How far do principles of fairness affect SME lending?

This article was originally published by Leasing Life on 08 July 2016

The withdrawal by the FCA of its unfair contract terms guidance has highlighted an issue of relevance not only to lenders who deal with consumers but also to B2B lenders who operate in the SME sector, whether it is to a small incorporated business, a small partnership or a sole trader.

That issue concerns the availability of a wide range of products to a diverse customer base on terms which are not only suitable for the customers for whom they are directed, but which are clear, fair and not misleading – one of the FCA’s high level principles. Whilst that principle applies only to regulated transactions, it also makes good business sense for all customers. Asset finance is a valuable and accessible source of funding for all small businesses but lenders should play close attention to the terms on which it is provided.

Lenders for whom this sector is their core market place have had to grapple with FCA regulation in relation to what may be only a limited part of their business which is regulated. Challenges have included the need to ensure that treating customers fairly is central to any business model. However, funders cannot ignore the direction which the FCA itself may take in extending protections currently available to consumers and some small businesses to all SMEs[1].

So why should funders focus on agreement terms?

The Consumer Rights Act 2015

The CRA updated and revised the law on fairness in contracts between traders and consumers ("individuals who are acting for purposes outside their trade, profession or business). Lenders operating in both markets invariably rely upon a single set of terms and so applying the same set of standards across both sectors may be inevitable. Guidance on fairness in consumer contracts is contained in the CMA's July 2015 Guidance on the CRA's unfair terms provisions[2] . As lenders will know, the FCA has recently removed its own guidance on unfair terms, but the CMA Guidance is still an authoritative source of information.

Business-regulated agreements still need to meet the FCA's requirements of fairness and clarity, but to what extent might the CRA's requirements on fairness relating to transparency and legibility be relevant to determining whether terms are fair in a business context? It cannot be assumed that small business borrowers have a level of understanding or sophistication that is on a higher plain than that of the average consumer. This is certainly the theme explored in the FCA's recent discussion paper on SMEs, suggesting that these customers do require the same degree of protection as consumers who do not act for business purposes.

Transparency and fairness in all contract terms should, therefore, be the aim of all lenders in this sector. Treating all customers in the same open, fair and transparent way demonstrates the right culture to a firm which is regulated but which may also provide business-exempt finance.

The Unfair Contract Terms Act 1977
Exclusion of liability for business customers is still subject to principles of reasonableness in relation to quality, fitness for purpose, and certain other types of contractual term. Lenders need to carefully consider how they allocate risk through contractual exclusion clauses. This is clearly a challenge when it makes perfectly good sense not to have to take responsibility for the technical performance of assets which are simply being funded and which the lender is not actually supplying. Excluding such liability for consumer contracts is a CRA blacklisted term but are there any instances where it might be regarded as fair and reasonable to do so for businesses? The emphasis in what few reported cases there have been on this issue has been to find against lenders for the extremely wide manner in which many such clauses were drafted. Shifting risk to supplier warranties has never been a successful solution to this issue, but there may be others which ultimately strike a balance between fairness and the proper allocation of risk.

Penalty Clauses
Quite apart from reasonableness issues in relation to exclusion clauses, there is more clarity on when such clauses might be found unenforceable thanks to recent case law. Lenders do need to ensure that any termination sum provisions are properly drafted and clear to prevent them being found to be an unenforceable penalty clause.

CCA Unfair Relationship Provisions
Individuals and small partnerships do, of course, still have the ability to challenge the fairness of contractual terms even where their agreements are exempt. The courts have shown a willingness to consider the unfairness of relationships even for sophisticated investor borrowers[3].

Product Design and Distribution
Innovation and flexibility are clearly to be encouraged, but creating overly complex products without adequate consideration for principles of simplicity, transparency or fairness which prevent adequate assessment of suitability can only lead to renewed allegations of misselling.

Product Review
Likewise, products should be constantly under review after launch; are they meeting the needs of your customers and operating in a way which results in the right outcomes for your customers?

It is clear, therefore, that clarity and fairness of contract terms is not something that can be ignored by lenders. It is accepted that terms are intended to provide for what has to happen in various eventualities. However, good business practice must clearly provide that, for all customers, standard terms are clear, jargon free and fair where possible, striking a balance between lenders' and customers' interests.


[1] See the FCA's DP15/7 which examined this precise issue

[2] and Annex A

[3] See recent Court of Appeal decision in Nelmes v NRAM plc where failure to disclose a broker commission to a buy to let investor was held to give rise to an unfair relationship

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

David Wood


I advise clients in all sectors on asset and consumer finance documentation and procedures and FCA consumer and mortgage credit regulation.