Unfair contract terms – big changes mean big risk for businesses

30 August 2021
Edward Martin, Partner, Sydney Hazel McDwyer, Partner, Sydney David Smith, Partner, Melbourne Adam Walker, Partner, Melbourne

Many businesses will be familiar with the existing ‘unfair contract terms’ regime in the Australian Consumer Law (the ACL). Draft legislation has been circulated which will implement big changes, including potential penalties of $10 million or more. Businesses will likely need to review many of their contract terms, as the new regime will be much broader and carry much more serious consequences if breached.

The current regime

The current regime is contained in the ACL and, for financial products and services, in the Australian Securities and Investments Commission Act 2001 (Cth).

It applies to a contract if the following three criteria are met:

  1. The contract is a ‘standard form contract’.

There is no definition of ‘standard form contract’ but when deciding if a contract fits this description, a court must consider factors such as any bargaining power imbalance between the parties, whether one party prepared the contract before discussing the transaction with the other party and whether there was an effective opportunity to negotiate the terms.

  1. The contract is a ‘consumer contract’ or ‘small business contract’, within the definitions set out in the legislation.
  2. The contract contains an unfair term. A term will be ‘unfair’ if it:
  • would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
  • is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
  • would cause detriment (financial or otherwise) to a party if it is applied or relied on.

The types of clause that might be considered unfair include:

  • a broad indemnity in favour of just one party;
  • a broad limitation of just one party’s liability under the contract;
  • a right for one party, but not the other, to terminate the contract for convenience;
  • a right for one party, but not the other, to vary the terms of the contract; or
  • an option for one party, but not the other, to renew the contract.

The coming changes

Late last year the relevant Commonwealth, State and Territory consumer affairs ministers agreed to strengthen the existing regime – see their announcement on 6 November 2020.

An exposure draft of the legislation to give effect to the changes has now been released.

The key changes the draft legislation would implement are:

  1. An unfair contract term will no longer be simply void and unenforceable – it will be unlawful and the courts will be able to impose a remedy such as a civil penalty. This will significantly raise the risk for businesses. Consumer advocacy groups, and regulators such as the ACCC, have advocated for this change to provide a stronger incentive to businesses to remove unfair terms from their standard form contracts.

For a company, the maximum amount of the penalty will be the greater of:

  • $10 million;
  • 3 times the value of the benefit the company obtained from the breach of the law (if the court can determine the value of that benefit); or
  • if the court cannot determine the value of that benefit, 10% of the company’s annual turnover.

For a person other than a company (e.g. a sole trader or partnership), the maximum penalty will be $500,000.

Further, each unfair contract term in the same contract will give rise to a separate breach of the law and at least theoretically, could trigger a separate penalty.

  1. Many more contracts will be considered ‘small business contracts’. Essentially, a business contract will fall within the regime if one party to the contract (importantly, this could be either the supplier or the customer) has either:
  • fewer than 100 employees; or
  • annual turnover below $10 million.
  1. The draft legislation provides that if a court finds a contract term to be unfair, then in any subsequent court proceeding a term that is the same, or substantially similar, in its effect will be presumed to be unfair (unless a party to the proceeding proves otherwise). This presumption will apply where the term is proposed by the same person or entity who proposed the term that was found to be unfair, or where the term is part of a contract entered into in the same industry as the contract that contained the term that was found to be unfair.

This means the onus will be on all participants in an industry to monitor any unfair contract term cases the courts decide against their competitors, and ensure they don’t engage in similar practices.

Other tidy-ups

While we’ve summarised the major changes above, the draft legislation contains a number of other ‘tidy-ups’ intended to improve and bolster the regulation of unfair contract terms.

For example, the draft legislation clarifies that the following contract terms will not be subject to the unfair contract terms regime:

  1. a term required, or expressly permitted, by a law of the Commonwealth or of a State or Territory (this exception is already clear in the current legislation);
  2. a term included in the contract, or taken to be included in the contract, by operation of a law of the Commonwealth, or of a State or Territory, that regulates the contract; or
  3. a term whose inclusion has either of both of the following results:
  • one or more other terms are included in the contract, or are taken to be so included, by operation of a law of the Commonwealth, or of a State or Territory, that regulates the contract;
  • such a law requires one or more other terms to be included in the contract.

If the above is a bit hard to follow, the draft legislation gives the following example which may assist. Assume a State law provides that, if a retail lease contains a provision for termination on the ground of proposed demolition of the building containing the leased premises, then provisions set out in the State law are taken to be included in the lease. Exception (ii) above covers the provisions that are set out in the State law and taken to be included in the lease. Exception (iii) above covers inclusion of the provision for termination, since it has the result that the provisions set out in the State law are taken to be included in the lease.

While this may sound a little technical, it will clear up some areas of uncertainty that have been vexing certain industries for a considerable time.

Timeframe

The exposure draft legislation is open for public comment until 20 September 2021.

On that basis, our best guess is that the proposed changes, incorporating any tweaks that might arise from the public consultation process, will be legislated in the first half of 2022.

The new regime will take effect six (6) months after the legislation is passed and receives the Royal Assent. It will then apply to standard form contracts that are new, amended or renewed (but otherwise, it will not apply to existing standard form contracts). That means businesses will have six (6) months to review and amend all of their standard form contract terms – which is not a long period of time given the number and complexity of contract templates that are likely to need review in some businesses.

Implications for businesses

Businesses need to be aware that significant change is coming, and prepare for the need to establish a project to review their ‘standard form’ agreements.

Our experience is that there are a great many agreements in the marketplace that contain terms that are arguably ‘unfair’, however businesses are not overly concerned about them since the existing regulatory regime has not armed regulators to pursue this issue vigorously.

This is precisely why the changes are being introduced. The amended regime is designed to have ‘teeth’ and is intended to give businesses a strong incentive to comply. Once the new regime takes effect, we expect that regulators such as the ACCC will be keen to trawl the marketplace for offending contracts and to make public examples of businesses that don’t have their houses in order.

Therefore, businesses should start planning for the fact that they will need to implement a project to:

  • identify all of their contracts that might be considered ‘standard form contracts’ that are entered with consumers or small businesses, for example standard terms of sale, app licensing terms, loan agreements or standard purchase order terms; and
  • have them reviewed and amended to remove any ‘unfair’ terms, whilst minimising any commercial disadvantage to the business from these amendments.

For a large business that may use numerous template agreements and sets of standard terms across its operations, this could be a substantial project and the business will need to consider whether to resource it internally or to engage external lawyers.

Interestingly, the Regulation Impact Statement that the consumer affairs ministers considered when deciding to make the changes includes an estimate of the legal costs a business might need to incur to prepare for the changes. It states that an external legal review and amendment of a simple contract could cost between $3,000-10,000, while more complex contracts could cost slightly more. Based on our experience, these figures seem about right.

Please contact us if you’d like any assistance preparing for the introduction of the new requirements.

 

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Authored by:

David Smith, Partner

 

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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