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Report No. 199

Unfair (Procedural & Substantive) Terms in Contract

Chapter I


The subject of 'Unfair (Procedural and Substantive) Terms of Contract' has assumed great importance currently in the context of tremendous expansion in trade and business and consumer rights. In the last two decades, several countries have gone in for new laws on the subject in order to protect consumers and even smaller businessmen from bigger commercial entities. Several Law Commissions across the world have taken up the subject for study and recommended new legislation. The British and Scottish Law Commission has prepared its latest Report in 2004 on 'Unfair Terms in Contracts' (Law Com No. 292, Scot Law Com No. 199) with a new draft Bill annexed to the Report after reviewing its earlier laws.

The South African Law Commission, in its Report in 1998 on 'Unreasonable Stipulations in Contracts and the Rectification of Contracts' has reviewed the comparative law in several countries and has come forward with a draft Bill. The Discussion Paper of 2004 from Victoria (Australia) proposed by the Standing Committee of Officials of Consumer Affairs, the Interim Report of 2005 from Canada (British Columbia) prepared by British Columbia Law Institute and the Reports of the New Zealand Law Commission and Ontario Law Commission, etc. have added new dimensions to the subject.

The Law Commission of India in its 103 rd Report (1984) on "Unfair Terms of Contract", had dealt with the subject and proposed insertion of section 67A into the Contract Act. In as much as new concepts have been built into the subject in the last two decades, the Law Commission of India has taken up the subject afresh for further study.

The main highlight of this Report is the consideration of Unfair Terms of Contract by separating the 'procedural unfairness' and the 'substantive unfairness' in the matter of contracts or their terms. In the statutes in force or Bills prepared by other Law Commissions, while it is recognized that contracts or their terms may be unfair either on account of 'procedural unfairness' or on account of 'substantive unfairness', the discussion as well as the provisions of the statutes/Bills does not treat these aspects separately.

In fact, in some countries, while the distinction is realized, there is no consideration of the concepts separately and the result is that several sections combine 'procedural unfairness' and 'substantive unfairness'. The specialty of our Report is that not only have we tried to segregate the procedural and substantive unfair provisions of other countries in separate chapters, we have also kept the concepts separately in the Bill annexed to this Report.

What we mean by 'procedural unfairness' is whether there is unfairness in the manner in which the terms of the contract are arrived at or are actually entered into by the parties, or in the circumstances relating to the events immediately before the entering into the contract, or in the conduct of the parties, their relative position, or literary knowledge, or whether one party had imposed standard terms on the other or whether the terms were not negotiated. These and other circumstances relate to procedural unfairness.

What we mean by 'substantive unfairness' is that a term by itself may be either one-sided, harsh or oppressive or unconscionable and therefore unfair.

One party may have excluded liability for negligence or for breach of contract or might have imposed terms on the other which are strictly not necessary or might have given to himself power to vary the terms of the contract unilaterally etc. Such terms could be unfair by themselves.

The Indian Contract Act, 1862 has several provisions relating to 'viodable contracts'. These provisions deal with undue influence, coercion, fraud, mistake, misrepresentation etc. These are indeed 'procedural' provisions already contained in the Act. Likewise, the Contract Act deals with 'void' contracts or 'void' terms. These are 'substantive' provisions already contained in the Act. Similarly, the Specific Relief Act, 1963 contains provisions for granting relief where there is procedural or substantive unfairness.

But, what is now proposed in this Report and the Bill is to provide additional provisions of 'procedural unfairness' and 'substantive unfairness' and remedies for removing such types of unfairness.

These new remedies can be granted by the Civil Courts, arbitral tribunals and the consumer fora under the Consumer Protection Act, 1986.

The British and Scottish Law Commissions have indeed stated in their joint Report of 2004 referred to above that 'both substantive unfairness' (the substance and effect of the term) and 'procedural unfairness' (the circumstances existing at that time) must be taken into account.

Goldring and others have complained that the Australian Unfair Terms statutes have failed to distinguish between procedural and substantive unconscionability. The Discussion Paper, 2004 from Victoria (Australia) refers to the above statutes and states that 'the current regimes in Australia have created some confusion in practice because of their failure to distinguish between procedural and substantive unfairness'. The Paper states that in the Australian statutes such as the (NSW) Trade Practices Act, Uniform Consumer Credit Code, "the list of factors to which the court is required to have regard, in determining whether a contract is unjust, is a mish mash of process-oriented and outcome-oriented considerations".

The above Discussion Paper also states that whilst it has been argued that there is probably sufficient coverage of the procedural aspect of unfair contract terms, still the criticism noted earlier by Goldring et al, that current Australian legislation is problematic in that it does not distinguish between procedural and substantive issues, is considered to be valid. In order to create clarity, the opportunity might be undertaken, whilst addressing the issue of unfairness of contract terms, to rectify this situation. The Discussion Paper also stated:

"There would be better Court outcomes for aggrieved individuals due to the differentiation between procedural and substantive matters."

Indeed, the earliest source for distinguishing between 'procedural' and 'substantive' unfairness is a paper of 1967 by Arthur Allen Leff, Asstt. Prof. Washington University Law School, on 'Unconscionability and the Code - The Emperor's New Clause', published in (1967), University of Pennsylvania Law Review, p 485.

Arthur Leff comments on Section 2-302 of the Uniform Commercial Code (ESA) as follows:

"If reading this section makes anything clear, it is that reading his section alone makes nothing clear about the meaning of 'unconscionable' except perhaps that it is pejorative. More particularly, one cannot tell from the statute whether the key concept is something to be predicated on the bargaining process or on the bargain or on some combination of the two, that is, to use our terminology, whether it is procedural or substantive.... The draftsman failed fully to appreciate the significance of the unconscionability concepts necessary "procedure - substantive" dichotomy and that such failure is one of the primary reasons for section 2-302's final amorphous unintelligibility and its accompanying comment's final irrelevance."

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