Banking law

Consumer credit - By Simon Sugar, Barrister, 36 Bedford Row, LondonTest for determining whether a particular sum is part of the charge for creditWatchtower Investments Ltd v Payne and another (20 July 2001) CA.

The debtors owned freehold property subject to a mortgage.

The mortgage fell into arrears and the debtors obtained finance from the creditor in part to pay off the arrears.It was a term of the credit agreement and legal charge that the agreement was expressed to incorporate that 'where the agreement is secured by a second mortgage, any first mortgage arrears ...

must be discharged on or before completion of the loan'.The credit advanced to the debtors was stated in the agreement to be 11,300.

The mortgagee's arrears of 1,776 were discharged out of the advance of 11,300 and the balance paid over to the debtors.The amount of credit shown in the agreement was therefore not shown net of the amount paid by way of arrears.By virtue of the operation of sections 65(1) and 127(3) of the Consumer Credit Act 1974 ('the Act') the agreement would be unenforcable if it failed to correctly set out the amount of credit.The issue for determination by the Court of Appeal was whether the sum paid to discharge the mortgage arrears was provided by way of credit or as part of the total charge for credit.An item entering into the total charge for credit is not treated as credit: see section 9(4) of the Act.

It follows that, if the amount paid to discharge the arrears on the first mortgage was part of the total charge for credit, it should not have been included in the amount of credit in the document signed by the debtors.The Court of Appeal held that the key question in each case was whether part of the purpose of the transaction was that the borrower should borrow the item in dispute as part of the credit or whether it was part of the true cost of the credit.The answer to that question was held not to depend upon the subjective intentions of the parties but must depend upon a consideration of the communications between the parties set out against the surrounding circumstances.On the facts of the case the court held that the discharge of the arrears on the first mortgage was plainly part of the purpose of the loan and was not part of the total charge for credit.In the circumstances the agreement correctly set out the amount of credit advanced to the debtors.The test put forward by the Court of Appeal clarifies conflicting county court decisions and is clear and easy to understand.

However, understanding the test and applying it are two entirely separate matters.In certain circumstances the test will be difficult to apply because it will not 'always be easy to draw the line between an item forming part of the total charge for credit and an item forming part of the credit itself when the borrowing is for expenditure or a purpose required or authorised by the credit agreement'.