Unfair Contract Terms – analysis and toolkit

Article written by Keypoint Law Consulting Principal, Andrea Beatty, and Associate, Jack McIntosh; as published in the LexisNexis Financial Services Newsletter 2016, Vol 15, No. 5  

Unfair Contract Terms – analysis and toolkit

From 12 November 2016, the Unfair Contract Terms Law (UCTL) that provides protections for consumers will be extended to include standard form small business contracts (SFSBCs).

The Australian Securities and Investments Commission (ASIC) expects businesses to review their SFSBCs to remove any “unfair terms” before the UCTL comes into effect.

ASIC released guidance in February 2016 on the UCTL for small business financial products[1]. This article explains what steps need to be taken to achieve compliance with UCTL for small business (UCTSB).

This article takes into account the ASIC guidance information. It also discusses guidance released by the Australian Competition and Consumer Commission (ACCC)[2] for non-financial products and services.

ASIC is responsible for enforcing the UCTSB for financial products and services. The ACCC is responsible for enforcing the UCTSB for non-financial products and services that are regulated by the UCTL.

What is a standard form contract?

A contract stipulates and formalises the agreed terms between two parties. Where an inequality in bargaining power exists between the parties, the more powerful party can dictate the terms of the agreement in the form of a standard form contract and offer it to the less powerful party on a “take it or leave it” basis, giving the less strong party little or no opportunity to negotiate.

What is a small business contract?

A “small business contract” is one where:

• the contract is for the supply of goods, services (including financial services and products, including credit) or sale of (or grant of an interest in) land;

• at the time the contract was entered into, at least one party is a business employing less than 20 persons (including a not-for-profit business); and

• the “upfront price” payable is equal to or less than:

— $300,000; or

— $1 million if the duration of the contract is more than 12 months.

The UCTSB may apply to industry arrangements — even if industry codes of practice apply, including the Franchising Code of Conduct.

Therefore, franchising agreements that fall within the definition of small business contract will need to be reviewed for compliance with the UCTSB regime.

What is an unfair contract term?

When determining whether a term is “unfair”, the courts will examine the transparency of the term in question as well as the contract as a whole.

When examining the contract as a whole, the court will determine if the unfair term is counterbalanced by additional benefits being offered to the affected party. ASIC considers a term to be transparent if it is[3]:

• legible;

• written in reasonably plain English;

• presented clearly; and

• readily available to any parties affected by the term.

ASIC highlights the UCTL which states that a term is deemed unfair if[4]:

• it would cause a significant imbalance in the parties’ rights and obligations arising under the contract;

• the term is not reasonably necessary to protect the legitimate interests of the party benefiting from its inclusion; and

• the term would cause financial or other detriment to a small business if it were applied or relied on.

Examples of UCTSB terms

The ACCC gives examples of terms of an SFSBC which may be deemed unfair[5]. They include but are not limited to terms that exclusively:

• empower one party to avoid/limit its contractual obligations;

• empower one party to terminate the contract;

• empower one party to determine whether the contract has been breached;

• penalise one party for breaching/terminating the contract; and

• empower one party to vary contractual terms.

Powers of the court

If a court finds that a term in an SFSBC is unfair, there are various orders that can be made, including[6]:

• determining that the unfair term(s) is void, making it unenforceable. However, the rest of the contract is still binding;

• determining that the entire contract is void;

• varying the unfair term(s) of the contract;

• refusing to enforce the unfair term(s) of the contract;

• refusing to enforce the entire contract;

• directing the party to refund the affected party or to return the affected party’s property; and

• directing the party to provide services, at its expense, to the affected party.

Coverage of UCTL

The UCTL will apply to SFSBCs entered into or renewed on or after the enforcement date of 12 November 2016. As stipulated by ASIC, the protections apply in the various ways set out below[7].

• If a term of the SFSBC is varied on or after the enforcement date, the protections will only apply to the varied term.

• If an SFSBC is automatically renewed on or after the enforcement date, the protections will apply to the entire contract from the date of renewal.

• If a contract is automatically renewed on a periodic basis (e.g. monthly) and it is renewed on or after the enforcement date, the protections will apply to the entire contract from the date of renewal.

• If a contract is entered into on or after the enforcement date, the protections will apply to the entire contract.

The UCTL will apply to SFSBCs entered into between:

• a small business and a non-small business (such as a large company);

• a small business and a small business; and

• a small business and a consumer.

Which contracts and terms are not covered?

The UCTL does not apply to insurance contracts regulated by the Insurance Contracts Act 1984 (Cth), nor does the UCTL apply to shipping contracts, company constitutions and constitutions of like bodies[8].

Although this has not occurred in any other sector where the UCTL applies, the responsible minister reserves the power to determine that SFSBCs of a specific sector (e.g. small business loans) are exempt from the UCTL and specify another equivalent and enforceable law to apply instead. These exemptions must be applied for. Applications to the Minister are considered on the following basis:

• public interest;

• the impact of providing the exemption; and

• the impact to small businesses of prescribing the equivalent enforceable law.

The following terms are excluded from the UCTL:

• terms that stipulate the “upfront price payable”;

• terms that are required or expressly permitted by state, territory or Commonwealth law; and

• terms that define the main subject matter of the contract, such as the term which stipulates the service that is being acquired.

Impact summary

From 12 November 2016 onwards, certain terms within renewed SFSBCs, certain varied terms within existing SFSBCs as well as terms in SFSBC precedents will be considered unfair.

These unfair terms will be void and unenforceable unless the commercial basis for the provision for the term is included in the provision. Additionally, the commercial basis must be deemed fair and reasonably necessary to protect the legitimate interests of the party benefiting from the term.

If the unfair term(s) within a contract is deemed void, there is a risk of the commercial value of the contract being compromised, leaving a party stuck with a contract that may no longer be commercially viable. Other negative impacts include:

• negative impacts to the reputation of the business;

• further court orders to compensate the party to the contract affected by the unfair term;

• potential injunctions as well as specific performance orders being placed on the business; and

• possible penalties for misleading and deceptive conduct being placed.

Questions to ask

Do I use standard form contracts?

The UCTL brings into force an assumption that a contract is a standard form contract. This places the burden on a party to disprove the assumption.

There are various characteristics that distinguish a standard form contract from other contracts. These characteristics include:

• an imbalance of bargaining power existed with the other party at the time when the contract was entered into;

• the contract was pre-prepared by one of the parties prior to any transaction being entered into with another party;

• the terms consider and cater for the specific attributes of the party who prepared the contract; and

• the contract was offered on a “take it or leave it” basis, rather than giving the other party an effective opportunity and an open dialogue to negotiate the terms of the contract.

Another defining characteristic that will determine whether a contract is covered by the UCTL is the “upfront price”. The upfront price is the consideration that is paid or is to be paid under the contract.

The UCTSB only provides protections for small business contracts with an upfront price and contract length that fall within a specific range. These ranges include:

• contracts with a maximum upfront price of $300,000 with any specified period; or

• contracts with a maximum upfront price of $1 million and which specify a period of at least 12 months.

Could any of the clauses in my standard form contract precedents be considered unfair?

ASIC gives the following examples for UCTSB for financial products and services:

Example of a lender’s legitimate interest:

A small business obtains a loan, which is secured via a mortgage to the small business borrower’s residence. The contract contains a term stipulating that excessively large default fees will be applied upon default of payment by the borrower.

It is likely this term will be deemed unfair as it imposes a cost on the small business that exceeds the amount required to protect the lender’s legitimate interests[9].

Example of automatic rollover:

A small business enters a fixed-term lease for goods with an automatic rollover to a new fixed-term lease if the goods are not elected to be purchased or returned by the small business at the end of the term. Termination fees apply to exit the new lease contract.

The automatic rollover term will likely raise concerns as it enables the lessor to automatically renew the contract without the consent of the small business[10].

Example of a right to unilaterally vary the contract:

A small business obtains a loan. The loan contract contains a term that empowers the lender to vary any term/condition of the contract if written notice is provided. The small business does not have the right to end the contract.

The term will likely raise concerns as it empowers the lender to unilaterally increase the price and the small business does not have the right to immediately cancel the contract in the event that occurs[11].

The ACCC gives the following examples of potential UCTSB in the context of non-financial products and services.

Example of a term limiting liability:

A small business contracts a company to remove furniture. A term of the contract stipulates that no liability be accepted by the company for any loss or damage suffered by the small business.

This term likely raises concerns as it limits rights that the small business would have against the company[12].

Example of a term removing the right to refund of deposit:

A small business contracts a supplier to provide car parts. Under the contract, the parts must be supplied by a certain date. If the parts are not supplied by the date, the small business can terminate the contract but it must forfeit its deposit.

These terms will likely raise concerns as they penalise the small business for terminating the contract in circumstances where the supplier has breached the contract[13].

Do I have any existing contractual relationships with small businesses?

For the purposes of the UCTL coverage, a small business is defined as a business that employs less than 20 people (including casual employees employed on a regular or systematic basis).

As a business fluctuates in staff numbers, the relevant point in time to determine whether a party has entered into a contract with a small business is at the time the contract was renewed, varied or entered into. It is important to note that casual staff employed on a regular and systematic basis will be included in the employee count.

It is crucial to determine the number of staff employed by the parties because in order for the UCTL protections to cover the contract, at least one party to the contract must fall within the definition of “small business”.

With the above points in mind, businesses that employ fewer than 20 staff should review the terms of any contracts under consideration on a clause-by-clause basis.

How to achieve compliance with UCTL

AUCTSB compliance implementation project should be carried out in three stages.

Stage 1 — planning and information gathering

• develop criteria to identify “small business” customers;

• identify current possible SFSBCs; and

• apply “upfront price” ranges to identified SFSBCs.

Stage 2 — analysis and decision-making

• develop criteria to identify when a term may be “unfair”;

• consider and document the commercial rationale on which any “unilateral” rights or other potential unfair terms are founded;

• determine whether the potential unfair terms are legitimate and extend no more than is reasonably necessary;

• consider the legal right conferred by a potentially “unfair term” and create compliant innovative legal solutions with similar effect;

• develop pro forma clauses to replace potential unfair terms;

• track issues and action items;

• analyse impact and risk (different terms may carry differing risks if declared “unfair” for example, a term including a fee or charge is more likely to be challenged in a court proceeding and may lead to refunds);

• decide on implementation methods; and

• ensure your contracts transparently address renewal and end-of-term arrangements.

Stage 3 — outcomes: both compliance and commercial

• deliver project outcomes, including: — staff training; — systems changes; — clear revisions to standard form contracts; — follow through and resolution of action items; and — legal sign off;

• develop processes and procedures to detect potentially unfair terms;

• maximise customer confidence and satisfaction; and

• ensure compliance.

Action plan and practical tips

Prior to the 12 November 2016 enforcement date, all affected businesses must review and amend their SFSBC precedents and procedures relating to their existing and future small business clients to ensure compliance with the new regime. It is recommended that businesses with current and future SFSBCs held with small businesses:

• develop and implement a compliance plan;

• if the organisation is large, establish a project team to develop and implement the compliance plan;

• develop and implement a process to accurately identify existing small business clients each time a contract is renewed or varied;

• develop and implement a process to accurately identify small business clients each time a contract is entered into;

• review your standard form contracts development procedures;

• identify the contracts which fall within the scope of the UCTL and review the identified contracts clause-by-clause;

• isolate the identified clauses that may be considered unfair and develop compliant clauses which achieve the same outcome or develop and insert a fair commercial basis to justify the clause;

• classify clauses and create UCTL-compliant clauses to be used in all SFSBCs;

• develop and implement training for staff members who will be handling standard form contracts; and

• review arrangements with third parties who may assign contractual relationships to your business (such as contractors) to ensure the contracts they utilise are UCTL-compliant.