by Giesela Rühl
Distance contracts (Fernabsatzverträge, contrats à distance, contratti a distanza, contratos a distancia) are contracts concluded over distance communication media, such as telephones, telefax, email or the internet (e-commerce; contract (formation)). Their significance has exponentially increased in recent years given the progress in communication technology and, in particular, the spreading of the internet. Since they create various problems, they have spawned legislation in most legal orders and, especially, in the European Union.
a) Basic problems of distance contracts
Distance contracts are different from other contracts in that the contracting parties, using modes of distance communication, do not meet in person. The party purchasing goods or services, therefore, typically runs the risk of being the victim of an information deficit. Since she cannot physically inspect the goods or services before conclusion of the contract, she knows much less about the product than her contracting partner. As a result, search goods, whose qualities and characteristics are recognizable through inspection or handling before the conclusion of the contract, change into experience goods, whose quality and characteristics are recognizable only after conclusion of the contract, namely, after the goods are sent. This, in turn, is problematic because asymmetrical distribution of information may induce an adverse selection process. Specifically, if the purchaser of a product cannot estimate its quality and characteristics before concluding the contract, ie where high-value products cannot be distinguished from low-value products, vendors of lower quality products have an incentive to offer their products at the same price as purveyors of higher quality products. However, purchasers will not be prepared to pay a higher price in such a situation. Since they must be prepared to receive a product of merely average quality for a high price, they will accordingly only conclude a contract where the price corresponds to this expectation of average quality. Since this price is less than that of high-quality products, vendors of such products will be forced to reduce their prices, which they can only do if they reduce the quality. Where they do not do so, they run the risk of being forced out of the market. In both cases a downward spiral can set in, which in the worst case would lead to the collapse of the distance contract market. This risk is accentuated if, alongside the asymmetrical distribution of information, the formation of the distance contract is accompanied by situation specific monopolies. These emerge when a purchaser loses the opportunity to evaluate the offer against others. This is the case, for example, if the offer is made on the telephone or in the context of television programmes and the purchaser must immediately accept or decline the offer.
b) Strategies to solve these problems
To avoid the negative effects of asymmetrical information and situation specific monopolies, various strategies have emerged. They can be classified as either public ordering or private ordering. In Europe, the most important instruments of public ordering are found in the Distance Contracts Directive (Dir 7/1997) and the Financial Services Directive (Dir 65/2002). Both are applicable to almost all contracts made by the exclusive and systematic use of distance communication means. However, their scope of application is restricted to contracts between professionals and consumers (b2c) (consumers and consumer protection law). Not included are distance contracts between professionals (b2b) and distance contracts between consumers (c2c), although information asymmetries and situation specific monopolies can occur here too. For distance contracts falling within the scope of application of the two directives, various mechanisms have been designed to ameliorate the above-described problems. In particular, the directives oblige the professional to provide certain information to the consumer before the conclusion of the contract (information obligations (consumer contracts)). Moreover, they allow the consumer to withdraw from the contract within a certain time without giving reasons (right of withdrawal). Concerning the level of private ordering, these two instruments are supplemented by reputation mechanisms and quality signals.
2. Professional’s duty of providing information
With the information duty of the professional, the Distance Contracts and the Financial Services Directives attempt to overcome the typical information deficit afflicting the consumer in distance contracts by obliging the professional to provide certain information before the formation of the contract (contract (formation), information obligations (consumer contracts)). Specifically, pursuant to Art 4 of the Distance Contracts Directive and Art 3 of the Financial Services Directive, the professional must reveal or make available its identity and its address, the main characteristics of the goods or (financial) services, the price of the goods or (financial) services including all taxes, delivery costs and the arrangements for payment, delivery or performance. Where the information is given orally, Art 5 of both the Distance Contracts and Financial Services Directives requires the professional to subsequently send a written confirmation that contains the contractual conditions and the details of the right to withdraw. Since the information duty of the Distance Contracts and the Financial Services Directives allows the consumer to benefit from important information, it helps to resolve the information asymmetry typically present in distance contracts.
However, this alone does not mean that the professional’s information duty represents an efficient way of combating the problems of distance contracts or protecting consumers. Since it increases the costs of contracting, the information duty only proves efficient if its advantages pay for and exceed these costs. This, however, is questionable: the information duty is supplemented by the consumer’s right to withdraw from the contract within a certain period of time. During this period, the consumer can determine whether the product meets her expectations and needs. Since she can do so better after receipt of the goods or (financial) services than she can after receipt of the information provided before the conclusion of the contract, much can be said for the argument that the information duty needlessly increases the costs of contracting at the consumer’s expense.
However, the efficiency of the information duty is questionable for yet another reason: it is unclear whether and to what extent it achieves its stated goal, namely enhancing consumer decisions by supplying information. The burden of reading the information will be taken on by the consumer only if the associated costs do not exceed the expected benefits. If this is not the case, ie where the costs are higher than the benefits, the consumer will decline to read the information (rational ignorance). But even where the consumer examines the information sent, this does not mean that the consumer will be better informed. Studies from the fields of consumer and behavioural science show that the decisions of consumers do not improve when the amount of information transmitted exceeds a certain level. Obviously, the human capacity for taking on and processing information has limits and more information will not necessarily mean more understanding. On the contrary, after a certain threshold, more information reduces the quality of decision making because important information is no longer perceived as such. Against this backdrop, it cannot easily be determined whether the information duty imposed on businesses helps to overcome the informational asymmetry in distance contracts described above or whether it does so in an efficient way. But even where both queries are answered in the affirmative, there is no doubt that the information duty cannot completely protect consumers from the dangers of distance contracts. The most comprehensive—oral or written—information cannot replace personal experience with and the physical examination of the purchased goods. Also, situation specific monopolies can only be partially remedied by information duties. It is therefore obvious that the information duty can only be one building block in the system of consumer protection afforded in the context of distance contracts.
3. The consumer’s right of withdrawal
The second and, in practice, more important instrument for solving the problems associated with distance contracts is the consumer’s right of withdrawal (right of withdrawal). It is to be found in Art 6 Distance Contracts Directive as well as Art 6 Financial Services Directive and permits the consumer to withdraw from the contract within a certain period of time. The period for goods and services is a minimum of seven working days and for financial services 14 calendar days. For distance contracts relating to the sale of goods, it begins with the receipt of the goods and, otherwise, with the conclusion of the contract. Other than the use of legal warranties, the right of withdrawal does not require the giving of reasons. The unravelling of the contract is therefore possible even if the goods or (financial) services are in conformity with the contractual promise.
Like the professional’s information duty, the right of withdrawal serves, primarily, to balance the information deficit that the consumer faces in distance contracts. Through the possibility of examining, handling and testing the goods, the consumer is able to collect the same information she would have been able to collect had she purchased the goods in her own locale. At the same time, the right of withdrawal mitigates the negative effects of situation specific monopolies since, during the withdrawal period, the consumer can consider and evaluate offers of other vendors in order to decide whether she has obtained a good bargain. The right of withdrawal can therefore prevent a situation in which the consumer is tied to a contract that fails to meet her preferences and that, consequently, is inefficient. In addition, the right of withdrawal can promote efficient behaviour on the part of the professional: since the unravelling of the contract is expensive and difficult, a rational vendor will attempt to keep the number of withdrawals as low as possible. In particular, the vendor will attempt to avoid asking too high a price, falsely representing or misdescribing the product and exploiting moments of surprise. On the condition that the consumer makes use of the right of withdrawal and does not refrain from doing so due to higher transaction costs, the right to withdraw from the contract thus induces efficient behaviour on the part of the professional.
Against this background, the right of withdrawal mitigates the problems associated with the conclusion of contracts by means of distance communication. However, whether it improves the efficiency of distance contracts or secures the functionality of the distance contracts market is —as with the professional’s information duties—not certain. This is because the right of withdrawal carries with it at least two problems: first, the contract becomes more expensive due to temporal delays and the increase in legal uncertainty. Second, and practically worse, it entails the risk of opportunistic consumer behaviour. If the consumer can use the goods or the financial services during the period of withdrawal, she is incentivized to take the value of the goods or (financial) services and still avail herself of the right to withdraw from the contract. The same applies where the value of the goods or (financial) services regularly or typically changes due to external circumstances. In both cases, an unlimited right of withdrawal leads to an enrichment of the consumer at the cost of the professional—an enrichment that has nothing to do with the purpose of the right of withdrawal. Article 6(3) of the Distance Contracts Directive, therefore, excludes the right of withdrawal where the risk of opportunistic conduct is particularly high. For example, there is no withdrawal right in contracts for the delivery of audio and video recordings or computer software nor in contracts for the provision of gaming and lottery services. Further, the right of withdrawal is excluded pursuant to Art 6(3) of the Distance Contracts Directive and Art 6(2) of the Financial Services Directive in contracts for, respectively, the delivery of goods or the provision of (financial) services whose price is dependent on fluctuations in the financial market which cannot be controlled by the supplier.
The two directives, thus, attempt to reduce the danger of opportunistic consumer behaviour created by the right of withdrawal. However, due to unfortunate rules on the one hand and ill-fated formulations on the other, these attempts are not always successful.
An example of an unfortunate rule is the duty of the professional to pay the costs of return, which is provided for in Art 6(2) of the Financial Services Directive and by some national legal orders. It reduces the consumer’s incentive to make reasonable efforts prior to the conclusion of the contract to check the suitability of the goods or (financial) services. Since the consumer does not assume even the most minimal risk in the ordering process, she is encouraged to order goods on the off-chance of a satisfactory result and, where this does not prove true, to return the goods at the cost of the professional.
An example of an ill-fated formulation is that of Art 6(3) of the Distance Contracts Directive excluding the right of withdrawal for contracts for the delivery of audio and video recordings or computer software. A natural reading of the provision requires that the consumer unseal the product before the exclusion becomes valid. As a result, the right of withdrawal still seems to exist for products that were never sealed in the first place and, in fact, this is the interpretation that prevails in the literature. However, it implies that the consumer can withdraw from contracts for products even where the professional is incapable of ‘sealing’ the product, eg where it is downloaded from the internet. Article 6(3) of the Distance Contracts Directive, thus, increases the risk that the consumer acquires the value of unsealed goods and then avails herself of the right of withdrawal at the cost of the professional. This danger would be reduced if Art 6(3) of the Distance Contracts Directive was interpreted in a manner that did not rely on the sealing of the product so that the right of withdrawal was excluded irrespective of the existence of a seal. The unsealing mentioned in Art 6(3) of the Distance Contracts Directive would accordingly constitute an additional requirement for sealed products whilst not affecting originally unsealed products. However, such an interpretation is generally rejected with the justification that exclusionary provisions such as that of Art 6(3) Distance Contracts Directive are to be interpreted narrowly. The ill-fated formulation of the provision, therefore, leads to the result that the Distance Contracts Directive cannot entirely extinguish the dangers created by the right of withdrawal.
4. Reputation and quality signals
That the risks connected with distance contracts are dealt with by means of the Distance Contracts and Financial Services Directives, and therefore on the level of public ordering, does not mean that they are the only instruments for reducing the unwanted side-effects of information asymmetries and situation specific monopolies. In fact, next to the above-described public ordering mechanisms, various mechanisms are in place on the level of private ordering.
The most important private mechanism that can mitigate the risk of a collapse of the distance contracts market is the reputation mechanism. By potentially influencing future sales or losses, it encourages the professional to behave respectably independent of any legal obligation. It works by facilitating access to information about the conduct of the professional in earlier transactions. The access to the relevant information is typically provided by the repeated conclusion of contracts and the build-up of long-term business relationships. As a means of overcoming information asymmetries, such a mechanism is even implicitly acknowledged by the above-mentioned directives: according to Art 3(2) of the Distance Contracts Directive, the provisions of the directive do not apply to contracts for the delivery of foodstuffs, beverages or other goods intended for everyday consumption supplied to the consumer’s home, to his residence or to his workplace by regular roundsmen. Next to the build-up of enduring business relationships, which directly furnish the consumer with information about the business, the reputation mechanism can work by providing information about trade with other consumers. The most important data-stores are to be found on the internet, specifically in reputation portals like <www. epinions.com> or information platforms like <www.tripadvisor.com>. But also businesses like eBay and Amazon, which function as virtual marketplaces, contribute to the spreading of information about the conduct of businesses by asking for assessments of the conduct of trading partners, later visible to others.
Aside from reputation mechanisms, information asymmetries in distance contracts can also be overcome by the transmission of credible quality signals. They permit the consumer to draw conclusions about the otherwise invisible quality of the product. Important signals in this sense are contractual guarantees and warranties. Since the provision of a guarantee entails costs for the professional, this signal cannot be imitated easily by other offerors. As offerors of a low-quality product must calculate that a guarantee or warranty will regularly be claimed, it can only be provided by significantly elevating prices. Thus, the provision of a guarantee or warranty signals to the consumer a certain quality that she would not otherwise recognize. The same effect can be achieved through memberships in acknowledged trade associations or quality seals. These also send signals about the otherwise indeterminable quality of goods or (financial) services and reduce the typically asymmetrical know- ledge between consumers and professionals that is prevalent in distance contracts. Private regulatory mechanisms, thus, complement the various instruments of public ordering and ensure the orderly performance of distance contracts as well as the proper functioning of the distance contracts market.
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