Unfair contract terms and the burden of knowledge…

6 July 2020
Victor Asoyo, Partner, Brisbane Shantal Evans, Partner, Brisbane Craig Green, Partner, Brisbane Liam Hennessy, Director, Brisbane

On 28 May 2020, the first case on unfair contract terms for bank contracts was handed down by the Federal Court of Australia in Australian Securities and Investments Commission v Bendigo and Adelaide Bank Limited [2020] FCA 716 (ASIC v Bendigo and Adelaide Bank Limited). The court found certain clauses in the contract’s terms and conditions to be unfair within the meaning of section 12BG(1) of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) and declared them void from the outset. The impact this case has on lending institutions that may have similar (quite ubiquitous) clauses in their contracts (e.g. indemnities) cannot be underestimated.

Unfair contract terms have been the focus of regulators and industry bodies alike in recent years. In March 2018, ASIC released a report identifying the types of terms in standard contracts for consumers that could potentially raise concerns under the unfair contract terms law. This article outlines the elements of unfair contract terms provisions for business lending contracts, what we know from ASIC’s guidance, what we know from the case of ASIC v Bendigo and Adelaide Bank Limited, and the implications for affected lenders who rely on these clauses.

UCT Regime for Business Contracts

Since 1 July 2010, ASIC has been able to deal with unfair terms in standard form consumer contracts for financial products and services, including credit products like home loans. From 12 November 2016, the unfair contract terms provisions applying to consumers under the Australian Consumer Law and the ASIC Act were extended to cover standard form ‘small business’ contracts e.g. business loans (UCT Regime).

Section 12BF provides that the UCT Regime applies to contracts for the supply of financial goods or services where:

  • a party to the contract is a ‘small business’ which employs fewer than 20 people; and
  • the ‘upfront price payable’ does not exceed $300 000, or $1 million if the contract is for more than 12 months.

Section 12BG provides that any terms in such contracts which meet the following criteria may be considered ‘unfair’ by a court:

  • the term 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 that would benefit from its inclusion i.e. the bank; and
  • the term would cause financial or other detriment (e.g. delay) to a small business if it were to be applied or relied on.

In deciding whether a term is unfair, a court must take into consideration the extent to which the term is transparent and the contract as a whole. Once found to be an unfair term, the court has the power to make various orders including declaring all or part of the contract void, varying the unfair terms, and refusing to enforce those terms. A term that is void would be treated as if it never existed while the contract remains intact in so far as to operate without it. In effect, parties to the contract would not be able to rely on a term that is declared unfair by a court.

What Could Constitute UCT

In ASIC v Bendigo and Adelaide Bank Limited, the court found that clauses which fell within the following categories were unfair:

  • Indemnity clauses – where the customer may be liable for the liability, loss or costs suffered or incurred by the Bank;

The customer must compensate the Bank if any liability is incurred in relation to circumstances which are, amongst other things, not of material risk to the Bank, not in the customer’s control, and could have been mitigated by the Bank.

  • Event of default clauses – where the Bank can declare an event or circumstance as constituting the customer’s default which would in turn allow the Bank to take certain actions e.g. cancelling the loan facility;

The Bank can call a default and subsequently take disproportionate actions such as cancelling the loan facility and making the outstanding sum payable immediately or on demand under the same unfair circumstances as above and does not permit the customer to remedy the default.

  • Unilateral variation and termination clauses – where the Bank can vary the upfront price and financial services supplied or terminate the contract; and

The Bank has a one-sided discretion to cancel or reduce the loan facility even though the customer is compliant with their loan repayments, and to impose a termination fee on the customer regardless of the reason for termination.

  • Conclusive evidence clauses – where the Bank’s certificate is conclusive evidence of the amount owed unless the customer proves otherwise.

The Bank can place an evidential burden on the customer upon matters which the Bank is better positioned to provide evidence for.

In deciding whether a term is unfair in each of the categories mentioned above, the court mainly drew upon the following criteria:

  • whether the terms would cause a significant imbalance in parties’ rights and obligations: s 12BG(1)(a);
  • whether the terms would cause detriment to a party if relied upon: s 12BG(1)(c); and
  • whether the terms were transparent: s 12BG(3).

The table we have prepared below explains in detail Justice Gleeson’s reasoning in applying these criteria to the clauses in the categories listed above. (Any entities or individuals who use these types of clauses in their documentation may be well advised to study the table to consider if any of the clauses in their document fall within or may fall within these categories.)

In addition, the court found that each of the terms fell within the examples of unfair terms listed in section 12BH of the ASIC Act. The court also considered the contract as a whole in accordance to section 12BG(2)(c) of the ASIC Act and found that there was nothing in the contract which mitigated the unfairness caused by each of the terms.

The industry also has further guidance from ASIC, which has explained that in considering the transparency of a term, ‘Terms hidden in the fine print, or terms that are phrased in legal or complex language, may not be transparent. However, a term that is transparent could still be unfair’. Concerning the assessment of the fairness of a term in the context of the contract as a whole, ASIC elaborated that, ‘For example, a potentially unfair term may be counterbalanced if additional benefits are offered under the contract to the small business. This means that a term could be unfair in one contract but not unfair in another’.

Implications and Next Steps

It is important to note that the clauses were found to be unfair due to the particular way they were drafted, and not because they fell within a particular category e.g. they were an indemnity. The point to be taken away is that terms falling under these categories may now be under greater scrutiny and present a higher chance of being challenged. As a consequence, companies that have the above types of clauses in their contracts need to review them now.

ASIC Commissioner Sean Hughes addressed the urgency for banks to act in response to the outcome of the case. Mr Hughes said, ‘ASIC is committed to protect small business owners of Australia from unfair terms in loan contracts, particularly where business borrowers are confronted with inflexible standard terms. Yesterday’s judgment shows that ASIC will take the necessary steps to enforce the law’. He also warned that, ‘Importantly, insurance firms should be preparing to extend these obligations in insurance contracts.’

For now, lenders who are lending to small businesses and are applicable to the UCT regime should review their contractual documentation to make sure that they are compliant. In turn, insurers will need to undertake the same process (and we are aware that many are already well on their way into this journey).

Our Banking & Finance and Regulatory teams have deep experience in this space and would be happy to assist you. Please reach out to your usual Gadens’ contact if you would like any further information.

 

Table 1:

Case: Australian Securities and Investments Commission v Bendigo and Adelaide Bank Limited [2020] FCA 716

Legislation: Australian Securities and Investments Commission Act 2001 (Cth)

Impugned ClausesIndemnification ClausesEvent of Default ClausesUnilateral Variation and Termination ClausesConclusive Evidence Clauses
Significant Imbalance in Parties' Rights and Obligations:

s 12GB(1)(a)

  • the customer has no corresponding rights;

  • the circumstances in which the liability, loss or costs may be incurred are not within the customer's control (e.g. change in value of the property); and

  • the Bank controls at least some of the circumstances in which the liability, loss or costs may be incurred and are able to avoid or mitigate them.


[51]

  • the default consequences are severely disproportionate (e.g. the Bank can cancel the loan facility even if the customer is meeting all their obligations and making their repayments on time);

  • the clauses do not allow the customer to remedy a default;

  • the clauses create a default based on events that may not cause any credit risk to the Bank (e.g. where misleading or untrue information such as a director’s date of birth is provided);
  • the clauses are written in vague and largely undefined circumstances; and

  • the clauses create an event of default where:


    • the customer makes an untrue or misleading statement which is insignificant (e.g. error as to a director's date of birth);

    • any part of a relevant document may become void or voidable (e.g. due to this litigation which is entirely within the Bank's control and not the customer); and

    • the Bank forms an opinion that something has happened – regardless of whether that opinion is incorrect / an opposite opinion is reasonable, and the customer is not entitled to rectify any matter on which the opinion is based.


    [58], [59], [60]

  • the terms allow the Bank to unilaterally vary the financial services without giving a sufficient notice period to the customer;

  • the terms allow the Bank unilaterally to vary the contract to permit one party, but not the other, to vary the obligations at will;

  • some of the terms allow the Bank to terminate if the customer does not accept the new terms; and

  • the customer has no corresponding rights.


[67]

  • the term allows the Bank to impose, by the issuing of a certificate, an evidential burden on the customer about matters upon which the Bank is best placed to provide primary evidence;

  • the Bank has no additional duty;

  • the customer has no corresponding right; and

  • the customer cannot contest the amount stated in the certificate unless the customer can demonstrate a 'manifest error'.


[76]
Detriment:

s 12GB(1)(c)

  • the liability, loss or costs that may be incurred:


    • are not within the customer’s control;

    • may not have been caused by the customer; and

    • may have been caused by the Bank’s or its agent’s mistake, error or negligence, and could have been avoided or mitigated by them.


    [52]

  • the Bank can cancel the loan facility and make the outstanding sum payable immediately or on demand;

  • the customer would be liable for all costs including an unspecified amount of break costs;

  • there is no right of set-off for the customer but there is for the Bank; and

  • the customer has no rights to remedy the default.


[61]
Termination clauses:

  • the amount of funds available to the customer could be reduced; and

  • the customer must pay unspecified fees and break costs if they terminate the facility as a result of the Bank relying on one of these terms.


[68]


Variation clauses:

  • if the customer accepts the change, it will incur higher fees and charges;

  • if the customer does not accept the change or fails to provide the additional security requested, the facility may be terminated and the customer must pay the outstanding sum within 30 days of the Bank's original request; and

  • unspecified fees and break costs may be payable by the customer.


[69]

  • requires the customer to disprove matters upon which the Bank is best placed to provide primary evidence; and

  • would cause detriment if relied upon in circumstances where the certificate is incorrect but the customer could not or did not seek to disprove it.


[77]
Transparency:

s 12GB(3)

  • does not express the breadth of the borrower's obligation in reasonably plain terms (e.g. the phrase "legal expenses on a full indemnity basis" is not reasonably plain);

  • sets out a multiplicity of cross-references (e.g. a term would refer to 35 definitions – some of which further refers to other definitions); and

  • sets out examples 'without limitation' which does not clearly state the scope of the borrower's obligations.


[54]
N/A

Found to be Transparent

  • usage of complex defined terms (e.g. the term 'Periodic Review' or 'Periodic Revaluation' without any apparent 'periodic' aspect);

  • unclear if there is any limitation on the Bank’s power to act 'by notice to the Borrower';

  • some cancellation clauses are listed under a title which does not indicate that they involve cancellation of the facility (e.g. the clauses' title 'Use of Facility'); and

  • the comprehensive nature of the changes that are permitted by the terms is not indicated in the headings (e.g. the clauses' heading 'Change to Terms' / 'Changes').


[72] [73]

  • the phrase 'determination of any amount … is conclusive in the absence of manifest error' lacks transparency because of its legal language.


[81]

 

 


Authored by:

Craig Green, Partner
Shantal Evans, Partner
Victor Asoyo, Partner
Liam Hennessy, Director

The authors would like to thank Jenn Loh for her assistance and research in preparing this article.

This update does not constitute legal advice and should not be relied upon as such. It is intended only to provide a summary and general overview on matters of interest and it is not intended to be comprehensive. You should seek legal or other professional advice before acting or relying on any of the content.

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