Technical Guidance
Credit Card Contracts
A recent decision gives credit card debtors some relief from
unconscionable clauses
F
rom a cup of coffee to a luxury cruise
and beyond, credit card purchases are
made in startling numbers, all over the
world, ever y day. The terms of the contracts are often glossed over by the party
responsible for payment. A recent decision, Hang Seng Credit Card Ltd & Ors v
Tsang Nga Lee [2000] 3 HKC 269, applied
the Unconscionable Contracts Ordinance to
the terms of the contract between the card
company and the customer to read down
the provision relating to payment of legal
costs on default.
General Principles
The usual credit card transaction involves
three parties:
1. the creditor, as the company which issued the card and set up the scheme
2. the debtor or customer to whom the
card is issued, and
3. the supplier of the goods or services
who takes the credit represented by the
cards as payment or the promise of payment for those goods or services.
The creditor is usually a bank and the supplier is the merchant or institution that contracted with the creditor to accept the credit card.
Generally there are three contracts:
1. the contract between the creditor and
the debtor
2. the contract between the creditor and
the supplier, and
3. the contract between the supplier and
the debtor.
Under his contract with the creditor, the
debtor has an obligation to pay the creditor
for debts incurred, at face value, for goods
purchased or services supplied. In accordance with the terms of their contract, this
payment must be the full amount due either within a certain time or over a period
of time. In each case interest is payable on
the amounts outstanding. Under the contract between the creditor and the supplier,
the creditor undertakes to pay the supplier
for the amount of goods sold or services rendered, but at less than face value. The difference between the price and the payment
November / December 2000
represents profit for the creditor on the
transaction.
The third contract is between the
debtor and the supplier. The nature of this
contract is more difficult to assess. Generally you would expect this to be a simple
contract for the sale and purchase of goods,
or for the delivery of agreed services.
Where the subject matter is goods, you
would expect the Sale of Goods Ordinance to
apply thereby giving the debtor as purchaser the protection which that Ordinance gives, including warranties of title,
merchantable quality and so on. This contract does not really fit within the definition
of s 3(1), which requires payment of a
‘price’, ie a money consideration.
The debtor does not pay the merchant
for the goods, the creditor pays the merchant an amount less than the price of the
goods at a later date. As a result, some authorities argue that the contract does not
come under the Ordinance, and more seriously that the purchaser is not protected
by the warranties made by the supplier.
Although the relationship between the
creditor and the debtor is one of credit and
the loan of money to the debtor, the better
view is that the transaction represents a sale
of contract between debtor and supplier in
that the creditor pays the price on behalf
of the debtor thereby satisfying s 3(1).
What is the position if the debtor purchases goods, uses the card for payment, and
prior to the creditor paying the supplier, the
creditor becomes insolvent? Re Credit Charge
Services Ltd [1989] Ch 497 held that payment
by use of credit card was an unconditional
payment and that the supplier could not sue
the debtor as the liability of the debtor to
the supplier was frozen when the card was
accepted. The supplier then had to seek
payment from the creditor because the contract represented authority to the card holder that he could contract with the supplier
and that the creditor would honour the supplier’s voucher on presentation: R v Lambie
[1981] 2 All ER 776.
These are the general principles governing
relationships under credit card transactions.
The contract between the supplier and the
creditor is considered to be one between
equal bargaining parties because it is a commercial rather than a consumer contract. So
any unequal terms will probably bind the
supplier without the court intervening to
relieve the supplier from harsh terms because the contract has been effected in the
course of business.
Debtor and Supplier
But what of the principles in the contract
between the debtor and the supplier? The
contract between these parties is not generally considered to be commercial because
the debtor is usually a consumer, and so
not of equal bargaining power with the
creditor. In cases of corporate credit cards,
this interpretation may be set aside because
the card was issued in the course of the
debtor’s business and therefore the debtor
and creditor are equal parties.
A number of ordinances are relevant to
contracts between debtors and suppliers.
The Money Lenders Ordinance is relevant, particularly in regard to the legality of any
interest chargeable. In most cases the creditor will be exempt from the operation of the
Ordinance (see s 33A and Schedule 1). The
Unconscionable Contracts Ordinance enables a
court to refuse to enforce, limit, revise or
alter the whole or part of certain types of
contract where one party is a consumer and
the affected part or whole is unconscionable.
There are five listed guidelines that may be
considered with other factors to establish
unconscionability. Finally, the Control of Exemption Clauses Ordinance prevents the
enforcement of unreasonable exemption
clauses in certain contracts with consumers.
The Hang Seng Case
So what happened in the Hang Seng case?
Several debtors owed money to several creditors for credit card debts. The creditors sued
and obtained judgments against the debtors. The terms of the individual contracts
between each debtor and each creditor included an obligation on the part of the debtor to pay costs. Each creditor’s contract had
a different clause on this issue. Hang Seng’s
clause included ‘all costs payable to debt
collectors’ and Pacific Finance’s clause stated that ‘the pleaded cost also includes administrative costs’. The clause in the
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Technical Guidance
Standard Chartered contract was the most
extensive providing for:
all costs and expenses directly or indirectly incurred by the Bank in demanding, collecting and attempting to collect
or otherwise in enforcing ‘the agreement’ including without limitation the
charges of any agent or service provider (eg debt collectors) on a full indemnity basis.
In considering whether these clauses operated to make the debtors liable for the costs
of collection on a full indemnity basis, the
Court said that it had a role to play in assessing the amount of any costs awarded in an
action against the defendants, here the debtors. Why? Because the Court is given a
discretion under s 52A of the High Court
Ordinance to look at the circumstances of
each case, and to review the terms of the
contract, by reference to the provisions of
the Unconscionable Contracts Ordinance.
That Ordinance applies to contracts for
the sale of goods and services. The contract
between the debtor and the creditor was one
for the supply of credit under which the
bank was treated as lending money to the
debtor to purchase goods or obtain services.
The interest rates were very high. In the ordinary course of events, even without the
Unconscionable Contracts Ordinance, the court
would be able to look at the contract and
see whether the rate of interest made it
unenforceable.
This reflects the right given to the Court
by the Money Lenders Ordinance to reopen (or
review) a money lending contract where the
interest rate is too high. But in this case each
creditor was a bank and so was exempt from
the provisions of that Ordinance. So the only
way to avoid or modify the clause was to see
whether the Unconscionable Contracts Ordinance applied.
If it did, and the clauses relating to payment were unconscionable on the grounds
of being unreasonable, then the court
would excise those clauses from the contract. The court would then simply assess
costs in the usual way by reference to its
discretion under the terms of s 52A. In each
case the clause was considered unconscionable due to four factors:
1. The equality of the parties – the creditors were in a much stronger bargaining
position and the contracts were standard
form contracts without any contribution
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The Prospective Accountant
to the drafting by the debtors.
2. The ability of the debtor to understand
the ‘cost’ clause – generally the clause
was not only not explained to the
debtor but was not drawn to his attention when he entered into the contract.
3. The availability of identical services
from another source – there was no
choice because in Hong Kong most of
these kind of contracts contain the
same terms.
4. The extent of the clause – here it was
extremely wide.
All factors were considered in the debtors’
favour and contra proferentem the creditors
with the result that these clauses were not
enforceable because they were unconscionable. The Court awarded fixed costs
on the High Court scale as being the fair-
‘The court is not
shackled by the
traditional or
classic theories in
contract law’
est costs in the circumstances. These costs
were not excessive and represented costs
which would have been awarded by the
Court in an ordinary cause of action.
One other factor the Court considered
was the extortionate interest rate (in one
case it was in excess of 48 per cent). But as
the creditors were banks and exempt by
the terms of s 33A the transaction could
not be reopened under the Money Lender
Ordinance.
Yam J in his judgment said that in applying the Unconscionable Contracts Ordinance
‘the court is not shackled by the traditional
or classic theories in contract law’. His Lordship was probably referring to the fact that
the guidelines used to interpret the clauses
were not rules of interpretation for contracts; instead they were factors which a
court of equity would consider in deciding
whether or not the defendant had acted
unconscionably.
In some of these cases of unconscionability there is no contract between the
parties, and the Court has to decide if a
remedy is possible (see for example the
remedy of restitution in AG v Blake [2000]
UKHL 48). In other cases the plaintiff has
claimed his breach of contract was caused
by the unconscionable actions of the defendant (eg the estoppel against the vendor
in Pacific South (Asia) Holdings Ltd v Million
Unity International Ltd [1997] 3 HKC 440,
which turned the tables by making the vendor not the purchaser the guilty party).
The OTB Case
Fortunately for the debtors the Court did
not consider an earlier Hong Kong decision.
This was the case of OTB International Credit
Card Ltd v Michael Au [1980] HKLR 296. In
that case one of the terms in the contract
between the creditor and the debtor provided that:
In the event of loss or theft of the card,
the Holder must immediately notify
the Company by registered mail or
telegram and until such notification
is received by the Company, the Holder
will remain responsible for all purchases
charged through the use of such
Card.
When the debtor discovered that his card had
been stolen, he telephoned the creditor company the same day and the next morning
wrote to the creditor. However, on the day of
the theft the card had been used to make
purchases to the value of HK$3,216.00. The
suppliers had not checked the signature on
the back of the card and the creditor billed
the debtor for these purchases.
The debtor argued this exemption of
liability clause was unconscionable. Without
any legislation to assist the Court, because
this was more than a decade before the enactment of the Unconscionable Contracts Ordinance, the Court of Appeal had to rely on
contract principles to decide whether the
clause operated. These contract principles
had recently been considered in Photo Production Ltd v Securicor Transport Ltd [1980]
AC 827, which allowed an exemption clause
to operate if it was not unreasonable and
was necessary for the protection of the creditor in light of the benefits which the debtor
received under the contract. But Photo Production concerned two equal bargaining parties whereas the OTB case concerned a bank
November / December 2000
and a consumer, ie unequal bargaining parties. However, the Court said:
The company ought not to be responsible indefinitely for a lost card. Indeed
it may well have been lost through the
negligence or foolishness of the holder.
And for his part the holder obtains considerable benefits from the provision by
the company of immediate credit without security. (Cons JA delivering the
judgment of the court at 298).
That judgment seems unduly harsh as
the debtor, whilst not performing immediately his obligation to write to the creditor,
did at least seek to prevent use by telephoning the creditor. The creditor maintained that it could not act on a telephone
call without a letter with the debtor’s signature because the phone call may have been
a hoax.
So the only solution was to consider
the contractual solution. What did the contract say? Did the events that happened
fit within the terms of the contract? If so,
the terms of the contract operated and
were not unreasonable. This is how Photo
Productions interpreted the clause in that
contract.
Reviewing Interim Reports
The HKSA recently released a new auditing standard. Richard
George focuses on the key features of SAS 700
I
n July 2000, Statement of Auditing Standards 700 ‘Engagements to Review Interim
Financial Reports’ (SAS 700) was issued by
the HKSA. SAS 700 provides standards and
guidance to auditors in reviewing and reporting on interim financial reports.
Objective of a Review
Engagement
The objective of a review of an interim financial report is to enable the auditors to
report to the board of directors whether, on
the basis of the review procedures carried
out, anything has come to the auditors’ attention that causes them to believe that
material modifications should be made to
the interim financial report.
An interim review provides moderate
assurance that an interim financial report
has been prepared in accordance with the
requirements of Statement of Standard
Accounting Practice 25, Interim Financial
Reporting (SSAP 25) and with the relevant
provisions of the Listing Rules.
Scope of a Review
An interim review differs from an audit in
the extent of the procedures performed and
the level of assurance provided. An audit
involves extensive procedures designed to
provide the auditors with sufficient evidence
to provide positive assurance regarding the
November / December 2000
reliability of the financial statements. While
an interim review involves the application
of audit skills and techniques, the scope of
review procedures is not as extensive. Accordingly, an interim review provides only
a moderate level of assurance that the interim financial report is free from material
misstatement.
An interim review is focused primarily
on enquiries to management and the application of analytical procedures to the interim
financial data in order to assess whether accounting policies and presentation in the
interim financial report have been consistently applied unless otherwise disclosed. In
particular, the auditors will design their interim review procedures to focus on the
recognition, measurement and presentation
issues discussed in SSAP 25. An interim review does not normally include audit
procedures such as tests of controls and verification of assets, liabilities and transactions.
Engagement Letters
The auditors should clarify through discussion with the client the scope of the interim
review engagement and the intentions of
the directors regarding the inclusion of an
interim review report in the company’s interim report. These issues should be
clarified before agreeing the terms of the
engagement.
The Result
These days, given the inequality of bargaining power and that it was a standard form
contract, the Court could consider matters
beyond the contract. This is what happened
in Hang Seng. What Photo Production did was
to enable the Court to interpret the clause.
What the Unconscionable Contracts Ordinance
does is to enable the court to remove the
clause it considers unconscionable and to
interpret what is left of the contract in a more
reasonable and ‘conscionable’ manner.
Judith Sihombing is a Lecturer at the
University of Hong Kong.
Planning
The auditors should plan their work to ensure that an effective interim review is performed. The auditors should update their
understanding of changes in the client’s
business to ensure review enquiries are relevant and review procedures are appropriate, as well as to assess the appropriateness
of the responses and other information
obtained.
Other Auditors
The auditors should establish the scope of
review work required (if any) for each division, subsidiar y, associate and jointly
controlled entity. The auditors should notify any other auditors of the nature and
extent of work required, the form of report
required and the reporting timetable.
Materiality
Auditors should apply the same materiality
considerations applicable to an audit opinion on an interim financial report. SSAP
25 requires that materiality should be assessed directly in relation to the interim
period financial data.
Documentation
The auditors should document their interim review work. In particular, the
auditors should document matters that are
important in providing evidence to support
the conclusion in their review report and
that their review was conducted in accordance with SAS 700.
Procedures and Evidence
The auditors should use their professional
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39
Technical Guidance
judgment in determining the specific nature,
timing and extent of review procedures.
The extent of review procedures should
reflect the risk of misstatement in the interim financial report. In designing review
procedures the auditors should be guided
by the following factors:
• their knowledge and experience of the
entity, the industry within which it operates and of prior period audits and
the areas of specific identified risk
• the extent to which a particular item is
affected by management judgment
• the entity’s accounting systems
• the materiality of transactions and account balances, and
• management’s own assessment of the
risks underlying the interim financial
report and the monitoring and other
controls established to mitigate those
risks.
The following procedures are ordinarily
included as part of a review of an interim
financial report:
• obtaining an updated understanding of
the entity’s business and the industry
in which it operates
• enquiries concerning the entity’s accounting principles and practices
• enquiries concerning the entity’s procedures for recording, classifying and
summarising transactions, accumulating information for disclosure in the
interim financial report and preparing
the interim financial report
• enquiries concerning all material assertions in the interim financial report
• analytical procedures designed to identify relationships and individual items
that appear unusual, including:
– comparison of the interim financial
report with those for prior periods
– comparison of the interim financial
report with anticipated results and
financial position, and
– study of the relationships of the elements of the interim financial report
expected to conform to a predictable pattern based on the entity’s
experience or industry norm.
• enquiries concerning actions taken at
meetings of shareholders, the board of
directors, audit committees and other
committees of the board of directors
and other meetings that may affect the
interim financial report
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The Prospective Accountant
•
•
•
reading the interim financial report to
consider whether the interim financial
report appears to conform with the
basis of accounting indicated
obtaining reports from other auditors,
where considered necessary, who have
reviewed components of the entity, and
enquiries of persons having responsibility for financial and accounting
matters concerning, for example:
The review
provides boards
and audit
committees with
enhanced
assurance that
the interim
financial report is
free from material
misstatement
Subsequent Events
The auditors should enquire about events
subsequent to the interim financial report
date that may require adjustment to or disclosure in the interim financial report.
Management Representations
The auditors should obtain written representations from the directors in respect of the
interim financial report. It is important that
the auditors include representations on specific matters such as the substance of significant assertions, estimates or interpretations
of facts by the directors that have a significant effect on the interim financial report.
Discussion of Findings
Prior to issuing their interim review report,
the auditors should communicate their
findings in general to the board of directors and the audit committee. Matters that
may be communicated include:
• the scope and results of the review procedures undertaken
• the process by which the interim financial report was prepared, including the
process used by management in formulating accounting estimates and the
basis for the auditors’ conclusions regarding the reasonableness of those
estimates
• changes to accounting policies and
presentation, and
• issues which have been discussed with
management.
Review Conclusion
–
whether all transactions have been
recorded
– whether the interim financial report has been prepared in accordance with the basis of accounting
indicated
– changes in the entity’s business activities and accounting principles
and practices, and
– matters as to which questions have
arisen in the course of applying the
foregoing procedures.
If based on their review procedures the
auditors have reason to believe that the interim financial information may be
materially misstated, they should carry out
such procedures necessary to issue an unmodified review report or to confirm that
a modified review report is required.
An unmodified review report contains a
review conclusion expressed in terms of a
‘negative assurance’ as follows: ‘On the
basis of our review, which does not constitute an audit, we are not aware of any
material modifications that should be made
to the interim financial report for the six
months ended …’.
Modifications
Under SAS 700, the auditors will modify
their interim review report where they conclude that material modifications to the
interim financial report either are or may
be required to be made. Such modified
interim review reports will arise where the
auditors disagree, either about an adopted
accounting treatment or about the extent
of disclosure in the interim financial report,
November / December 2000
or where the auditors encounter a material limitation in the scope of their review
work. Modification of the interim review
report will also be required where there is
fundamental uncertainty, eg a significant
level of concern about the company’s ability to continue as a going concern.
If the prior period review report on the
interim comparatives or the auditors’ report
on the preceding annual financial statements was modified and the matter giving
rise to the modification has not been resolved, the review report should refer to the
modification and discuss the current status
of the matter giving rise to the modification
and the implications for the information
presented in the interim financial report.
Interim Comparatives
Users of interim reports are likely to assume
that the interim comparatives were subject
to the same review procedures as the current year interim financial information.
Where an interim review is to be performed
for the first time and the auditors are not
engaged to perform a review of the interim
comparatives in accordance with SAS 700,
they should modify their review report.
November / December 2000
Other information
Although the auditors are not responsible
for other information accompanying the
interim financial report (eg MD&A), the
auditors do consider whether other information is materially inconsistent with the
matters covered by their review report, or if
it is misleading. If any apparent misstatements or material inconsistencies cannot be
resolved through discussion with the directors, the auditors may decide to make
reference to the misstatements or inconsistencies in their review report.
Requests to Discontinue an
Engagement
There may be circumstances where the
auditors indicate to the directors that their
report may be modified and, as a result, the
directors may request the auditors to discontinue the review engagement rather
than accept a modified review report. For
example, where the potential modification
arises from a disagreement about an accounting treatment, the directors may seek
to discontinue the engagement because the
Listing Rules require disclosure of such
a modification to be made in the interim
report. If such a situation arises, the auditors should inform the audit committee as
soon as possible.
Enhanced Assurance
A review by the company’s auditors performed in accordance with SAS 700 brings
independent professional challenge and
scrutiny and, importantly, given the increasing complexity of financial reporting rules,
is designed to focus on the key recognition,
measurement and presentation issues. Thus
the review provides boards and audit committees with enhanced assurance that the
interim financial report is free from material misstatement and has been properly
prepared in accordance with the requirements of SSAP 25 and the relevant provisions
of the Listing Rules.
It is expected that reviews of the interim
financial reports will prove to be an integral part of the process by which boards and
audit committees satisfy themselves as to the
integrity and reliability of interim financial
reports issued under the Listing Rules.
Richard George, Technical Department, Deloitte
Touche Tohmatsu.
The Prospective Accountant
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Technical Update
This information is for students’ reference only and has no relation to the examinability of such
information. Students should refer to the comparison tables that appear in the January/February
costs. Sundry repairs and maintenance costs
should be expensed as incurred.
The Society’s Financial Accounting
Standards Committee will provide an illustrative example in the final version of this Interpretation.
and July/August issues of the Journal before each examination diet to understand the examinability
SAS 600 ‘Auditors’ reports on
financial statements’
of such materials.
HKSA Standards and Guidelines
Draft Interpretation 11 ‘Property,
plant and equipment – major
inspection or overhaul costs’
This Draft Interpretation is closely modelled
on the equivalent Interpretation issued by the
IASC’s Standing Interpretation Committee.
It addresses the issue of whether or not the
cost of a major inspection or overhaul of an
item of property, plant and equipment occurring at regular intervals over the useful
life of an asset and done to ensure the continued use of the asset should be capitalised
or expensed. This Draft Interpretation only
concerns ‘major’ inspection and overhaul
The Securities and Futures Commission has
amended the Securities (Accounts and
Audit) Rules. The revised Rules came into
operation on 12 June 2000. Under the revised Rules, where a securities dealer’s
accounting period straddles 12 June 2000,
auditors must report matters required for
both the period up to 11 June 2000 and the
period from 12 June 2000.
Legislation
Code
LN 273 of 2000
Ordinance
Inland Revenue (Amendment) Bill 2000
5 October 2000
Stamp Duty (Amendment) Bill 2000
5 October 2000
Banking Ordinance (Amendment of Third Schedule) Notice 2000
(Made under section 135(3) of the Banking Ordinance (cap 155))
November / December 2000
Gazetted on
5 October 2000
The Prospective Accountant
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