PART 6

EXTORTIONATE CREDIT TRANSACTIONS

February 2010

31.4B.121 Extortionate credit transactions - introduction

The provisions of the Act relating to extortionate credit transactions [note 1] [note 2] allow the office-holder to apply to court for credit transactions to be adjusted where, for example, the company or bankrupt has been charged an unfairly high rate of interest, has been subject to unfair credit terms (such as severe default provisions) or was in a vulnerable position at the time of the transaction.  It has to be said that applications to adjust credit transactions under the Act are very rare – in fact, there appears to be no case law on the matter.  There have, though, been applications to adjust credit transactions under similar provisions in the Consumer Credit Act 1974 (see paragraph 31.4B.122) which give some idea as to how the courts view matters in this regard.

The difficultly in bringing actions is thought to be as a result of the wording of the Act that requires the terms of the credit transaction to not just be exorbitant - they must be “grossly” exorbitant (see paragraph 31.4B.129) [note 3] [note 4].

 

31.4B.122 Legislative background

The relevant provisions in the Act are based on similar provisions in the Consumer Credit Act 1974, in force at the time the Act was drafted, which allowed debtors to challenge unfair and extortionate terms in credit agreements.  As a matter of interest, it should be noted that these provisions were repealed and replaced by provisions relating to “unfair relationships” in the Consumer Credit Act 2006 [note 5], though the 2006 Act has no effect on existing insolvency legislation.

 

31.4B.123 Realising an excessive credit transaction where recoverable amount is over £5,000

As explained in detail in Part 1 of this chapter, all antecedent recoveries where the amount to be recovered is over £5,000 are handled by The Service’s antecedent recovery contractor (see paragraph 31.4B.5).  The advice and information in this Part of the chapter will assist the official receiver in understanding extortionate credit transactions and assessing whether there is a matter for recovery to be passed over to the contractor.

The following are the areas on which the official receiver should, ideally, obtain information before instructing the contractor:

• The date of winding-up or presentation of bankruptcy petition
• A copy of the agreement entered into
• An explanation of the company’s/bankrupt’s circumstances when they entered into agreement
• Any explanations given by the bankrupt or the insolvent for entering into the agreement.
• A statement of account with the creditor

 

31.4B.124 Realising an excessive credit transaction where amount to be recovered less than £5,000

The antecedent recovery contractor engaged by the Service (see paragraph 31.4B.5) will only accept instructions where the amount to be realised is more than £5,000.  Where the amount to be recovered is less than £5,000, it is unlikely to be worth the cost of action other than entering into correspondence with the beneficiary requesting payment.  Paragraphs 31.4B.17 to 31.4B.21 of Part of this chapter give information and advice on the steps to be taken where the recovery is likely to be below £5,000.

 

31.4B.125 Vulnerable transactions

Under the provisions of the Act the following credit transactions are vulnerable to an action for adjustment by the office holder:

• where the terms of it are or were such as to require grossly exorbitant payments to be made (whether unconditionally or in certain contingencies) in respect of the provision of the credit [note 6] [note 7], or
• where it grossly contravened ordinary principles of fair dealing [note 8] [note 9].

There is no definition on the Act of what constitutes “grossly exorbitant”, but case law decided under the similar provisions of the Consumer Credit Act 1974 (see paragraph 31.4B.122) give some indication of the considerations by courts in deciding such matters.  These are outlined in paragraph 31.4B.133.

 

31.4B.126 Burden of proof

If the liquidator/trustee considers that a credit transaction or agreement is extortionate, he/she may apply to the court for an order setting it aside (see paragraph 31.4B.135). Unlike many of the other provisions relating to the recovery of transactions, the burden of proof in actions to adjust extortionate credit transactions is on the creditor to prove that the transaction was not extortionate or otherwise unfair [note 10] [note 11].

 

31.4B.127 Time limit

In order for a transaction to be successfully challenged, it must have been entered into within three years of the company going into liquidation (for compulsory liquidations this will be the date of the making of the winding up order) or the commencement of the bankruptcy (the date of the making of the bankruptcy order), as the case may be [note 12] [note 13].

 

31.4B.128 Provision of credit

For a transaction to be vulnerable to an action for adjustment it must be a transaction for, or involving, the provision of credit.

The term “credit” is not defined in the Act but is defined in the Consumer Credit Act 1974 as including a “cash loan and any other form of financial accommodation” [note 14].

It can be taken, therefore, that any transaction entered into by a debtor for those things that would normally be recognised as credit transactions (such as loans, hire-purchase or deferred payment) are capable of being caught under the wording of the Act, as are any matters related to the credit transaction, such as the provision of security.

 

31.4B.129 Grossly exorbitant terms or unfair contravention of principles of fair dealing

The Act requires that the terms entered into, or the circumstances where the debtor entered into the credit agreement, to be grossly exorbitant or grossly contravening the ordinary principles of fair dealing, as the case may be [note 15] [note 16].

In order, therefore, that a transaction could be successfully overturned, the official receiver, as liquidator/trustee, would need to demonstrate that the transaction, or the terms of the transaction, were unfair or exorbitant to a large margin against the norm.  It should be noted that the transaction does not have to have been taken out in unfair circumstances and contain unfair terms to be capable of being adjusted.  It would be sufficient to demonstrate either feature.

 

31.4B.130 Grossly exorbitant terms – interest rate

In the context of this chapter, the most important term to any credit transaction is usually the interest rate and, unsurprisingly perhaps, it is this term that is most likely to be subject to scrutiny when considering whether or not a credit transaction contained grossly exorbitant terms.

Neither the Act nor the Consumer Credit Act(s) give any indication as to a level of interest that would be considered to be grossly exorbitant.  This may appear to be an oversight but it is considered that were there to be a prescribed level, then creditors may be afforded the opportunity to structure credit terms in such a way as to avoid falling foul of the prescribed level.  In other respects, the setting of a prescribed level may have the effect of stifling credit lending as lenders who would otherwise have lent in high risk circumstances (albeit, at a higher than usual level of interest) may be discouraged by the possibility of the transaction being adjusted at a later date.  It would be difficult to set a level that would automatically have the effect of avoiding both possible consequences and, in the event, matters have been left to the courts to decide.

There have been cases decided which give some indication as to the mind of the court when deciding these matters.  The highest level of interest to be unsuccessfully challenged was 48% (where the lender took considerable risk lending the money, and provided it quickly [note 17]) but lower rates of interest have been successfully challenged – in cases where good security was given, rates of 42% and 39% have been successfully challenged.

Of course, ultimately each case will turn on the facts.  Paragraph 31.4B.131 contains an overview of the areas likely to be considered by a court when deciding matters.

 

31.4B.131 Matters to be considered when deciding whether an interest rate is grossly exorbitant

As outlined in paragraph 31.4B.130, the rate of interest charged is not in itself always sufficient to persuade the court that it is grossly exorbitant.  The rate charged must be considered alongside other factors, such as:

• Security – generally, interest should be charged at a lower rate where security is given.
• Risk – The higher the level of risk to which the lender is exposed, the higher the rate of interest to be expected.  A poor credit rating normally equals a greater risk.
• Urgency – Where the borrower(s) require(s) the money urgently and, perhaps, leave the lender insufficient time to do the normal credit checks, the rate of interest charged might be expected to be higher.

 

31.4B.132 Other potentially grossly exorbitant credit terms

The rate of interest charged may not be the term (or the only term) in a credit transaction that could be considered to be grossly exorbitant.  Matters such as the redemption terms, (upwards) movement in the interest rate charged contrary to the underlying rate or severe default provisions may also be considered.

 

31.4B.133 Grossly contravening the ordinary principles of fair dealing

There is no prescriptive list of the types of matters that would constitute a credit transaction contravening the ordinary principles of fair dealing.  Some examples follow:

• An agreement signed without the borrower having proper opportunity to read the terms and conditions.
• An agreement entered into in threatening or intimidating circumstances.
• An agreement entered into in breach of the relevant Consumer Credit Act provisions, such as those relating to the regulations on advertising.
• An agreement entered into at a time, or in circumstances, where the borrower was vulnerable.
• Where the borrower was induced to enter into the agreement by false or misleading statements.
• Where important details have been hidden in the small print.
• Where interest is charged on monies not lent (such as a first payment deducted from the amount advanced).

 

31.4B.134 Exorbitant credit transactions – advice

Where there is doubt as to whether a credit agreement is in breach of the relevant Consumer Credit Act, advice may be sought from the local Trading Standards Department.  Contact details can be found here (http://www.tradingstandards.gov.uk/).

 

31.4B.135 Remedies

Having found the transaction to have extortionate terms, or to be contrary to the ordinary principles of fair dealing, the court has wide-ranging powers to adjust the transaction.  Specifically, the court may order one or more of the following [note 18] [note 19]

• Provision setting aside the whole or any part of any obligation created by the transaction;
• Provision otherwise varying the terms of the transaction or varying the terms on which any security for the purposes of the transaction is held;
• Provision requiring any person who is or was party to the transaction to pay to the liquidator/trustee any sums paid to that person, by virtue of the transaction, by the debtor;
• Provision requiring any person to surrender to the liquidator/trustee any property held by him/her as security for the purposes of the transaction;
• Provision directing accounts to be taken between any persons.

The court is not obliged to make an order, even where it finds that the transaction was exorbitant.

 

31.4B.136 Alternative remedies

An extortionate credit transaction may also be challenged as a transaction at an undervalue – information and advice relating to which can be found in Part 3 of Chapter 31.4A.

 

 

[Back to Part 5 – Avoidance of dispositions of property] [On to Part 7 – Transactions defrauding creditors]