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Consumer law and unfair contracts

February 1, 2009 | 7 Comments | Stephen King

My colleagues in Monash Law are running a conference on “national consumer law and unfair contracts”. Details are available here.

This is an important topic worthy of a lot more research. Consumer protection laws can have unexpected outcomes that may harm consumers. A recent example of research in this area, by Armstrong, Vickers and Zhou, is available here.

Victoria already has legislation that ‘protects’ consumers from ‘unfair’ contract terms. It would be good to fully understand the costs and consequences of these laws before introducing any new regulations at the federal level. Consumer Affairs Victoria (CAV) summarises the laws here.

The premise behind these laws, as stated by CAV really worries me. Apparently we need these laws because “Suppliers generally have greater bargaining power than consumers”.

In markets open to competition, this statement is simply not true. If I don’t like one supplier I just walk out and go to another one. So is the problem really a lack of competition rather than any general ‘exploitation’ of consumers? But if this is the case, are rules against ‘unfair’ terms in contracts the right way to deal with the problem, or should the source of the lack of competition be addressed?

Good regulation involves defining the market problem then making sure that the new laws are the best way to address that problem (and that they are better than doing nothing). “Unfair contract laws” may be the wrong solution to a non-existent problem!


Comments

7 Responses to “Consumer law and unfair contracts”

  1. Marks on February 2nd, 2009 12:48 am

    What do you say to the following example:

    I buy an airfare on a discount airline.
    They refuse to fly me, and then refuse to engage in any discussion about compensation.

    Of course, next time I can go elsewhere, but I am now down a considerable amount of $$ and with no practical way of getting my $$ back. 

    The discount airline is just so big that it can sit on my complaint till I give up.

    I don’t see the market really dealing with this by itself.

    I am prepared to invest my tax dollars so that there is an agency big enough and with enough clout to make the  airline behave.

    What do you think?

  2. hrgh on February 2nd, 2009 10:45 am

    Well put Marks.

  3. Flapple on February 2nd, 2009 12:23 pm

    We know consumers demand provides a powerful force for produces to improve the major characteristics of products and services. But in modern markets business wrap products and services in complex standard form contracts that specify hundreds of more product characteristics (such as the behaviour of the firm in the situation where an aircraft maintenance problem causes a delay in the flight).

    Certainly we expect consumer demand to drive market competition on core product characteristics such as price and quality in achieving the product’s primary function.

    I doubt we could expect this to occur for characteristics much further down the list. Characteristics which do not manifest themselves in every purchase, but only once in a while can have a significant impact on individuals.

    For example, a person signs up on a one year contract with a gym because, in their specific case they want the 6am pilates class, rather than any of the other services of the gym. Most people sign up for the weights room.

    The gym has a contract clause “we reserve the right to alter the terms of this contract at an time without notification”.

    The gym cancels the class, but the consumer must continue to pay out the one year contract, despite the fact that, in their individual estimation, the gym has essentially stopped providing the service they want.

    Of course they complain and when they have paid another $500 for no service, change to another gym, and yet there are 99 other gym member who sign up for the weights room and the gym doesn’t care about that  one consumer. Market forces will drive on the primary product characteristics, but not on the minor ones.

    In the past, standard form contracts were not so prevalent and goods were sold with their core price/quality characteristics and relying on the common law for the other contractual characteristics.

    This is an interesting issue that raises issues about how market competition works in modern markets for good defined with complex contractual arrangements and with our greater understanding of consumer behaviour.

    I am not sure that it should be dismissed with a ‘“Unfair contract laws” may be the wrong solution to a non-existent problem!’

    Although it is encouraging that Mr King is suggesting more people look into this issue.

  4. David on February 2nd, 2009 7:14 pm

    Marks: If that was the general practice of the airline then they will build a reputation for it.

    Alternative airlines who differentiate themselves by providing better service, ceteris paribus, will eventually capture those customers who aren’t happy with the former airline (which would hurt their bottom line). If enough customers switch, the effect on the bottom line might be enough to make them reconsider their return policies. Theoretically anyway.

    Flapple: in regards to your example of gyms failing to provide pilates classes, if there was an market solely for pilate classes (exclusive of weights room), then firms would enter and cater for this niche segment.

    In both cases (and for like examples) choice between alternative providers of service (i.e. competition) is the driving force for those firms to provide those services (in theory).

  5. KC on February 2nd, 2009 10:07 pm

    It might be helpful to distinguish between transactional contracts and relational contracts.  In the former, it is usually possible to define the terms of exchange exhaustively.  In the latter, the contract governs an ongoing relationship and it is impossible for the contract to be exhaustive.  To cater for unforeseen changes, the contract will often contain clauses that allow one party (typically the supplier) to unilaterally change the terms of the contract under certain circumstances.  Contract law is all about attempting to strike a balance between “freedom of contract” and “fairness” in circumstances where the contract fails to explicitly address an unforeseen development.  Doctrines like “estoppel”, “mistake”, “unconscionable conduct”, etc have developed to deal with situations that the parties to the contract have not foreseen.  The legislation on unfair contracts is merely the latest development in contract law to address the problem of non-exhaustive contracts.  It is possible to argue firms benefit (ex ante) from unfair contracts legislation in so far as it gives consumers confidence that firms will not behave opportunistically by using unilateral variation rights to alter the terms of the trade (ex post).  Without satisfactory consumer protection laws, consumers may simply decide not to trade at all.

  6. KC on February 3rd, 2009 5:15 am

    Further to my earlier post on transactional and relational contracts, Albert Hirschman’s concepts of “exit” vs “voice” also help explain the role of unfair contracts legislation. According to Hirschman, there are two ways a healthy organisation gets feedback from its constituents: (a) “exit”, where the constituency “vote with their feet” – e.g., where consumers switch to a competitor; and (b) “voice”, where the constituency remains committed to the organisation and engages with the organisation to get the organisation to address the constituency’s concerns.

    In transactional contracts, exit is the primary mechanism.  In relational contracts, exit is not always possible (e.g., where there are high switching costs), nor is exit always preferable to voice.   A law that prohibits “unfair contracts” encourages a firm’s customers to remain engaged with the firm.  The threat of complaining to regulators or taking legal action can be an effective way for consumers to engage with the firm. 

    Economists traditionally advocate “exit” as the preferred mechanism for consumers to provide feedback.  However, “exit” may be a more costly way to provide feedback than “voice”.  It would entail changing the nature of the relationship between firm and clients from “relational” to “transactional”.  It is not obvious that the transactional mode of contracting is inherently superior to the relational mode of contracting.

    Finally, even in competitive markets, relational contracting may dominate.  Markets are often competitive “ex ante”, but not “ex post”.  Competition for the “footloose customer” is strong, but weak for the “loyal customer”.

  7. ‘Unfair contract terms’ law - where is the evidence? : Core Economics on March 1st, 2009 12:06 pm

    [...] These include outlawing ‘unfair contract terms’. I have mentioned my concerns in this area before – but will do so [...]