Fit for consumption?

A borrower is a consumer of credit.  The purpose of credit laws is to provide an environment in which the credit is fit for consumption.

The Moneylenders Act of 1908 provided a small degree of protection for consumers from unscrupulous lenders. It was pretty simple.  If you lent money at rates in excess of 10% you were deemed to be a moneylender and the Court had the right to re-open the contract and punish you for being a naughty lender.

Seventy three years later, in 1981, the Credit Contracts Act introduced greater protection in times of more sophisticated lending practices and products focusing on four areas:

to inform :      lenders were required to provide full information about the contract so borrowers were fully informed before they became irrevocably bound;

to compare:   lenders had to disclose the cost of credit as a finance rate – if every lender disclosed the same information in the same way borrowers could compare apples with apples;

to prohibit:     certain credit terms were prohibited.  A standard  method for calculating default rates, was introduced.

to protect:      the Courts were given powers to re-open “oppressive contracts” and punish “oppressive conduct” by lenders.

That legislation lasted 22 years before it was replaced by the Credit Contracts and Consumer Finance Act 2003.  The CCCFA required more comprehensive disclosure and removed the finance rate.  But it extended the prohibitive elements and banished unreasonable fees.  It also requires lender to consider requests for hardship.

Nine years later, in April 2012, a Bill to amend the CCCFA has been introduced by the Minister of Consumer Affairs.  Here is how the Ministry of Consumer Affairs presented his statements

Tougher laws for loan sharks

“The Government is getting tough on loan sharks and lenders who don’t play fair. Money lenders should not be able to prey on desperate people, leaving them and their families trapped in a spiral of debt,” says Mr Tremain.

“These will be the biggest changes to consumer credit law in a decade. It is time for a significant shift in lending laws to increase protection for borrowers and target irresponsible lenders.”

Key changes include:

  • Making it illegal to lend money to someone whose loan repayments would be likely to result in substantial hardship;
  • Requiring more timely and complete disclosure of loan terms, and extending the ‘cooling off’ period for borrowers to cancel their loan;
  • Obligating lenders to properly consider applications by borrowers for hardship relief, and provide reasons for their decisions;
  • Better controls against misleading, deceptive or confusing advertising;
  • Introducing a new Code of Responsible Lending – and allowing for lenders to be banned from the industry for non-compliance;
  • Providing that borrowers won’t have to pay the cost of interest or fees if their lender is not a registered financial service provider.

“With such significant changes, it is important that we get it right. “

You can’t argue against the opening remarks against loan sharks and unscrupulous moneylenders.  Parliament paid lip service to these sentiments in 1908. Maybe after 104 years we are finally going to get it right.

It would be easy, looking back over the history of credit laws in New Zealand, to be cynical and say that like all of the law changes before it, the new Bill is a case of politicians appeasing the consumer masses and appearing to give comfort to the constituency.  The Bill was, after all, promised by another Bill in the lead up to the last election.

But that is being cynical.  The reality is that Parliament very rarely gets things right every time, first time, so if there are elements of the credit laws that need to be tidied up then they should be.  So what are the main changes?

Responsible lending 

A new section 9B will operate from when the amended Act becomes operative. This requires every lender to comply with the following principles:

  • Exercise reasonable care and skill
  • Provide the borrower with sufficient information to make informed decisions
  • Ensure the terms are not unduly onerous and expressed in clear, concise and intelligible manner;
  • Not do or say anything misleading, deceptive or confusing to the borrower
  • Make reasonable enquires as to the borrower’s financial circumstances’ and requirements and objectives in entering into the agreement
  • Be satisfied before entering into the agreement that:
    • The borrower can be reasonably expected to make the repayments under the agreement without suffering substantial hardship; and
    • The agreement is otherwise appropriate for the borrower having regard to the borrower’s circumstances, requirements and objectives
    • Not charge unreasonable credit fees
    • Not advertise in a way that is misleading, deceptive or confusing to borrowers.

Within two years of the amendment coming into force, the Minister must prepare and publish a Responsible Lending Code which will elaborate on the above principles and offer guidance on how the principles maybe implemented.

On the face of it, the principles seem fair.  But nothing is ever perfect and the English language is always open to interpretation so regulating such a crucial and emotive area creates potential uncertainty.

The first big uncertainty is that lenders are going to have to wait 2 years for guidance in the form of the Responsible Lending Code so they will have to apply the principles as they see fit.  Varying approaches  itself will have an effect on competition.  Those wanting more market share will take a broad approach.

The law is pretty settled as to what is meant by “reasonable care and skill”.  That is objective.

But it is less clear what makes up “sufficient Information” to make an “informed decision”.  What is sufficient for a person who is financially savvy and who is familiar with borrowing may be quite insufficient for a first home buyer who left school at age 15.  How can a particular borrower make an “informed decision” when he/she may not be able to understand the information provided? Is it right to be subjective when the lender or broker may not understand the borrower’s capacity to absorb information?

“Not unduly onerous” still leaves it open for the terms to be onerous – which is probably not a bad thing.  Every time we borrow or put ourselves under financial strain in order to get a long term benefit, the terms could be said to be onerous so some latitude is always going to be required.

Now I really have a problem with the use of the word “intelligible”.  To whom must it be Intelligible?  Everything I say and write is completely intelligible to me.  But the people I deal with have a wide range of people, and experiences.

I understand what I am saying because it is based on my own experiences in my jurisdiction.  When talking to someone from overseas, we can both agree completely about what has been said, but if I am using words in a context that is only relevant to my experience and the other person is hearing them and applying their own experience and business background as context, we can each come away from the conversation with completely opposite views of what was meant, even though we agree on what was said.

The same can be said for “confusing”.  As a lawyer, I like to think that what I say and write is clear, concise and not confusing.  As a realist, I know this doesn’t always happen. Confusion is as subjective a test as intelligible.

The substantial hardship test is similar to “not unduly onerous”.  It acknowledges that making repayments may often cause hardship.  But it is the level of that hardship that is relevant.  In the Australian legislation, substantial hardship is linked to whether a person with a security over their residential home would have to sell that home in order to repay.  If the answer is yes then that is an indicator of substantial hardship.

Fortunately we have not included such a test and I hope the guidelines in two years time do not do so.  Many mortgages are taken out for a short period because the borrower intends to either sell or refinance.  If a mortgagee is taken out for a short term, it is implicit that the only way, ultimately, to repay will be to either sell if the market for refinancing has gone when the loan term expires.

Requiring the lender to form a view that the loan is otherwise appropriate is stronger than the double negative in the Australian legislation.  An Australian lender has to determine that the loan is “not unsuitable”.  Despite the double negative, I believe the Australian version is preferable.

Suitable and unsuitable are two ends of the spectrum. But in reality, there is a wide range of options in between.  A lender in Australia can decide that a loan clearly not unsuitable, even though it may not be clearly suitable.  Under the suggested amendments a New Zealand lender will have to go further and be satisfied that the loan is clearly suitable.  It may not be clearly suitable but also may not be clearly unsuitable – it falls in between.

Disclosure and Publication of terms

Under the proposed section 9H, a lender will have to publish standard terms on its website and at its offices.

A lender will also be required to publish information about all of the costs of borrowing in relation to every type of agreement.

This seems fine but it is unlikely that many borrowers will read these.  When shopping around,  they only look for the headline terms.  Perhaps a consumer group may go further and undertake a review of comparative contracts and publish a matrix of terms between lenders.

A sensible change is that disclosure of the terms of a specific contract must now be made before the contract is entered into.  At present, this can be up to 5 days after the contract has been entered into.

Objective / Subjective / The educated borrower

People are different.  They come from varying backgrounds with varying experiences and varying levels of understanding.  One of the real tests of any credit law is to make sure that it is effective across all of these levels of variation.

The difficulty for a lender is that where it is required to make a subjective assessment in relation to a borrower, short of putting the borrower through an intelligence or awareness test, it has to make this subjective assessment based on objective grounds.  In the absence of clear evidence to the contrary, a lender should be able to assume a level of understanding and competence on the part of the borrower and should not be prejudiced if this assumption is wrong.

If the borrower is applying for a loan via an intermediary, then the broker assumes the role of the lender in making these assumptions.

It would be very helpful if a lender or broker did not have to rely upon these assumptions as to competence and understanding of borrowers but could rely upon an independent third party assessment.

This is not as left field as it may seem.  Kym Dalton, previously of AMS, has created an online process in Australia for the education of home loan borrowers.  When completed, a borrower sits a simple test and is issued with a certificate confirming that the borrower has been through the training programme and has demonstrated a degree of understanding of the issues.

The trouble with all truth in lending disclosure requirements is that while they are intended to make things intelligible and not confusing for borrowers, the unintended consequence is that borrowers drown in a deluge of information.

Hopefully, an educated borrower will know enough to capture the results of the information downpour and channel it so it and the ensuing credit contract, is fit for consumption.

Jonathan Flaws