Buyer better beware when it comes to paying a deposit

Firms routinely use customer's deposits. David Prosser explains why Farepak may not be a one-off scandal

The collapse of Christmas hamper company Farepak, whose customers this week began receiving charitable payments worth just 15p for every pound they have made of festive savings, could be just the tip of the iceberg. While the scandal has caused understandable outrage, consumer groups warn that hundreds of thousands of people are losing out in very similar fashion each year, usually in much smaller - and less widely publicised business failures.

"I'm one of around 1,000 insolvency practitioners in the UK and I personally deal with 10 of these cases a year," says Keith Stevens, a partner at accountancy firm Wilkins Kennedy. "There are thousands of companies going bust every year and taking customers' money with them - while I wouldn't want to sound heartless, the sad truth is that Farepak is a fairly everyday type of occurrence."

In fact, although they may not realise it, consumers are exposed to a potential Farepak-style loss every time they pay for goods or a service and don't receive it immediately.

Buy something over the internet, for example, and there's a chance the supplier could go bust before the products are despatched. Put down a deposit on, say, a kitchen, double glazing, a new car or home furnishings, and you could lose your money if the supplier goes under before the delivery date.

Even an annual magazine subscription is risky - if the publisher goes out of business after three issues, you may not get a refund.

The risk may sometimes be even less obvious. Many products come with extended guarantees and warranties - 10 years on new housing, for example. But if the company providing the guarantee goes bust in the meantime, the promise becomes worthless. The problem is that there are few legal obstacles to prevent companies using customers' deposits and advance payments for their own purposes.

At Farepak, the losses have been especially large because the company had more than 100,000 customers paying in over an extended period. Since it wasn't required to ring-fence this cash, it used the money to shore up the business and then lost it. However, exactly the same thing routinely happens elsewhere, warns Stevens. "Very few companies that consumers pay substantial deposits to are legally obliged to ring-fence customers' money," he says. "When we get called in to deal with corporate insolvencies, we invariably find customers' deposits are used as working capital."

Joanne Barker, a legal adviser at Which?, the consumer group, warns that as Farepak customers have discovered, customers caught out in this way have very few rights. "We hear about these cases very regularly," Barker says. "Unfortunately, as unsecured creditors, customers are at the bottom of what can be a very long queue when it comes to repayments."

As the story below explains, there are some limited ways in which consumers can protect themselves. But consumer groups believe the law needs to be strengthened in order to give customers' more chance of getting their money back.

"There needs to be more protection for customers in this area," says a spokeswoman for Citizens' Advice.

Barker points out that consumers are at risk of becoming victims of rogue operators, as well as legitimate businesses that cease trading. "The lack of consumer protection is pretty surprising," she says. "Especially when you consider how easy it is for companies and their directors to close down and then begin trading again under a different name."

Which? believes schemes of a similar nature to Farepak, which operate almost identically to regulated financial services companies, need to be regulated, particularly where people are handing over money so far in advance of the goods actually being delivered.

However, such regulation would leave customers of many other businesses unprotected and with no way of knowing whether it is safe to hand over money in advance.

How to protect yourself from a future Farepak

* The safest option, if you're paying in advance, is to do so on a credit card. Under Section 75 of the Consumer Credit Act, any purchase made on a credit card for goods or services worth more than £100 (even if you pay less than this on plastic) is protected. If you don't receive what you've paid for, or it is unsatisfactory, you can reclaim the money from your credit card provider if you can't get redress anywhere else.

* An alternative is Visa's "charge back" system, which applies to payments made on debit or credit cards carrying the Visa logo. "Our operating rules allow your bank to reclaim money from the other party's bank," explains a spokesman. "But it is up to your bank to decide whether or not to try and do so - there is no statutory protection for customers."

* Which?'s Joanne Barker also advises people to be very wary about making large upfront payments for goods and services that have yet to be delivered. "With most consumer contracts, you will normally be able to opt to pay on completion, rather than in advance," she says.

* If you're paying a builder or some other kind of company providing work on an ongoing basis, don't pay the full bill in advance. "It's understandable that a builder, say, may want you to pay in instalments, but there is room for negotiation and, in order to protect yourself, try to pay in a way that reflects work that has actually been done."