Are you a small business that employs fewer than 20 people? Are you contemplating entering into a standard form contract that involves a financial product or a contract for the supply of goods and or services (including financial services)? Is the upfront amount payable under the contract less than $300,000 or $1 million if the contract is for more than 12 months?
If you said yes to all the above – then your small business contract is likely protected against unfair terms under the Australian Consumer Law and Australian Securities and Investment Commission Act 2001 (ASIC Act).
On 12 November 2016, the unfair contract term provisions in the ACL and ASIC Act were extended to cover terms of standard form contracts to which small businesses are parties.
(To find out more about these changes, read our previous article on our website).
Following this, ASIC has since conducted a review of small business loan contracts offered by the big four banks (Banks). Released on 15 March 2018, the report focused on whether the Banks had brought their small business contracts into compliance with the law.
ASIC found that there were several terms in small business contracts that potentially breached the unfair term provisions.
What is a standard form contract?
A standard form contract is typically a ‘take it or leave it’ contract where the opportunity to negotiate the contract terms is limited. This includes business loan contracts, broker agreements, credit card contracts and contracts relating to the sale or grant of interest in land. Small businesses, given their size, are often vulnerable to ‘unfair terms’ being included in standard-form contracts and have little ‘leverage’ to negotiate out of such terms.
When is a term unfair?
A term in a contract is ‘unfair’ if it:
- causes a significant imbalance in the parties’ rights and obligations;
- is not reasonably necessary to protect the benefitting party’s legitimate interests; and
- would cause detriment to the other party.
Unfair terms may be declared void and unenforceable by a court.
Clauses to look out for
In its report, ASIC referred to several clauses used by lenders that were likely to be unfair in standard form contracts. These include:
1. Entire Agreement Clauses
‘Entire agreement’ clauses typically state that the contract, as agreed by the parties, represents all of the rights and obligations between the parties.
Entire agreement clauses may be unfair if they absolve the lender from any contractual responsibility for conduct, statements or representations that the lender’s staff may have made to small business borrowers about how the contract would operate.
2. Broad indemnification clauses
Clauses that require borrowers to cover losses, costs and expenses incurred due to the fraud, negligence or wilful misconduct of the bank, its employees or agents or a receiver appointed by the bank are likely to be unfair.
In Australian Competition and Consumer Commission v JJ Richards & Sons Pty Ltd  FCA 1224, the court declared unfair and void a broad indemnification clause which required the small business customer to indemnify JJ Richards for all liabilities, claims, damages actions, costs and expenses which may be incurred by JJ Richards as a result of or arising out of or other in connection with the agreement.
3. Event of default clauses
Event of default clauses describe the events or circumstances which constitute a default by the borrower and which entitle the lender to apply default consequences. These default consequences often include – applying default interest rates; requiring immediate repayment of all principal and interest; changing the repayment terms; and/or appointing investigating accountants to report on the business.
ASIC found that non-monetary events of default are often described at a high level of generality. This gives lenders a broad discretion about whether to treat a particular event or circumstance within the general description of an event of default as an actual default.
4. Financial indicator covenant
A financial indicator covenant in a small business loan is a condition about the financial position or operations of the business (typically in the form of a ratio) that the small business borrower must meet. For example, a covenant may specify that the ratio of the value of the loan to the value of the secured property that the loan cannot fall below (the loan to valuation ratio or LVR).
A covenant may be unfair if the contract entitles lenders to treat every breach of a financial indicator covenant as an event of default entitling enforcements action, even where the breach does not present a material credit risk to the lender.
5. Unilateral variation clauses
These terms give lenders (but not borrowers) a very broad discretion to unilaterally vary terms and conditions of the contract, without the consent or reasonable notice to the small business borrower.
A unilateral variation clause can be counterbalanced however if the borrower has sufficient advanced notice of the variation before it comes into effect. This gives the borrower a real and reasonable opportunity to exit the contract without penalty, as opposed to merely accepting the variation.
ASIC’s report provides a timely reminder for both small businesses and lenders to review the terms of their standard contracts. This is particularly important given the recent Banking Royal Commission, which is scrutinising practices within the banking industry.
In saying this, it is often difficult and complex to determine whether a contractual term is unfair. Since the test for unfairness is fact-dependent, it may not seem immediately obvious which terms are allowable, and which terms are unfair for small businesses. Moreover, any contract term must be considered in the context of the contract as a whole and with industry practices.