Introduction and background

The new financial year looks set to be a good one for small business. Following on from the generous $20,000 tax break offered to small businesses in the 2015-16 federal budget, small business stands to further benefit from changes to the Australian Securities and Investment Commission Act 2001 (Cth) (ASIC Act) and theAustralian Consumer Law (ACL) which will see businesses employing less than 20 people offered the same protections against unfair contract terms (UCT) currently afforded exclusively to consumers. The new legislation which was introduced to Federal Parliament on 24 June 2015 is expected to come into effect in early 2016.

Click here to view image.

What sort of transactions will be captured by the new regime?

The proposed amendments will extend existing protections in relation to unfair contract terms to contracts that are defined as a “small business contract”. A contract will be a “small business contract” if:

  • the contract is for the supply of goods, services (including financial services and financial products as defined in the ASIC Act) or a sale or grant of an interest in land;
  • at the time the contract was entered into, at least one party to the contract is a business (including a not for profit business) that employs fewer than 20 persons; and
  • the “upfront price” payable under the contract is not more than $100,000 (or $250,000 if the duration of the contract is more than 12 months). 

The upfront price payable under a contract is the consideration that is provided or is to be provided under the contract and does not include any consideration that is contingent on the occurrence or non-occurrence of a particular event (e.g. amounts payable in the event an option is exercised by one party, or in the event of a default etc).

The new provisions will apply to small business contracts that are entered into on or after the commencement of the amended legislation. The regime will also apply to small business contracts that are:

  • renewed on or after the commencement of the amended legislation, in which case the regime will apply to the entire contract as renewed; or
  • varied on or after the commencement of the amended legislation, in which case the regime will apply to the varied terms.

It is interesting to note that the new provisions will apply to small business contracts regardless of whether the small business is an acquirer (that is, a customer) or a supplier. This is intended to capture situations where small businesses supply goods and services to large businesses often on terms drafted heavily in favour of the large business.

What is the effect of the proposed regime?

The extension of the unfair contract terms regime to small business contracts will mean that a term of a small business contract is void and unenforceable if:

  1. that term is unfair; and
  2. the contract is a standard form contract.

Unfairness

In order for a term of a small business contract to be unfair under the regime, it must be shown that the term:

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

The legislation also requires courts to have regard to the small business contract as a whole and to consider whether the term is transparent when determining whether that term is unfair. A term will be regarded as transparent if it is:

  • expressed in reasonably plain language; 
  • presented clearly; and
  • readily available to any party affected by the term.

Standard form contracts

In addition to being unfair, the term must also be in a standard form contract. Courts must take into account a number of factors prescribed in the legislation when determining if a contract is a “standard form contract”. These include:

  • whether there is an imbalance in the bargaining power between the parties in relation to the transaction;▪        
  • whether the contract was prepared by one party before any discussion relating to the transaction;
  • whether the contract is presented to party on a ‘take it or leave it’ basis;
  • whether a party was given an effective opportunity to negotiate the terms;
  • whether the terms of the contract take into account the specific characteristics of another party; and
  •  any other matter prescribed by the regulations.

A contract will be presumed to be a standard form contract unless a party to the proceedings proves otherwise.

Grey list of unfair terms

Interestingly, section 25 of the ACL and 12BH of the ASIC Act identify a “grey list” of terms that may be regarded as unfair. Examples of terms identified in the legislation as potentially unfair include terms that:

  • permit or have the effect of permitting one party (but not the another) to avoid or limit performance of the contract, to terminate the contract, vary the contract, to assign the contract or to renew or not renew the contract;
  • penalise or have the effect of penalising one party (both not another) for a breach or termination of the contract; or
  • permit or have the effect of permitting one party to vary the upfront price payable (without the right of another party to terminate the contract), to unilaterally vary the characteristics of the bargain or to unilaterally determine whether the contract has been breached.

Enforcement of the new regime

The legislation does not make it unlawful to include unfair terms into contracts. Rather, it deems terms within small business contracts to be void to the extent that they are unfair.

As currently drafted, the regime requires small businesses to apply to the Federal Court (or lobby the ACCC to apply to the Federal Court) for a declaration that a term of a relevant contract is an unfair contract term.

If a declaration is obtained:

  • a party can then seek an injunction preventing the other party from attempting to enforce the term that has been declared unfair; and
  • an injured person can seek a compensation order against the party that attempts (or has attempted) to enforce the term.

Click here to view image.

While the regime does not carry with it the threat of pecuniary punishment (such as in the case of unconscionable conduct or false and misleading representations), businesses that seek to include, apply or rely on unfair terms in small business contracts may face potentially significant compensatory burdens for engaging in such conduct. In addition, they may also face reputational risks if they choose to engage in such conduct.

The flowchart below may assist in determining whether you will be affected by the extension of the unfair contract terms regime to small businesses.

Will your business be affected by the extension of the unfair contract terms regime to small businesses?

Click here to view image.

How can you prepare for the introduction of the regime?

If your business is at risk of being affected by the new legislation, the new financial year is an apt time to pre-emptively assess the impact of the new legislation on your business and implement necessary programs and strategies to minimise your exposure.

We generally adopt the following processes in reviewing unfair terms:

  1. confirm whether the regime applies. That is, consider whether:
  • you or the parties with whom you contract may employ less than 20 persons;
  • the contract falls within the “upfront price” thresholds; and
  • the contract would be regarded as a “standard form contract”.
  1.  confirm how thorough an approach to compliance you wish to take from a risk-perspective. Because the test for unfairness is so general, it is relevant to consider whether you only wish to address significant “red flag” issues as part of your review, whether you wish to develop extremely “small business-friendly” terms, or something in between;
  2. identify those provisions which create a (significant) imbalance in the rights of the parties. We usually take a highlighter to an agreement to identify these, and these are the provisions which are then carried forward for the next stage of analysis;
  3. determine whether the imbalanced provisions are reasonably necessary to protect your legitimate interests. While sometimes the legitimate interest is obvious, in other situations, it requires considered internal analysis; and
  4. assess whether the provision as drafted protects that legitimate interest and therefore the term is unlikely to be considered unfair.

If your analysis reveals terms within standard form small business contracts that are at risk of being considered unfair, there are several possible approaches that you can adopt to address concerns:

Click here to view image.

Particularly borderline clauses should be drafted with severability in mind. Under the unfair terms regime, the contract continues to bind the parties if it is capable of operating without the unfair term. 

Finally, in our experience, a contract can be amended in ways that do not give up important and necessary protections for your business. Most often we are able to suggest removing “red flag” clauses that are rarely relied upon, or limit over-reaching clauses so that they more closely address the particular risks they were intended to cover in any event.