The outcome of the test cases will affect thousands of potential claims
Lenders must not mislead borrowers that their debts are enforceable, when in fact they are not, the Office of Fair Trading (OFT) says.
The regulator also says many debtors have, in turn, been misled about their ability to escape their debts.
The OFT's comments are part of an intervention in a series of High Court test cases about the enforceability of debts under the Consumer Credit Act.
The outcome could affect thousands of potential courts cases.
The OFT has supplied its draft guidance on part of the Consumer Credit Act (CCA) to Judge Waksman, who is hearing the cases in Manchester.
"The OFT's decision to prepare guidance at this time has primarily resulted from our concern that debtors are being misled as to the meaning and interpretation of sections 77-79 [of the Act] in particular," the OFT said in a letter to the judge.
"And on the other hand concern that some creditors appear not to understand the nature and extent of their obligations under these sections," it added.
The 12 test cases at the High Court in Manchester are aimed at settling a number of contentious issues about the interpretation of the law.
The general position is that lenders who wish to chase defaulting borrowers for the repayment of their loans have to comply with a number of obligations.
One of them is that under sections 77-79 of the Act they should supply a "true copy" of the original signed loan agreement within 12 days of the borrower asking for it.
If they do not then the debt is unenforceable until such time as the copy can be provided.
"Unfortunately, consumers have often been given an exaggerated expectation of what the creditor or owner must do in order to comply with an information request, as a result of misleading claims by claims management companies and inaccurate information on the internet," the OFT's draft guidance says.
"As a result, numerous disputes have been generated over whether a request has properly been made, whether the duties have been complied with and whether as a consequence the agreement can be enforced," the OFT adds.
Unfair business practices
The OFT's guidance clearly disagrees with some of the arguments that have been put forward by some claims management companies on behalf of their clients.
In particular, the regulator points out that it is perfectly legal and proper for a bank that has lost the original loan agreement, or whose copy is illegible, to supply an accurate "reconstituted" version instead, to show that the agreement did in fact include the information specified by the Act.
"It is important to remember that the purpose of these sections is to provide information to consumers, not to provide a method for consumers to avoid paying their debts," the OFT says.
But the OFT goes on to advise that lenders would be acting unfairly, and potentially in breach of their consumer credit licenses, if they misled borrowers by:
• hiding or disguising the fact that there was never a proper signed agreement in the first place
• providing only a copy of the current terms and conditions, not the original ones
• confusing the borrower as to who they should send an information request after selling the debt to a debt collection company
• failing to preserve data so the borrower cannot be given an up to date statement of account.
Carl Wright of Cartel Client review, one of the claims management companies involved in the test cases, welcomed the OFT's views.
"During 2008 and 2009 the number of financial claims made by consumers have increased significantly," he said.
"Banks and credit card companies have in the main, steadfastly refused to confirm any inability to be able to provide a 'true copy' of the requested credit agreement, where one never existed."
A recent High Court case, between Philip McGuffick and the Royal Bank of Scotland, established that even if a debt is temporarily unenforceable, the lender can still mark a customer's record with a credit reference agency as being in default, because the debt itself has not been extinguished.
The OFT agrees with this, but its draft guidance goes against the grain of other conclusions of that case.
The judge said it was legal for lenders to take other steps to get their money back, such as demanding repayment of the loan, issuing a default notice, threatening legal action, and even starting legal proceedings.
But the OFT said it might take a dim view of these tactics.
"For the purposes of considering whether a company is fit to hold a consumer credit licence, the OFT can take into account any practices which we consider to be oppressive, misleading or improper, whether they are unlawful or not," an OFT official said.
The OFT's draft guidance says: "No communications or requests for payment should in any way threaten court action or other enforcement of the debt where the creditor or owner is aware that it cannot and will not be entitled so to enforce the agreement."
"The creditor or owner should make it clear in communications to the debtor that the debt is in fact unenforceable," it adds.
The guidance goes on to warn that: "To mislead debtors into making payment may in certain circumstances amount to an unfair commercial practice under the Consumer Protection from Unfair Trading Regulations 2008."
"It is quite clear that the OFT guidance would increase consumer protection and instigate standards within the banking industry that would reduce the abuse of consumer rights," said Carl Wright.
The OFT has delayed publication of its draft guidance until the outcome of the Manchester High Court hearings, whose judgements are expected to be delivered in January 2010.