Discussion Paper Summary

April 2000

Consumer Credit Law Review, Part 2: Application - What Transactions Should Consumer Credit Legislation Apply To?

This is the second public consultation document to be released by the Ministry of Consumer Affairs as part of the Consumer Credit Law Review. It discusses the issue of the application of consumer credit law, or what transactions the legislation should apply to. In particular, it considers what classes of transaction should be regulated as consumer credit contracts.

The paper also raises the issue of whether some forms of transaction should be regulated separately. Specifically, it questions whether there is still the need for a separate Act to regulate hire purchase. Since the passing of the Credit Contracts Act 1981, the Consumer Guarantees Act 1993, the Credit (Repossession) Act 1997, and the Personal Property Securities Act 1999, the justification for the Hire Purchase Act 1971 is less obvious. Views are sought on whether it is necessary to retain the Act. There is also a brief discussion on long-term consumer leases and whether they should be treated as a distinct form of transaction.

The paper discusses the current test used to apply consumer credit protection. The focus is on the monetary ceiling of $250,000 which is the primary means used to define a "controlled credit contract". Disclosure provisions and the three day cooling-off period are mandatory only for controlled credit contracts. Because the monetary ceiling has become outdated through price inflation, leaving significant consumer credit contracts unprotected, the Ministry believes that it may no longer be the appropriate application test.

The document also discusses whether a monetary ceiling of $250,000 might be having the effect of regulating – inappropriately – a large number of commercial credit contracts. Reasons why commercial credit is distinct from consumer credit include:

• functional differences – consumer credit underpins consumption while commercial credit is more concerned with production
• different characteristics of borrowers – consumers being more vulnerable
• different sources of credit – in particular, businesses rarely borrow from marginal lenders ("cash-loan" companies)
• a different relationship between borrowers and lenders – lenders normally take a more active interest in the affairs of their business borrowers
• better security is generally offered by business borrowers for credit.

The Ministry also argues that inappropriate regulation of commercial credit can lead to:

• legislation being less effective – because protections that are appropriate for consumers may not be appropriate for businesses
• increased compliance costs – through complying with disclosure and documentation requirements
• restrictions on flexibility and innovation – due to the need to meet regulatory requirements
• opportunistic use by borrowers – defaulting business borrowers can make "strategic" use of legislation in attempting to avoid their obligations.

Lastly, business borrowers would still have protection if not covered by consumer credit legislation. In particular, the Fair Trading Act 1986 offers protection, and remedies may be found in both the common law and the law of equity. It is also notable that the banking industry has in place well-regarded self-regulatory mechanisms.

The document finishes by outlining various alternatives to the current monetary ceiling in the Credit Contracts Act, examining their respective advantages and disadvantages. These are:

• Raising the monetary ceiling – however, this would result in increased coverage of commercial credit contracts.
• Lowering the monetary ceiling – this test is based on the premise that consumers most often borrow small amounts. An issue is whether home finance contracts should be excluded from a ceiling, as a ceiling that excluded most commercial credit contracts would also exclude most home finance.
• A natural persons test – this test would regulate all credit contracts via natural persons (as opposed to legal persons). The test is arbitrary in its treatment of commercial borrowers. Additionally, without a monetary ceiling it would regulate many commercial credit contracts.
• A test to include small business – it would be possible to define small business entities in legislation, in order to provide protection for them. However, matters of definition would be complex.
• A contracting out provision – commercial borrowers could be permitted to contract out of credit legislation. Because lenders would likely seek to always contract out when lending to commercial borrowers, it would have little, if any, advantage over blanket exclusion of commercial credit.

The Ministry’s preferred option is for a purpose test, which would restrict regulation to credit provided to a "natural person" primarily for "personal, domestic or household" use. The test, and variations of it, are coming into more widespread use internationally. Australian evidence shows the test is workable for lenders and borrowers. Advantages include its flexibility and consistency with market practice. However, it may result in uncertainty in limited situations. On balance, it appears to offer a favourable approach.

Discussion Paper - full text

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