights or obligations of its corporators or members;[86] and

                                                     (3)           (except in so far as the contract purports to exclude or restrict liability for negligence or breach of duty in respect of death or personal injury)

                                                                             (a)           any contract of marine salvage or towage;

                                                                             (b)           any charterparty of a ship or hovercraft; and

                                                                             (c)           any contract for the carriage of goods by ship or hovercraft.[87]

5.66                                      We are not aware of calls for business-to-business contracts of the types excluded from UCTA to be brought within the scope of the unfair terms legislation. We would be interested to hear any evidence suggesting that any of them should be covered, but provisionally we propose to maintain the existing exemptions.

(b) International contracts

5.67                                      As we noted in Part III, UCTA section 26[88] exempts from the operation of certain sections of the Act any contract for the supply of goods which is made by parties in different States and which involves carriage of the goods between States, offer and acceptance across State borders or delivery in a different State to that where the contract was made. We have proposed that all the provisions to protect consumers should apply to “cross-border” contracts.[89] Should international business-to-business contracts continue to be exempt?

5.68                                      In their First Report, the Law Commissions gave three reasons for exempting international supply contracts: (a) that, where goods were exported from the UK to another country, it was for the legal system of that country rather than that of our own to specify how far contractual freedom should be limited or controlled in the interests of consumers or other purchasers; (b) that contracts of an international character ordinarily involved transactions of some size between parties who were engaged in commerce and who wished to be free to negotiate their own terms; and (c) that it would be undesirable to make proposals which would place UK exporters under restrictions which would not apply to some of their foreign competitors.[90]

5.69                                      It seems likely that conditions have changed to some extent since 1977. For instance, we suspect that there are now many small “cross-border” contracts within the EU, and many of them may be between parties who are not regularly involved in that kind of commerce. Moreover, one of the aims of recent EU legislation on contracts has been to increase the confidence of consumers in making contracts under other legal systems than their own (many of which will be cross-border contracts) and so to enhance the operation of the single market.[91] It would be odd to pursue this aim for consumers but to ignore it for business-to-business transactions, which must have the potential to play an equal role in the development of the single market. However, we are not aware of any calls for changes to the law on this point affecting business-to-business contracts.

5.70                                      We invite views on the question whether international business-to-business contracts should be exempt from the controls proposed for domestic contracts.

(c) Choice of English or Scots law

5.71                                      UCTA also exempts from its operation contracts in which English or Scots law applies only because the parties have chosen the law of a part of the UK to govern their contract.[92] The aim of this exemption was to avoid discouraging “foreign businessmen from agreeing to arbitrate their disputes in England or Scotland”.[93]

5.72                                      We invite views on whether the exemption for contracts subject to the law of a part of the UK only by choice of the parties should continue to apply to the new regime for business-to-business contracts.

(d) Utilities and the definition of contract

5.73                                      Agreements for the supply of gas, electricity or telecommunications to businesses would be within the new regime because they are now regarded as contracts in the strict sense.[94] Where a utility agreement is not a contract (as appears to be so in the case of agreements for the supply of water[95]) it is at present outside the scope of UCTA, but is subject to a regulatory framework which Parliament presumably regards as adequate. We therefore see no reason to include such agreements within the new legislation except to the extent that this is required by the Directive. Since the Directive applies only to consumer contracts, non-contractual utility agreements with businesses can safely be excluded. Even if the ECJ were to develop the concept of a “contract” in such a way as to include non-contractual utility agreements, this would not affect business-to-business agreements because they are outside the scope of the Directive in any event. Our provisional view is that the new regime need not extend to non-contractual agreements between utility suppliers and businesses.

9. The test to be applied

(1) The basic test

5.74                                      In Part III, we provisionally proposed that the basic test in the new legislation for consumer contracts should be whether, judged by reference to the time the contract was made, the term was a fair and reasonable one.[96] We see no reason to make the basic “fair and reasonable” test any different for business-to-business contracts from the test we propose for consumer contracts.

5.75                                      We provisionally propose that the same “fair and reasonable” test should apply to business-to-business contracts as we propose for consumer contracts.

(2) Plain and intelligible language

5.76                                      We have provisionally proposed that, for consumer contracts, lack of transparency (by which we mean not only that the language is plain and intelligible but that the terms are readily accessible to the consumer, and that the layout of the contract document is easy to follow) should be listed among the factors that should be taken into account in assessing fairness.[97]

5.77                                      The extent to which an exclusion clause is transparent is already a factor to be taken into account under UCTA. Schedule 2, guideline (c) directs the court to consider

whether the customer knew or ought reasonably to have known of the existence and extent of the term (having regard, among other things, to any custom of the trade and any previous course of dealing between the parties).

5.78                                      The transparency of the term must be directly relevant to this question. Some cases have referred to the difficulty of understanding a clause as one ground for holding it to be unreasonable.[98] Where a term is clear, that is often a factor in the decision that the term was reasonable.[99] Transparency is important both to the question of reasonableness and to the effective operation of the “market” in terms.[100]

5.79                                      We provisionally propose that the factors to be taken into account in assessing fairness should include whether the contract is transparent, in business-to-business as well as consumer contracts.

5.80                                      We also raised in Part III the question whether it should be possible for the court to hold that a term is unfair simply because it is not “transparent” – in other words, whether the court should have the power, if it considers it appropriate, to hold the term to be unfair even though, had it been transparent, it would have been fair. We provisionally proposed that “transparency” be incorporated into the list of factors in such a way that it is clear that a term may be unfair principally or even solely because of lack of transparency. Should the same apply in business-to-business contracts? We are hesitant to take this further step, as it seems to us that a business confronted with terms that are unintelligible or hard to read can, unlike consumers, be expected to complain and refuse to contract without clarification. On the other hand confusing presentation, which may equally go to transparency, may confuse business people and consumers alike.

5.81                                      We invite views as to whether, for business-to-business as well as consumer contracts, transparency should be incorporated into the list of factors in such a way that a term may be found unfair principally or solely because of lack of transparency.

(3) The list of factors

5.82                                      UCTA contains “guidelines” for the application of the reasonableness test.[101] For consumer contracts we have provisionally proposed a rather fuller list than that in UCTA: the list tries to set out what we understand to be the major issues in relation to unfair terms.

5.83                                      We consider that a list of factors relevant to the application of the “fair and reasonable” test would be useful in relation to business-to-business contracts as well as consumer contracts, particularly to give guidance to businesses as to how they may ensure that their terms are reasonable. We also think that the list should contain the same factors as that for consumer contracts, though naturally they may apply somewhat differently in a business context.

(4) An indicative list

5.84                                      For consumer contracts the legislation must include a list of terms which may be unfair. We have provisionally proposed that the indicative list be reformulated to make it easier to understand and apply in the UK.[102] It should also be expanded to cover certain terms which are commonly considered to be unfair but which are not referred to in the Directive.[103] We propose that the business should have the burden of proving that any term which is so listed is fair and reasonable.[104]

5.85                                      Should there be a list for business-to-business contracts? We pointed out in Part IV that in relation to consumer contracts the list serves two functions: the first is to give information to businesses and consumers as to what, in an individual case, is likely to be regarded as an unfair clause. The second is to make it easier for the OFT and the other bodies listed in Schedule 1 to ensure that unfair terms are not used by businesses, and for businesses to know what terms are likely to be unacceptable. We discuss below whether any body should be given the power to prevent the use of unfair terms in business-to-business contracts; if this is not done, then clearly the list will not have the second function here. It will still perform the first function.

5.86                                      Even if there is to be no power to prevent the use of unfair terms in business-to-business contracts, we consider that a list of some sort is important for the first function. At a minimum, it should be made clear that clauses excluding and restricting liability for breach of contract or for negligence are “suspect”.[105] As we explain in the next section, we also consider that if a term is on the indicative list the business seeking to rely on it should have the burden of proving that the term is reasonable. This would replicate the effect of UCTA.[106]

5.87                                      However we doubt whether, in a business-to-business contract, there are other types of clause which are so likely to be unfair that the party relying on them should be obliged to prove that they are reasonable. It may be that experience will prove us wrong.

5.88                                      We provisionally propose that the indicative list for business-to-business contracts be limited to clauses excluding and restricting liability for breach of contract or for negligence [breach of duty], but that there should be power to add to the list by Ministerial Order.

(5) Burden of proof

5.89                                      In our view, a business which seeks to rely on a “listed” term should be able to do so only if it shows that the term is fair and reasonable. For consumer contracts, one alternative proposal is that the business should have to prove that any term subject to the legislation is fair and reasonable, whether the term is on the indicative list or not. We do not think that it would be right to impose such a burden in business-to-business contracts; to do so would create unnecessary uncertainty.

5.90                                      We provisionally propose that, where a term has not been listed, the burden of proving that a term in a business-to-business contract is not fair and reasonable should be on the party disputing the clause.

10. Ancillary questions

5.91                                      In this section we deal with a number of ancillary questions that we considered earlier in relation to consumer contracts.

(1) Third parties

5.92                                      We explained in Part III that third party beneficiaries of a contract who have the right to enforce a term of the contract under the Contracts (Rights of Third Parties) Act 1999 cannot rely on any provisions of UCTA, except section 2(1).[107] In Scots law a third party with a ius quaesitum tertio may apparently rely on any part of section 16, so that he may challenge clauses excluding business liability not only for death or personal injury but also for other loss or damage caused by negligence. In Part IV we made the provisional proposal that for consumer contracts this position be maintained.[108]

5.93                                      We provisionally propose that the existing position of third party beneficiaries be maintained for business-to-business contracts as well as consumer contracts.

(2) Secondary contracts

5.94                                      Just as for consumer contracts, it should not be possible to evade the controls over business-to-business contracts by means of a secondary contract, whether between the same parties or different parties. The issues are the same as they are for consumer contracts and we refer readers to the discussion in Part IV.[109]

(3) Evasion by choice of law

5.95                                      As for consumer contracts,[110] it should be made clear that the rules on unfair clauses in business-to-business contracts are mandatory, so that if the contract has a close connection to the UK they will be applied under the Rome Convention despite a choice of another system of law.

(4) Effect if term invalid

5.96                                      The issues over the effect of a term being invalid because it is not fair and reasonable are the same for business-to-business contracts as they are for consumer contracts. Again we refer readers to the earlier discussion.[111]

5.97                                      We propose that the rules on secondary contracts, evasion by choice of law, and the effect of a term being held invalid should be the same for business-to-business contracts as we have proposed for consumer contracts.

11. Preventive action

5.98                                      Though we propose that all business-to-business contracts should be subject to control by the courts whatever the size of the business to whose detriment the term operates, the question of whether there should be provisions to permit authorised bodies to take preventive action against the use or the recommendation of unfair terms in business-to-business contracts needs separate discussion. It is a question of considerable difficulty.

5.99                                      The preventive powers given by UTCCR regulations 10–15 are designed to correct widespread market failures caused by, on the one hand, insufficient margins of active consumers to police the market and, on the other, the scarcity of organisations able to influence the market by collective action on behalf of consumers. We have indicated already our view that the work of the OFT’s Unfair Contract Terms Unit has had a major impact on the market.[112] The OFT has secured the removal of many unfair terms which were almost certainly invalid under UCTA; and this shows that allowing parties to challenge terms in their individual contracts, while invaluable for them, has a limited impact on contracting practice generally.

5.100                                      Is such a general policing power needed over terms in contracts between businesses? It seems likely that there are many businesses which are sufficiently sophisticated and powerful to be able to bargain for terms that they think suitable, or at least to ensure that terms they consider inappropriate will not in practice be applied against them. To the extent that this leads suppliers to modify their standard terms, this may operate to protect not only the business concerned but also other businesses with similar interests (unless the supplier discriminates between customers and applies different standard terms to different groups, which we think would be costly and therefore unusual). However, it is not always the case that less sophisticated or powerful businesses will benefit.

5.101                                      First, a powerful business may simply insist that its suppliers contract on its own terms. This will leave the supplier’s standard terms in place for contracts with less powerful customers.

5.102                                      Secondly, the powerful business may not be concerned to have the offending term removed from the supplier’s conditions. Instead it may simply rely on its market power to ensure that the supplier will not enforce the term against it.[113] The term will still apply to the supplier’s contracts and may be enforced against less important customers.

5.103                                      Thirdly, different customers may have different requirements. For example, a small business is likely to have few reserves to meet contingencies and therefore may be more risk-averse than a larger business. Thus a price variation clause in the supplier’s conditions may be acceptable for a larger business but a matter of grave concern for a smaller enterprise. Larger and more powerful businesses may therefore not exercise any pressure on the supplier to remove the term, leaving smaller businesses unprotected.

5.104                                      Fourthly, it is clear from reported cases that unfair terms do persist in business-to-business contracts and that they are sometimes applied by the suppliers in question.[114]

5.105                                      A case can be made, therefore, for a body having power to prevent the use of unfair terms by businesses in their contracts with other businesses. Such controls are found in some continental countries. In Sweden it has been reported that the powers have seldom resulted in reported cases, but there may have been informal settlements resulting in unfair terms being withdrawn and the existence of the powers may have had a considerable influence.[115] The relevant legislation in Germany is also seldom used in business-to-business contracts.

5.106                                      If there were to be such preventive powers, should they be available to protect any size of business? Since the problems are almost certainly greatest for small businesses, it is perhaps arguable that the preventive powers should be slanted in this direction, either by requiring this to be taken into account explicitly by the authority or by giving the powers only to authorities or organisations that are empowered to act on behalf of small businesses.

5.107                                      The result might be that suppliers would find that they need two sets of conditions, one for small business customers and a second for others. There would obviously be some additional cost involved, but this would be off-set by the increased efficiency in the terms being matched more closely to the needs of different customers.

5.108                                      However, it seems quite possible that many of the replacement terms will be acceptable to all customers. A parallel may be drawn with the OFT’s experience with terms offered to consumers. It appears that frequently businesses whose terms are challenged as being unfair are actually using them without having considered them in much detail. They frequently concede that the terms, at least if applied literally, give them a quite unnecessary degree of protection and might operate unfairly against consumers. They are then quite ready to change the terms to something fairer.[116] It seems plausible that the same is true for business contracts. If so, the gain in efficiency and fairness would be greater still.

5.109                                      It might be argued that encouraging businesses to improve their standard terms does not alter the reality of the contractual relationship but only the formal position, as in practice the terms are not applied literally but in a fair way. This is admittedly not a justification for allowing the persistence of unfair terms in consumer contracts, since consumers may be put off from claiming by the apparently draconian terms, but, arguably, businesses are unlikely to be deterred in this way. The argument cannot be dismissed out of hand, but it has at least two weak points. The first is that it seems costly to both sides to employ terms that do not fit the reality of their contractual relationship, since there will be considerable scope for disagreement as to what that “reality” is. The second is that it, in effect, leaves a great deal to the discretion of one party, who may apply the terms in what it perceives to be a fair way but which, judged more objectively, is not fair. An example of this is the Finney Lock Seeds case,[117] in which a seed company which supplied seed to a farmer limited its liability in the event of the seed being defective to a return of the contract price. The House of Lords held that the clause was unreasonable. One of the principal reasons for doing so was evidence that, in practice, the seed company would normally pay some further compensation when seed was defective; this was taken to show that even the seed company considered the clause to be unreasonable. Put another way, the clause gave the seed company complete discretion to decide whether to pay further compensation according to its own evaluation of whether the fault was primarily its own or that of the farmer, rather than according to a judicial determination of the question. In effect, the clause purported to oust the jurisdiction of the courts over payment of compensation for breach of contract. In these circumstances it is perhaps unsurprising that the clause was held to be unreasonable.

5.110                                      It seems to us that the decision whether to recommend the extension of the “preventive” powers of UTCCR to business-to-business contracts depends on the answers to at least two questions. The first is whether it is in principle desirable to extend the controls. The second is whether there is some suitable body to take on the task of taking action against businesses that use unfair terms, or trade associations and other bodies that recommend them. It is possible that an association concerned with the interests of businesses, particularly small businesses, might be a candidate. However, to operate an effective unit to police unfair terms would be expensive, and we do not know whether there is any body that would be prepared to meet the necessary expenditure.

5.111                                      We invite views on the desirability and the practicability of extending the preventive controls over unfair terms to business-to-business contracts.