Thursday, 2 March 2017

Clear and Present Danger: Spotlight on Unfair Contract Terms in Small Business Contracts


Introduction

It is vitally important for all Australian businesses to have a thorough understanding of the new Unfair Contract Term (UCT) laws in relation to small business contracts.  These laws, which came into effect on 12 November 2016, state that any term in a small business standard form contract which is found to be an UCT will be void and unenforceable. While it is ultimately up to a court or a tribunal to determine whether a term is an UCT, the Australian Competition and Consumer Commission (ACCC) and the Australian Securities and Investment’s Commission (ASIC) have now signalled that they will be taking enforcement action in relation to UCTs which they find in small business standard form contracts.

Why was the UCT law introduced?

As explained by the ACCC, the new UCT laws were needed due to the prevalence of UCTs in small business standard form contracts. As stated by the ACCC -[1]
  • 60% of small businesses claimed to have experienced unfairness in terms and conditions;
  • 44% of small businesses reported experiencing some harm as a result of unfair terms;
  • Small businesses are less likely to thoroughly review the contract due to the fact that such contracts are often too complicated and the small business lacks the requisite legal expertise; and
  • 30% of small businesses advised that they spend less than 9 minutes reviewing each standard form contract.
The ACCC also found that on average small businesses were offered about 8 standard form contracts over a twelve-month period.

How does the UCT law work?

There are number of discrete steps which businesses need to work through to determine whether a particular term is a UCT:
  • Is the contract a standard form contract (SFC)?
  • Is the SFC being offered to a small business?
  • Is the value of the SFC below the statutory contract value thresholds?
  • Is the contract term or the particular type of contract excluded from the new laws?
  • Is the term unfair?
  • Is the term transparent?
  • Have we looked at the whole contract?
1. Is the contract a standard form contract (SFC)

A SFC is a contract which is offered on a take it or leave it basis. In other words, the terms of the contract are not subject to negotiation between the parties. 

Section 27(2) of the ACL sets out a range of factors which a court may take into account to determine whether a contract is a STC:[2]
  • Whether one of the parties has all or most of the bargaining power;
  • Whether the contract was prepared by one party before any discussion relating to the transaction occurred between the parties;
  • Whether another party was, in effect, required either to accept or reject the terms in the contract in the form they were presented;
  • Whether another party was given an effective opportunity to negotiate the terms of the contract; and
  • Whether the terms take into account the specific characteristics of another party to the particular transaction.
Importantly, section 27 of the ACL creates a reverse onus of proof in relation to whether a contract is a SFC. This section states that if one party to a proceeding alleges that a contract is a SFC, it is presumed to be a SFC unless the other party proves otherwise. Accordingly, larger businesses will have to prove that the contract is not a SFC, which they may be able to do by disproving the factors listed above.

2. Is the SFC being offered to a small business?

If the contract is determined to be a SFC, the next step is to determine whether the SFC has been offered to a small business. 

The UCT laws only apply to SFC’s which are offered to small businesses which are defined as businesses which employ less than 20 people, including casual employees, employed on a regular and systematic basis.

The calculation of the number of employees is made at the time the contract is entered into. This means that an increase in the number of employees employed by a small business, to more than 20 employees, after the entry into various SFCs will not have the effect of excluding its SFC’s from the UCT laws. By the same token, a reduction in the number of staff employed by a business, to below 20 employees, after the entry into various SFCs will not transform all of that business’s SFC into SFC’s which are subject to the new UCT laws.

The ACCC has suggested that if a large business is in doubt about how many employees a business they are dealing with has, they should seek a written assurance from the small business about its employee numbers. The other option suggested by the ACCC is to simply assume that the contract is caught by the new small business UCT laws.

3. Is the value of the SFC below the statutory value limits?

In addition, the employee requirement, there is also contract value threshold which must be satisfied before the new UCT laws apply. The current thresholds are that the total upfront value of the SFC is either below $300,000 for a one year contract or under $1 million for a multiple year contract.

The upfront value of the contract is calculated at the time the contract is entered into and includes any contingent payments which are referrable to the supply. 

However, as explained by the ACCC, any amounts which cannot be calculated with certainty at the time of entry into the contract are unlikely to be included in the upfront price. For example, a franchise royalty which is expressed as a percentage of the franchisee’s sales will not be included in the upfront price calculation. This approach to calculating the upfront price will result in a much large number of SFCs being caught by the new UCT laws for small business.

4. Is the contract term of contract excluded from the new laws?

The next step is to work out whether any of the various exclusions apply.

The most significant exclusion relates to the upfront price payable. The legislation makes it clear that a term which “sets the upfront price payable under the contract” is not an UCT. In other words, the new UCT laws cannot be used by small businesses to effectively argue that the price payable under the contract is unfair and as such that they have no obligation to pay for the goods or services. 

Section 26 of the ACL also excludes terms from the scope of the UCT laws if they define the subject matter of the contract. A small business cannot claim that a term giving effect to the supply of the primary good or service is an unfair term. Indeed, it would be a strange result if a small business could allege that a contract for the supply of a particular product was unfair because the small business did not now wish to purchase that particular product.

Other exclusions in terms of subject matter of the term include any terms which are required or expressly permitted by a law of the Commonwealth, a State or a Territory. This could include terms requiring a small business to obtain a particular State or Territory licence or terms which reflect legislative provisions which permitting the limitation of liability (for example exclusion of liability for high risk recreational services).

The legislation also specifically excludes particular types of contracts from the scope of the new UCT laws – namely:
  • contracts of marine salvage or towage;
  • charter party agreements in relation to ships;
  • contracts for the carriage of goods by ship; and
  • constitutions of companies, managed schemes or other bodies.
Importantly, various financial services contracts are subject to the UCT legislation, such as the various SFCs used in the banking sector for credit cards, bank accounts and other financial products.

Unfortunately, most general insurance contracts have been excluded from the reach of the new laws. This exclusion was justified on the basis that general insurance contracts, such as car and home insurance, are currently regulated under the Insurance Contracts Act 1984.

5. Is the term unfair?

Once a business has worked its way through each of the above steps, the next step is to consider the substantive effect of the term and to determine whether that term is unfair. The legislation sets out three factors which, if established, would mean that a term is unfair. 

Two important issues need to be stressed about these three factors. First, these three factors are the exclusive factors which must be proven to establish that a term is a UCT. In other words, they are not three non-exhaustive factors meant as guidance for the court but rather constitute the statutory test which the court must apply. Second, the factors are cumulative in the sense that each factor must be proven in turn in order to establish that a term is a UCT.

A term of a small business contract is unfair if:

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

b. it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and

c. it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.

As is apparent, the first step in the process in determining whether a term is unfair is to assess whether the term itself would cause a significant imbalance in the parties’ rights and obligations. This criterion is not linked to the size of the respective parties, which is only relevant to determining whether the contract is a SFC.

The legislation also states that the term “would” cause significant imbalance. This suggests that courts will only strike down terms will have a “material” and “meaningful” impact on the rights and obligations of one of the parties. Lesser impacts are unlikely to render the term a UCT.

The court will also have to determine whether the term is reasonably necessary to protect the interests of the party advantaged by the term. The use of the term “reasonably” makes it clear that the court will be applying an objective test to determine whether the term protects a business’s legitimate interests.

Finally, the court must be satisfied that the term will cause determine to a party if it were to be applied or relied on. There are three issues to note about this factor:

(a) a party will have to satisfy the court that term will cause practical detriment to a party if it is relied on by the other party. In other words, a mere theoretical detriment is unlikely to be sufficient to satisfy this factor;

(b) a party must show either financial detriment or other detriment. Therefore, non-financial detriments, such as time or inconvenience, or even reputational damage, may be sufficient to enliven the UCT jurisdiction; and

(c) the test is prospective, in the sense that the court will be required to speculate on the effect of the term if it was applied or relied on. Therefore, a party seeking to invoke the UCT laws will not need to show that the term was enforced or even that the other party threatened to enforcement the term. The mere existence of the term in the contract will be sufficient. Additionally, a claim by a business that they would never enforce a particular term will not save that term from being characterised as a UCT.

The fact that a party does not have to prove that the other party has sought to enforce, or threatened to enforce, the alleged UCT expands the reach of the UCT legislation considerably.

6. Is the term transparent?

A further consideration in determining whether a term is a UCT is whether the term is transparent. A term is considered to be transparent if it is:
  • expressed in reasonably plain language;
  • legible; and
  • presented clearly; and
  • readily available to any party affected by the term.
The suggestion in the legislation is that terms which are not transparent are more likely to be characterised as unfair. In practical terms this means that highly legalistic language, small fonts and tightly packed and largely illegible text in SFCs may tip the balance in favour of the term being characterised as an UCT.

7. Looking at the whole contract

A final step in the process will be an obligation on the court to consider the whole contract. While not expressed in the legislation as a final step, in practice it is likely that the court will undertake a final overview of the entire contract before determining whether a particular contract term is a UCT.

The importance of this step is to ensure that a particular term is not being assessed by the court in isolation from the rest of the contract. It is likely that in many SFC’s, a number of terms will work to advantage of one party, whilst other terms will work to the advantage of the other party. Accordingly, it is important to ensure that the court looks at the overall balance of terms in the SFC to make sure that one party is not challenging a particularly disadvantageous term, whilst the same time gaining the benefit of a number of other advantageous terms.

Examples of unfair contract terms

The legislation also helpfully sets out some examples of the types of terms that may be unfair. The following is a summary of the examples of potential UCTs listed in the legislation - namely terms which:

(a) permit one party to unilaterally avoid or limit performance under a contract;

(b) permit one party to unilaterally, terminate, vary, assign, or renew the contract or to unilaterally determine whether the contract has been breached or to interpret its meaning;

(c) penalise one party for a breach or termination of the contract;

(d) permit one party to vary the upfront price payable under the contract without giving the other the right to terminate the contract;

(g) permit one 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;

(i) limit one party's vicarious liability for its agents or its right to sue another party; and

(l) limit the evidence one party can adduce in proceedings or imposes an evidential burden on one party in proceedings relating to the contract.

The main distinguishing feature in the above examples is that they provide one party with unilateral rights and powers under the contract. For example, unilateral rights to terminate the contract without cause or the exclusive right to interpret the meaning of the terms of the contract.

Another important feature of the above examples is whether they may be seen as apportioning contractual risks between the parties in an uneven way. Implicit in these examples is a concern about a larger business forcing a smaller business customer to assume most, if not all, of the contractual risk arising under the SFC.

ACCC Guidance

On 10 November 2016, the ACCC issued a report entitled Unfair terms in small business contracts: A review of selected industries.[3] The purpose of this Report was to provide a breakdown of the common terms of concern identified in particular industries, and to discuss the kinds of changes that businesses made.

Unsurprisingly, the ACCC identified the following types of terms as being of particular concern:
  • Unilateral variation clauses
  • Limited liability and wide indemnity clauses
  • Unilateral termination and renewal clauses
  • Terms imposing early termination charges
  • Cost recovery terms;
  • Liquidated damages clauses; and
  • Overly broad restraints of trade clauses
Additional risk areas

In addition to the areas identified above, businesses should also be conscious of the following potential risk areas:

Whole of agreement terms

Whole of agreement terms are quite standard in most SFCs. These clauses seek to exclude one parties’ liability for pre-contractual representations, particularly pre-contractual oral representations, which may have been made by the large business to the small business customer. I believe that these is a risk that such terms may be found to be UCTs in circumstances where inconsistent pre-contractual representations have in fact been made by the large business and relied upon by the small business customer.

Choice of law terms

Terms which seek to exclude Australian jurisdiction in favour of overseas jurisdiction in relation to transactions made by small businesses within Australia may also be characterised as unfair. While such clauses are likely to be unenforceable to the extent that they seek to exclude mandatory protections such as those contained in the ACL in relation to consumer guarantees, it is arguable that such clauses may also be UCTs. Such clauses are particularly common in the IT industry in relation to the sale of hardware and software products to small businesses.

Arbitration clauses

Arguably a clause in a SFC that states that a small business customer can only obtain a remedy under a SFC through compulsory arbitration in an overseas location, such as Singapore, may be characterised as an UCT, particularly where the contract value is relatively low. This is particularly the case where the term seeks to exclude all other legal avenues and makes binding arbitration in a foreign country the sole and exclusive dispute resolution process available to the small business consumer under the contract.

Class action exclusion clauses

It is also arguable that contractual terms which prevent small business consumers from participating in class action litigation against large business suppliers may be characterised as a UCT. Such terms may be seen as unfairly excluding a small business’s legitimate legal rights to seek redress under the contract by joining a class action.

Conclusions

With the introduction of the new UCT laws for small business SFCs on 12 November 2016 it is vitally important for businesses to carefully review all of their SFCs to ensure that they do not contain any UCTs. This is particularly important given both the ACCC and ASIC have signalled that they will be moving from the education phase to the enforcement phase in relation to the new UCT laws. While the process of reviewing each SFC can be quite a laborious process (particularly for businesses with a large number of SFCs) the costs and inconvenience of undertaking this process are greatly outweighed by the clear and present danger of failing to identify and remove all UCTs from your small business SFCs.


[1] Dr Michael Shaper, ACCC Deputy Chair, Competition & Consumer Issues for SME’s, presentation to SME Committee, Law Council of Australia and Law Society of NSW Conference, ‘Small Business: Still the Centre of Attention”, 25 August 2016.
[2] Section 27(2) ACL
[3] ACCC, Unfair terms in small business contracts: A review of selected industries, November 2016 at http://www.accc.gov.au/system/files/B2B%20UCT%20-%20Final%20-%20Unfair%20terms%20in%20small%20business%20contracts%20%20A%20review%20of%20selected%20industries_0.PDF

1 comment:

Unknown said...

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