A holistic assessment of the fairness of penalty terms in consumer contracts

Case C-738/19 A v B EU:C:2020:687 (10 September 2020)

The question

What will the court take into account when assessing the fairness of penalty terms in a consumer contract?

The key takeaway

The European Court of Justice (CJEU) has clarified that, when assessing whether a specific term is unfair under the Unfair Contract Terms Directive, the courts are obliged to consider the cumulative effect of all the terms, and not simply the unfairness of the clauses relating to those which the consumer has challenged.

The background

In 2017 a social housing landlord (L) granted a lease to the tenant (T) in Amsterdam. The lease was subject to the “General terms and conditions of social housing” (the T&Cs), which included various penalty clauses that prohibited T from subletting the property and mandated that T must personally occupy the property and vacate on termination of the contract. Under clause 7.14 of the T&Cs, the tenant would be fined €5,000 if they were found to be subletting the property. The contract also included a general “residual” penalty clause that applied where the tenant breached any of its contractual obligations where there was no applicable special penalty clause.

Upon inspection, L discovered that T had been subletting the property to a subtenant (ST) for a  higher rent price than under the original L-T lease. Consequently, L brought proceedings to:

• terminate the L-T contract and evict both T and ST;
• recoup overdue rent from T;
• recoup a €5,000 penalty for the breach of the no subletting rule; and
• recover the additional profit made by T.

The District Court of Amsterdam was unsure whether clause 7.14 was unfair in light of Article 3(1) of the Unfair Contract Terms Directive (93/13/EEC) (the Directive), so it referred the case to the CJEU for clarification on two specific points:

1. When assessing if a term is unfair under Article 3(1), does a national court need to take account of all the terms of the contract, or just certain terms?

1. When assessing if the €5,000 compensation is disproportionately high in relation to point 1(e) of the annex to the Directive, must an assessment concern only the terms that relate to the same breach?

The development 

Under the Directive, every contract term that is not individually negotiated must be reviewable in order to determine if it is unfair. Where such a term causes a significant imbalance in rights and obligations on a consumer, then it will be deemed unfair. The Directive also requires domestic courts to take account of all the contract terms in the round when assessing whether the specific disputed term is unfair.

The CJEU recognised that, as L’s action was not based on the “residual” penalty clause, despite its presence there could not be a cumulative penalty for a single breach. However, the CJEU was clear that where other terms of the contract are relied on by the supplier against a consumer in regards to the same breach, the cumulative effect of all the terms (even if they are not in themselves individually unfair) must be considered by the court when assessing whether the one contractual term that forms the basis of the dispute is unfair. The nature and context of the obligation and relationship, respectively, should be borne in mind. The national court would therefore be obliged to examine whether a consumer contract term is unfair by considering the interaction between the term at issue and all other relevant terms within the context of their respective scope. To determine whether a penalty amount is “disproportionately high” the court must place substantial weighting on terms that relate to the same breach.

This ruling is consistent with the Competition and Markets Authority’s (CMA) guidance on provisions relating to unfair terms in the Consumer Rights Act 2015 (which implements the Directive). This guidance states fairness must be considered in the context of the whole contract and the circumstances around the agreement. When assessing fairness, national courts will have regard to (i) the subject matter and nature of the contract, (ii) the factual matrix at the time of agreement, (iii) the other contractual terms, and (iv) where it depends on another contract, those terms also. The CMA guidance also makes clear that a finding on fairness does not require proof that a term has already caused harm.

It is therefore important to consider the cumulative effect of all the contractual terms as opposed to simply considering the unfairness of individual clauses relating to those that may be challenged by a consumer. A penalty that is according to law and appears fair may be considered unfair by the courts when it and other relevant terms cumulatively expose a consumer to a disproportionate sanction for the same breach.

When drafting a consumer contract, consider consumer penalty and contract terms holistically and ensure that penalty terms: (i) relate to a genuine pre-estimate of loss; (ii) state that a consumer has to pay reasonable compensation; or (iii) state that the consumer has to pay compensation according to law.

Contracting parties would be wise to consider all of the following factors when agreeing to terms to ensure that a term can be considered fair:

• the nature and subject matter of the contract;
• all of the circumstances that exist when the term was agreed;
• all of the other contract terms; and
• all of the terms in any other contract that the current term relies on.

Winter 2020