The existence of unfair contract laws in Australia is nothing new. The effect of breaching these causes the offending provisions in a contract to be void from the contract’s outset (void ab initio). To date, these provisions have been restricted to standard form contracts to consumers and small businesses (which I’ll refer to below as Contracts).
expansion of this law
On 9 November 2023, the definition of a small business changes as follows.
Current test – contracts for goods, services, a grant of an interest in land, financial services or financial products | New Test – contracts for goods, services or a grant of an interest in land (Australian Consumer Law) | New Test – Contracts for the supply of financial services or financial products (ASIC Act) |
Businesses that employ fewer than 20 people (includes casual employees employed on a regular or systemic basis) Upfront price not more than $300,000; or $1,000,000 if the contract has a duration of more than 12 months | A person who carries on a business and employs fewer than 100 full time equivalent people (includes casual employees employed on a regular or systemic basis) Annual turnover less than $10,000,000 | A person who carries on a business and employs fewer than 100 full time equivalent people (includes casual employees employed on a regular or systemic basis) Annual turnover less than $10,000,000 Upfront Price (excluding interest but including loan principle) not more than $5,000,000.00 |
The focus of the provision is now on the party to the contract rather than the business as a whole. As a result a special purpose vehicle owned by a business with turnover more than $10,000,000 will itself be a small business if it conducts a business. This is a particular risk for financiers of property developers or other enterprises conducting business through an SPV, as a new SPV will have no annual turnover at the relevant time.
Annual turnover is the previous year’s turnover calculated using a formula in the legislation and excludes non-taxable supplies, input taxed supplies (for GST purposes), supplies connected with an indirect tax zone and supplies not connected with the enterprise carried on by the business.
For lenders, this also means that the law may not apply to a loan contract for more than $5,000,000 with a small business, but will apply to a mortgage, any general security agreement or guarantee seeking to charge the land as security for the loan because a different test applies to the “grant of an interest in land”.
new offences
From 9 November 2023:
- It will be illegal to propose, rely on, or try to rely on an unfair provision in a standard form contract to which this law applies; and
- the fines relating to unfair contracts are increasing five-fold, upping the maximum penalty under the Act to $50,000,000.00 for a company and $2,500,000.00 for an individual. For the first time, these will apply separately to each unfair provision, multiplying the maximum penalties by the number of breaches.
A person who proposed an unfair contract provision in a Contract and seeks to rely on it after 9 November 2023 will also have now committed an offence. The maximum penalty is $2,500,000.00 per breach.
Unfair contract provisions
It’s important to note that a provision in a Contract is only unfair if all of the following boxes can be ticked in relation to the provision.
- The unfair contract law must apply to the provision (see the table above). For a small business contract, the contract must be standard form contract.
- 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 who would be advantaged by the term.
- The term would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.
In determining if the provision is unfair, a court must consider the contract as a whole and if the relevant provision is transparent. To be transparent the provision must be in the contract or readily accessible to the party affected by the term. It must also be legible, in plain language and presented clearly.
Provisions in Contracts that are not subject to the Act
Terms defining the contract subject and setting the upfront price payable under the Contract are not subject to the unfair contract provisions. For a loan, this is usually an establishment fee, interest rate or fee payable over the life of the loan even if based on a rate (such as a line fee).
Common Provisions subject to the unfair contract rules
Contingent Fees and Charges
A fee or charge that applies if something subsequently happens is not an upfront fee or charge. Early termination fees that recover actual expenses are allowed, but if they seek to recover a profit, the provision may be unfair. ASIC have published a regulatory guide devoted to early termination fees.
A contingent fee that goes further than recovering costs associated with the relevant event (such as termination) is said to create an imbalance in the rights of the parties and will be unfair if it a) doesn’t protect a legitimate business interest, and b) is in a standard form contract.
Although default rates and early termination fees are subject to the law of penalties, the test and penalties under the unfair contract laws are much tougher.
Some examples of unfair contract provisions
The Bendigo and Adelaide Bank case (Australian Securities and Investments Commission v Bendigo and Adelaide Bank Limited [2020] FCA 716) clearly discusses unfair contract provision in loan contracts between two divisions of the Bank and its customers.
Unilateral rights to change the contract
Clauses allowing one party to vary a contract have been held to be unfair if the other party does not have a right to terminate the contact both without penalty and within a reasonable time before the changes take effect. The court found 90 days was reasonable notice of a change of terms.
Events of default
The following events of default that allow one party to terminate a contract have been held to be unfair whether or not the lender sought to rely on the provisions.
- A default based on a breach of representation and warranty (no matter how inconsequential). The reasoning was that lender could terminate for an inconsequential breach such as a mistake in a director’s date of birth in a document.
- A transaction document being unenforceable because of an illegality. The reasoning was that the clause entitled lender to terminate the contract because of an unfair provision in the contract.
- A material and adverse change clause which allowed the lender to unilaterally form a view as to whether the provision was breached, regardless of the opinion being incorrect or unreasonable.
- Catch-all provisions that operate in vague and undefined circumstances, such as “anything occurs that is similar to the above events of default or has a substantially similar effect”.
The lack of an opportunity for the other party to remedy an event of default was a further reasoning behind the court’s determination that the events were unfair.
Indemnities
Indemnities that did not allow the borrower to mitigate the relevant loss, or unfairly shifted liability to the borrower by making them liable for loss caused by the lender, were also found to be unfair.
What can be done
Parties contracting with businesses will need to consider each contract as a whole before any amendment is made to it. After 9 November 2023, any change made to a contract will cause the new law to apply to the contract.
Business contracts that require compliance with a policy or operational manual will need to consider several issues. Changes to those manuals will invariably be unilateral changes, as often the policies or procedures are not open to negotiation and will be standard form contracts. The policies and procedures themselves are part of the contract, and after having regard to the to protection of the legitimate interests of the relevant party must not contain unfair provisions.
Parties must be prepared to negotiate their contracts in good faith and keep proper records of having done so. The onus of proving this will fall on the party relying on an unfair clause to prove that sufficient negotiation took place to negate the relevant presumptions by the law. This also applies to contracts drafted from a library of provisions or using clauses from similar contracts.
Allowing reasonable cure periods, limiting broad default provisions, and giving reasonable remedy periods will also mitigate the risk of a default provision being deemed unfair. Where the default leads to the loan being terminated, a fair notice period will likely depend on the nature of the default and the circumstances.
Contracts will also need to give reasonable opportunities for the other party to terminate the agreement without penalty if an event occurs which allows the first party to change the contract, such as a change in law or increased costs clause applying.
In some cases, a fair notice period may be greater than the minimum 30 days for the exercise of a power of sale, particularly if it relates to a non-default early termination event.
We have been reviewing our standard loan and security contract provisions and modifying them to mitigate the risk of containing unfair provisions. If you need assistance with this matter for yourself or your business, we can help.
