Principles of the European Contract Law and suitabilty obligations

Article 4:109 of the Principles of European Contract Law stipulates prohibits gaining the excessive benefit or unfair advantage for a party to take advantage of other party.(1) A party may avoid a contract if, at the time of the conclusion of the contract:(a) it was dependent on or had a relationship of trust with the other party, was in economic distress or had urgent needs, was improvident, ignorant, inexperienced or lacking in bargaining skill, and (b) the other party knew or ought to have known of this and, given the circumstances and purpose of the contract, took advantage of the first party’s situation in a way which was grossly unfair or took an excessive benefit.

Situations

This article applies in three situations; a) a party was dependent on or had a relationship of trust with the other party: b) a party was in economic distress or had urgent needs; c) a party was improvident, ignorant, inexperienced or lacking a bargaining skill. This article regards it as unfair that a party took advantage of the other in above situations or circumstances.In Japan, the each abusive practice is divided in different rules or principles. 

Against fiducially duty

Firstly, when a party was dependent on or had a relationship of trust with the other party, the abusive practice of the other party that take advantage of the first party’s credulity is regard as the breach of fiducially duty or duty of loyalty. The notion is not common, but tends to be adapted in lower court rulings in investment transaction cases. The remedy of the offence is damage relief by tort or lacking performance. However, the rationale of the duty seems to be ambiguous or confused amongst court rulings. Most court decisions seem to consider that the nature of breach of the duty is against good faith.  

Against public order and morals

Secondly, when a party is in economic distress or had urgent needs and the other party takes advantage of the first party’s situation in a way which was grossly unfair or took an excessive benefit, the other party’s practice is offensive to public order and morals (civil law, sec. 90). The notion of public order and morals is similar to the concept of “the unconscionable conduct”. The contract against the principle is void.

Undue influence or offence of suitability obligations

Third situation is that a party is in improvident, ignorant, inexperienced or lacking a bargaining skill. If the other party takes advantage of the first party’s situation, the practice of other party is regarded undue influence. It is usually to be considered as bread of good faith. However, if the injuries party is seriously damaged by the offence, it might be against public order and morals, taking account of the degree of wrongful intention in the other party. The breach of suitability obligations takes place in the same situation of the first party. Being subject to the suitability rule, when the other party recommends a particular transaction to the first party, the other parry must have a reasonable basis for believing that the transaction is suitable for consumer’s status. In making this assessment, the other party must consider the first party’s knowledge and recognition, same sort of trading experience, objectives and need of transaction, financial status and so on. As a result of assessment, if the other party knew or ought to have known of the first party’s situation where he is improvident, ignorant, inexperienced or lacking in bargaining skill, the other party must not progress the solicitation or form the contract with the first party as a requirement of suitability duty. In this occasion, to fulfill the offence of suitability obligations, the other party need not take advantage of the first party’s situation in a way which is grossly unfair or took an excessive benefit.

Remedy

The remedy of offence is varied depending of the state of the first party. When the lack of the suitability in the injured party is material, the contract that is formed under the situation should be capable of being void against public order and morals. But there can not be found such court ruling so far. Most ruling only indicates damage compensation against this rule.

Excessive lending is against suitability obligations?

Multiple-debtors

Consumer complaints for excessive lone does not decrease in Japan,[1]Our government published the multiple-debt improvement action program on April 20^th, 2007,[2][3] and completed the multiple-debt counseling handbook.[4]  The handbook is for the consultant of administrative body, and it aims for multiple-debtors to be able to get effective consultation from administrative consulting officers.But it is only for the multiple-debtors. It is necessary to establish a suitable scheme to prevent to be fell into the multiple-debt. Excessive lending marketing practice is necessary to be tacked with as most significant issues. At the time, the instrument of suitable obligations is useful to curve excessive lending by money lenders.

Restriction to the excessive lending

Are suitability obligations adapted to the money lending practice?The Money Lending Business Law[5] impose ask money lenders to investigate financial situation (income, other loan), repayment plan, and if lenders consider for borrowers not to be afford to repay his debt, lenders must not to form money lending contracts (art. 13(1). The guidance[6] of the law compiled by the FSA, asks money lending businesses discretion to excessive lending to consumers: money lenders is prohibit soliciting loan to consumers who is no necessity to have loan. It includes the practice that money lenders refuse to receive repayment from borrowers, persuading to maintain their loan. The money lenders are prohibited to offer pulling up a credit line, although consumers do not ask it (guidance 3-1-2(2)).[7]The Installment Sales Law has a similar provision. Creditors make effort not to finance to consumers who is considered to be difficult to make repayment in their financial status thorough suitable investigation borrower’s debt information that is registered in financial data information centre established by financial institution collectively (art. 38).Each laws aim to protect consumers, in addition to make money lending management maintain with sound condition. In the view point of consumer protection, the rationale of these laws can be sought in suitability obligations.It can be explained that when money lenders loan to consumers, they must have a reasonable basis for believing that loan is suitable for consumer’s financial status. In making this assessment, lenders must consider borrower’s repayment tolerance, other loan, financial situation (income and net worth), financial needs, and loan objectives.

Enforcement

However, it should be ineffective for prevention of excessive lending in a viewpoint of enforcement, because there is no sanction both administrative sanction and criminal penalty against these restrictions.

Consumer group insist to regulate the excessive lending under the administrative sanction, but the money lending business oppose it strongly referring some bad and side effect:

1.  Money lending business points out that it is difficult to establish certain criterion that is used the judgment whether the loan is excessive or not, because the financial status of borrower extremely vary due to individual and is variable depend on consumer’s circumstance constantly. This information is uneven distribution in consumer side, therefore it is quite difficult for the business to take such personal financial information and consider the affordability of repayment precisely;

2. If it is possible to make certain criterion, the restriction might be against borrower’s request in loan;

3. The restriction for lump sum lending has adverse impact upon the national economy such as incurring consumption decline.

Court ruling

In excessive lending case, some lower court rulings reduced money lender’s repayment claim to borrowers in virtue of good faith: Kushiro Summery Court decision on March 16^th 1994, Sapporo Summary Court decision on March 17^th 1995, Oita Summery Court decision on July 18^th 1995. Yokote Summary Court ruing reduced 20% of loan principal and rejected default interest performance claim by a lending business in virtue of good faith.

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[1] http://www.fsa.go.jp/status/kasikin/20070330/09.pdf

[2] http://www.kantei.go.jp/jp/singi/saimu/kettei/070420/gaiyou.pdf[3] http://www.kantei.go.jp/jp/singi/saimu/kettei/070420/honbun.pdf

[4] http://www.fsa.go.jp/news/18/kinyu/20070611-3.pdf

[5] Money-Lending Business Control and Regulation Law; Regulation for Loan Business in Japan

[6] Administrial guideline for management of money lenders

[7] http://www.fsa.go.jp/news/newsj/17/kinyu/20060307-1.pdf