Abstract
We investigate the impact of sanctions in the presence of abusive contract terms in a litigation model under asymmetric information on consumers’ ability to litigate. A firm may decide to write an abusive clause to extract part of a consumer’s surplus. Facing such a clause, consumers can seek compensation at a cost, but only a fraction of them are ready to go to court to obtain this compensation. If the case is brought to court, the abusive clause is unenforceable. We then explore the consequences of introducing an additional sanction to this unenforceability. Our results show that the mere non-enforcement of abusive clauses has no deterrent effect. However, the introduction of an additional sanction has to be done carefully because under certain conditions, it leads to more deterrence but may also worsen the utilities of some consumers and generate mixed effects on welfare.
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Notes
Gazal-Ayal 2007 even shows that when suppliers can adjust the content of the form contract, the few reading consumers cannot correct the market failure.
For a thorough discussion of the distinction between the European notion of abusive or unfair terms, on the one hand, and the American concept of unconscionability, on the other hand, see Sibony (2019). In what follows, and for the purpose of this article, we consider the two notions to be sufficiently close and raise similar questions (see Sect. 3 below). Hence, the scope of the article extends to both unconscionable and unfair terms.
Punitive damages are extra damages allowed in addition to compensatory damages. They are not intended to compensate for prejudice but rather for punishing bad faith and fraud and deterring such behaviour.
For example, in French law, a civil penalty may be inflicted upon the drafter of the contract. Article L 241-2 of the French Consumer Code provides that the amount of the sanction is limited to 3,000 euros for a natural person and to 15,000 euros for a legal entity.
This assumption could be questioned in fields where legislation has become excessively complex; for example, firms may not easily be able to discriminate between abusive and legal clauses. Mortgage loans offer a striking example of complex legislation, as emphasized by Schäfer (2014) and Schäfer and Wulf (2021).
In accordance with Shavell and Polinsky (2007)’s seminal work, we build on the idea that the efficiency of a sanction depends on its amount and its probability of occurrence. However, we focus on a situation with heterogenous consumers, which leads to specific results.
We build on the seminal model of settlement vs. trial first developed by Shavell (1982). In line with the standard literature, we assume that parties compare the expected costs of going to trial and settling with the subjective expected gain in both instances. The key feature of the model is that we consider heterogeneity among plaintiffs with respect to their subjective cost of going to trial.
Williams v. Walker-Thomas Furniture Co., 350 F.2d 445 (D.C. Cir. 1965).
In the legal doctrine, “substantive unconscionability” refers to the presence of an unfair term in the contract, while “procedural unconscionability” alludes to the parties’ respective bargaining power. In other words, the notion of unconscionability is more complex than that of unfair terms, in the sense that the procedural dimension is also taken into account. In the economic approach however, both notions are often used as synonyms (see for instance Bebchuk and Posner 2006). Moreover, even the European Directive 93/13/EEC of 5 April 1993 (see infra) uses the concept of “unfair terms” while it actually refers to unconscionable clauses according to the above mentioned definition. In what follows, for the sake of simplicity, we use unconscionable, unfair, and one-sided terms as synonyms.
Joined Cases C-240/98 to C-244/98 Oceano Grupo Editorial, EU:C:2000:346, section 25.
Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts.
Among other examples considered to be unfair are clauses that in effect exclude or limit the liability of a trader who fails to deliver the good or the service mentioned in the contract; make an agreement that is binding to the consumer but allows the professional party to get out of providing the good or service; and allow a trader to keep pre-payments if the consumer cancels the contract without allowing for equivalent compensation to the consumer where the trader cancels
Article 7 of the Council Directive 93/13/EEC of 5 April 1993 on unfair terms in consumer contracts.
This law is now defunct and has been replaced by §305-310 of the BGB since 2002.The black list enumerates terms that are always considered unfair, while the grey list provides terms that are presumed to be unfair. The professional party however has the possibility to prove that, given the circumstances, a given term on the grey list should be enforced. In a sense, the grey list can be analysed as a shift in the burden of the proof regarding the unfair nature of the term.
The notion of an abusive clause was first incorporated explicitly into the French Consumer Code in Article L 212-1 by the Scrivener law of 10 January 1978 (loi no78-23). Without explicitly mentioning the concept of an “abusive clause”: the prohibition of unfair terms was extended to contracts concluded between professional parties by a law dated 4 August 2008 (Loi no2008-776 of 4 August 2008.) Finally, as a result of the recent reform of civil liability (ordonnance no2016-131 of 10 February 2016), article 1171 of the French Civil Code provides that in all standard form contracts, clauses that have not been negotiated and entail a significant imbalance between the parties’ rights and obligations should be considered unfair.
The Directive (EU) 2019/2161 of the European Parliament and of the Council of 27 November 2019 regarding the better enforcement and modernisation of union consumer protection rules entered into force on 7 January 2020, and the transposition deadline was 28 November 2021. Member states are required to apply the new measures starting on 28 May 2022.
Commission Recommendation of 11 June 2013 on common principles for injunctive and compensatory collective redress mechanisms in the Member States concerning violations of rights granted under Union Law.
Law 2014-344 of 17 March 2014.
See the report from the National Assembly entitled “Rapport d’information sur le bilan et les perspectives des actions de groupe”, June 2020.
Such waivers have been approved by the American Supreme Court (AT&T Mobility v. Concepcion, 563 U.S. 333 (2011)) To our knowledge, the Court of Justice of the European Union (CJEU) has not ruled specifically on this issue. However, it is conceivable that such waivers would be considered as unfair according to the European Directive 93/13, particularly if the clause was not individually negotiated, to the extent that such clauses hinder consumers’ right to take legal action or exercise any other legal remedy. The key issue would then consist in determining whether the consumer was fully aware of the consequences of the clause at the time he signed the contract. This interpretation is consistent with a recent decision of the CJEU: in the Ibercaja Banco judgment (C-452/18, 9 July 2020) the court ruled that the clause according to which consumers waived the right to rely on the unfairness of a contractual term is valid only if it was clear to consumers what rights they were waiving and what were the consequences of such a waiver.
See, for instance, www.flightright.com or air-indemnité.com
This procedure is seldom used. For instance, no case was referred to the commission in 2018, 2019 or 2020. A single case was filed in each 2016 and 2017.
Abusive clauses are frequent in oligopolistic markets such as phone and internet subscriptions and bank services. However, even in a competitive market, firms might not have incentives to offer a contract without abusive clauses. If firms anticipate that consumers will not read the fine print prior to signing the contract–because transaction costs are excessively high–a rational profit maximizing firm will offer a contract with abusive terms (under the assumption that such terms generate an additional profit for the firm). Hence, the equilibrium in a competitive market will be such that all firms may offer contracts with abusive terms.
Consider, for instance, a consumer who has to pay termination fees or a situation in which the burden of proof rests only on the consumer. In such cases, the consumer can easily check whether such clauses are unfair. The transaction costs are much lower than in an ex ante setting when a consumer would have to study all possible contracts.
In cases of abusive clauses, lawyers’ fees can be negligible to the extent that the case is fairly simple. The fees borne by the plaintiff tend to be particularly low in a legal system that allows for class actions and contingency fee agreements. However, opportunity costs may be low or high depending on the consumers. Then, our litigation costs here are mainly opportunity costs.
One reason for the absence of judicial error is that there are lists of clauses provided by the European legislation and abundant case law in the United States that allow parties to anticipate fairly accurately whether a clause will be considered unfair, as mentioned in Sect. 3.
This information on the value of D is symmetric and known by all the parties.
Compared to Miceli (1994), our novelty is to consider two types of plaintiffs with different costs of bringing a case to court and to focus on how the sanction impacts the strategies of the parties.
Any settlement proposal between 0 and \(S=D-C_L\) would be a dominated strategy.
Since \(t^{*}= \frac{D-C_L}{D+C_d}\) and \(\frac{\partial t^{*}}{\partial D} = \frac{C_d+C_L}{(D+C_d)^{2}}>0\), the threshold defining the two equilibria increases in D.
Note that the consumers are still better off demanding compensation and obtaining \(D-C_L-R_p>0\), even if \(-F +D-C_L-R_p<0\), than not demanding compensation and suffering -F.
Recall that in equilibrium, the H-type consumer is indifferent between demanding compensation and not: this explains why the consumer’s utility is on average equal to -F.
For further developments on online reputation, see Cabral (2012).
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We are thankful to the participants in the Law and Economics Workshop at Tel Aviv University and in particular Shay Lavie, Avraham Tabbach and Alan Miller for their suggestions and comments. We would also like to thank the participants in the 2020 AFED Conference and the 2020 EALE Conference.
Appendix
Appendix
1.1 Appendix 1
We show that the firm always writes abusive clauses under the second type of equilibrium when \(D=F\). Its profit is \(\Pi = F - \alpha (F+C_d\)). Recall that \(\alpha \in [0; \frac{D-C_L}{D+C_d}]\). When \(\alpha \rightarrow 0\), then \(\Pi >0\). When \(\alpha = \frac{D-C_L}{D+C_d}\), then \(\Pi> 0 \Leftrightarrow F > \frac{F-C_L}{C_L+C_d} C_d \). Since \(\frac{F-C_L}{C_L+C_d} C_d \Leftrightarrow -C_LC_d < F C_L\), this equation is always true. As a consequence, \(\forall \alpha \in [0; \frac{D-C_L}{D+C_d}]\), \(\Pi >0\).
1.2 Appendix 2
The pooling equilibrium (\(\alpha \ge t^*\)):
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When \(D\ge F+C_L\), the sanction D is high enough to prevent the firm from writing an abusive clause. There is then no damage and no demand for compensation, so \(W_0=0\).
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When \(D<F+C_L\), the firm always writes an abusive clause, consumers always demand compensation, and the defendant settles. The profit of the firm is then \( \Pi = F- D + C_L\), while consumer utility is equal to \( U = -F+ (D-C_L) - R_p\). Social welfare is equal to \(W=-R_p\).
In this situation, the abusive clause entails a social cost. The explanation is as follows: on the one hand, there is a transfer of surplus F from the consumer to the firm, which has no impact on total welfare. On the other hand, the consumer spends \(R_p\) to obtain compensation \(S=D-C_L<F\) from the firm. The abusive clause therefore implies a costly demand for compensation, which generates a negative total surplus.
The mixed strategy equilibrium (\(\alpha < t^*\)):
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When \(D\ge F+C_L\) and \(\alpha \in [\alpha _d; t^{*}]\), the firm has no incentive to write an abusive clause. Welfare is then \(W_0=0\).
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When \(D < F+C_L\) or \(D \ge F+C_L\) and \(\alpha \in [0; \alpha _d]\), the firm always writes abusive clauses and settles with probability \(\psi ^{*}\). Given Section 5.3, the utility of the consumer is \(U=-F + \alpha (D - C_L - R_p)\), and that of the firm is \(\Pi = F - \alpha (D+C_d)\). Welfare is then \(W= - \alpha (C_d + C_L + R_p)\).
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Bienenstock, S., Desrieux, C. Abusive contract terms: Is unenforceability a deterrent sanction?. Eur J Law Econ 54, 187–216 (2022). https://doi.org/10.1007/s10657-022-09731-y
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DOI: https://doi.org/10.1007/s10657-022-09731-y