Unfair Contracts – A Small Business Risk

On 12 November 2016 new national unfair contracts legislation commenced which results in the invalidity of “unfair terms” contained in certain standard form contracts, if entered into, renewed or varied after that date.

Businesses need to review and potentially renegotiate or amend the terms of such contracts, to avoid the risk of unenforceability. And consider how they go about negotiating standard form contracts.

The Australian Consumer Law provides that a term of a “small business contract” is void if the term is “unfair”, where the contract is a “standard form contract”.

What is a “small business contract”?

A contract is defined as a small business contract if:

  • the contract is for the supply of goods or services, or a sale or grant of an interest in land; and
  • at the time the contract is entered into, at least one party to the contract is a business that employs fewer than 20 people; and
  • the upfront price payable under the contract is no more than $300,000 OR $1 million if the contract is for more than 12 months.

What is a “standard form contract”?

The term “standard form contract” is not defined, and is determined as a matter of objective fact.

However if one party alleges that a contract is a standard form contract, it is presumed to be a standard form contract unless the other party proves otherwise. This could be proved by demonstrating a genuine willingness to negotiate key terms of the contract.

In determining whether a contract is a standard form contract, a Court may take into account any matter it considers relevant, but must take the following matters into account:

  • whether one of the parties has all or most of the bargaining power;
  • whether the contract was prepared by one party before any discussion with the other parties;
  • whether another party was, in effect, required to accept or reject the terms of the contract in the form in which they were presented;
  • whether another party was given an effective opportunity to negotiate the terms of the contract;
  • whether the terms of the contract take into account the specific characteristics of another party or the particular transaction.

An example of a standard form contract is a contract prepared by one of the parties and presented to another party on a “take it or leave it” basis.

When will a term be “unfair”?

A term will be “unfair” if:

  • it would cause a significant imbalance in the parties’ rights and obligations arising under the contract; and
  • it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
  • it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.

The legislation gives examples of unfair terms:

  • a term that permits a party to unilaterally avoid or limit the performance of the contract;
  • a term that permits a party to unilaterally terminate the contract;
  • a term that penalises one party, but not another party, for a breach or termination of the contract;
  • a term that permits a party to unilaterally vary the terms of the contract;
  • a term that permits a party to unilaterally renew, or not renew the contract;
  • a term that permits a party to unilaterally vary the upfront price payable under the contract, without the right of another party to terminate the contract;
  • a term that permits a party to unilaterally vary the characteristics of the goods or services to be supplied, or the interest in land to be sold or granted, under the contract;
  • a term that permits a party to unilaterally determine whether the contract has been breached or to interpret its meaning;
  • a term that limits one party’s vicarious liability for its agents;
  • a term that permits one party to assign the contract to the detriment of another party without that other party’s consent;
  • a term that limits one party’s right to sue another party;
  • a term that limits the evidence one party can adduce in legal proceedings relating to the contract;
  • a term that imposes an evidential burden on one party in legal proceedings relating to the contract.

Some terms are excluded from the “unfair” definition:

  • terms that define the main subject matter of the contract;
  • terms that set the upfront price payable under the contract. In other words, the legislation will not protect parties who have simply made a “bad bargain”.

What happens if a term is unfair?

An unfair term is void (meaning it cannot be enforced in a Court).  However the contract continues to bind the parties if it can operate without the unfair term.

Should I review my existing contracts?

Yes.  The legislation applies to existing contracts that are renewed, and contract terms that are varied on or after 12 November 2016.  This includes contracts that are automatically renewed (rolled over) on or after 12 November 2016, periodic leases (eg month-to-month), and leases which go from a defined term to holding over.

Examples

The following examples are provided by the Australian Competition and Consumer Commission:

1. Right to unilaterally vary the contract

A small business enters into a two year contract for internet services. Under a term of the contract the internet service provider has the right to change its prices or services at any time without prior notice to the small business. The small business does not have the right to end the contract, even if the internet service provider increases the price significantly.

This term is likely to raise concerns as it allows the internet provider to unilaterally increase the price – varying one of the most important terms in the contract.

2. Automatic rollover

A small business enters into a 12 month contract with an advertising company to manage its promotional activities. Despite the 12 month term of the contract, a term in the contract has the effect of automatically renewing the contract for a further 12 months unless the small business gives written notice that it does not wish to renew the contract at least six months before the initial term expires. Under the contract, the small business must pay a large fee if it wishes to terminate the contract early.

This term is likely to raise concerns as it allows the advertising company to automatically renew the contract without the small business’ express consent.

3. No right to refund of deposit

A small business enters into a contract with a supplier to buy car parts. Under the terms of the contract, the parts must be supplied by a date specified in the contract. If the supplier is unable to supply the parts by the deadline, the small business has the power to terminate – however, if it does so, it must forfeit its deposit.

This term is likely to raise concerns as the term penalises the small business for terminating the contract in circumstances where the supplier has not met its obligations under the contract.

4. Right to terminate without cause with liquidated damages

A small business enters into a two year waste management contract.  The agreement provides that the supplier may terminate the agreement at any time by giving the small business 30 days’ notice. Another term of the agreement provides that, if the agreement is terminated, the small business must pay the supplier damages equal to the service fees for the remaining period of the agreement.

The term requiring the small business to pay damages is likely to raise concerns as it allows the supplier to effectively penalise the small business in the event of termination, even if the supplier terminates without cause. Such a term is unlikely to be necessary to protect the supplier’s legitimate interests.

5. Limited liability

A small business enters a contract with a removal company for an office relocation. A term of the agreement states that the removal company accepts no liability for any loss arising in the move, including loss arising as a result of the removal company’s negligence.

This term is likely to raise concerns as it seeks to limit rights the small business would otherwise have against the removal company.

6. Right to terminate franchise agreement with no cause

A franchisee enters into a five year franchise agreement with a franchisor. The agreement contains a term that states that the franchisor can terminate the agreement at any time without cause (i.e. even if the franchisee hasn’t breached the agreement). The agreement also states that if the agreement is terminated, the franchisee will not receive any compensation.

This term is likely to raise concerns as it is unlikely that such a term is necessary to protect the franchisor’s legitimate interests.

7. Franchise operations manual

A franchisee enters into a five year franchise agreement with a franchisor. The agreement contains a term that states that the franchisee must comply with the terms of the operations manual.

This term is unlikely to raise concerns. However, if the franchise agreement requires the franchisee to comply with the operations manual, the operations manual will form part of the franchise agreement. This means that terms in the operations manual can be declared unfair and made void.

In this example, the operations manual contains a term that states that if a customer makes a complaint about the franchisee, the franchisee must pay $500 to the franchisor. This term in the operations manual is likely to raise concerns as it unfairly penalises the franchisee and is unlikely to be necessary to protect the franchisor’s legitimate interests.

8. Right to unilaterally vary a franchise agreement

A franchisee enters into a franchise agreement for a cupcake franchise. A term of the agreement provides that the agreement can be terminated if the franchisee fails to sell a specified minimum number of cupcakes per month. Another term of the contract provides that the franchisor can, at any time and without the franchisee’s approval, change the minimum number of cupcakes the franchisee is required to sell per month.

The term allowing the franchisor to vary the minimum number of cupcakes the franchisee is required to sell is likely to raise concerns as it allows the franchisor to unilaterally make the contract more difficult for the franchisee to comply with. Such a term is likely to cause a significant imbalance in the rights of the parties to the agreement, and is unlikely to be reasonably necessary to protect the franchisor’s legitimate interests.

9. Liquidated damages

A small business enters into an agreement with a larger business to lease equipment for one month. The agreement provides that if the small business damages or loses the equipment, it will be required to pay 50 per cent of the amount that would have been paid to the larger business for leasing the equipment for the next five years. This amount is more than the cost to purchase the equipment new.

This term is likely to raise concerns as it imposes an unfair cost on the small business that does not appear to be reasonably necessary to protect the larger business’ legitimate interests.

10. Wide indemnity

A small business enters into a contract to provide architectural services to a larger business for a particular project. The contract contains a term that requires the small business to indemnify the larger business against all loss and damage arising in relation to the project, including loss or damage caused by the larger business.

This term is likely to raise concerns as such a wide indemnity creates a significant imbalance between the rights and obligations as between the parties and does not appear to be reasonably necessary to protect the larger business’ legitimate interests.”

Questions

Many legal and practical questions arise under the legislation – for example:

1. Is the contract a small business contract, including:

  • how do I work out whether another party to the contract employs fewer than 20 people? Are casual employees counted?
  • how do I work out the upfront price payable under the contract? What if the price depends on future commissions or royalties? Are exit fees counted?
  • does the legislation apply to businesses covered by industry codes?

2. Is the contract a standard form contract?

3. What if the contract consists of multiple documents?

4. What if the contract is partly or wholly verbal?

5. Does the legislation apply to Government contracts?

6. Is a particular contract term unfair?

7. What action can I take if I believe that a contract term is unfair?

8. What happens if a Court declares that a contract term is unfair?

9. Will sub-contractors be able to take advantage of the legislation in contract payment disputes?

10. What should I do to protect my business going forward, including:

  • reviewing and potentially re-negotiating unfair terms in existing contracts that will or may be renewed or varied on or after 12 November 2016;
  • reviewing and potentially amending unfair terms in contracts that will be entered into on or after 12 November 2016;
  • how contracts should be negotiated, in order to minimise the risk of the contract being found to be a standard form contract.

Please contact me if you would like legal advice on any matter concerning unfair contracts.

Greg Carter Litigation Lawyer Perth

“Contact me if you think you have an unfair contract, or want to ensure that you don’t negotiate an unfair contract.”

Greg is responsive, cost effective and commercial. He provides wise counsel and is a delight to work with.

Judy Siddins, former Legal Counsel, Australian Wildlife Conservancy