Contract drafters need to be aware that various clauses standard in IP licences may be considered unfair.
The unfair contract terms (UCT) regime contained in the Australian Consumer Law (ACL), has applied to standard form contracts entered into (or renewed) with small businesses since November 2016. Under these provisions a number of contractual clauses, some of which are routinely used in standard form contracts, including in the intellectual property (IP) field, may be void where they are unfair.
The Australian Competition and Consumer Commission’s (ACCC) Review of Selected Industries identified contractual terms of concern in industries including franchising, independent contracting and advertising – all industries in which IP often plays a strong part. It is likely that licences, distribution agreements and joint venture agreements will, in many instances, constitute “standard form contracts”.
In September the ACCC filed two separate proceedings under the UCT regime alleging that standard form contracts used by a waste management company and, in the second case, a supplier of serviced office space and virtual office services, contain unfair terms. It remains to be seen whether the decisions in these proceedings clarify a number of uncertainties associated with the UCT regime.
What are the unfair contract term provisions?
In a major shake up to the rules of contracting, section 23 of the ACL now provides that a term of a consumer contract or small business contract is void if the term is unfair and the contract is a standard form contract. The remainder of the contract will continue to operate to the extent that it is able to operate without the unfair term.
The UCT provisions apply to standard form contracts where at least one party is a small business (i.e. employs less than 20 employees, including casuals working on a systematic basis) and the upfront price payable is no more than $300,000, or $1 million if the contract is for over 12 months.
A term will be unfair where it:
- causes a significant imbalance in the rights and obligations of the parties;
- is not reasonably necessary to protect the legitimate interests of the party advantaged by the term; and
- would cause significant detriment to the small business if applied or relied upon.
At a minimum, when determining whether a term is unfair the courts must assess the extent to which the term is transparent (for example, where it is hidden in fine print or phrased in technical jargon) and consider the contract as a whole (for example, if there are counterbalancing terms that negate the impact of an otherwise unfair term).
The law does not apply to terms that define the subject matter of the contract, set the upfront price payable or are legally required or permitted. Where a party negotiates a term it is unlikely that the term will be considered to be an unfair term.
What is a standard form contract?
Standard form contracts are typically contracts that are offered on a “take it or leave it” basis. There is a presumption that a contract is a standard form contract, so the party that prepared the contract has to prove it isn’t. An agreement will not be a standard form contract where a small business was given an effective opportunity to negotiate the terms of the agreement, in which case the UCT will not apply. However, it is presently unclear what constitutes an effective opportunity to negotiate. Is it enough to provide a small business with time to negotiate amendments to the terms of the agreement?
Where a party can demonstrate a real willingness to make requested changes to key terms, it is likely that they will be able to prove that the contract is not a standard form contract and the UCT provisions will not apply. We therefore recommend that the contract drafter note on the contract that the terms of the agreement may be negotiated and, if appropriate, highlight clauses which the drafter is aware may potentially be considered unfair and provide the small business with ample opportunity to negotiate such terms. The drafter should also keep records of any negotiations that do take place as evidence that the agreement is not a standard form contract.
Examples of potentially unfair terms
Section 25 of the ACL provides examples of the kinds of terms that may be unfair. These include terms that may permit one party, but not the other, to: terminate, renew, vary the terms, penalise the other for a breach, determine whether the contract has been breached, or alter the characteristics of the goods or services to be supplied. They also include terms that may limit one party’s right to sue another or one party’s vicarious liability for its agents. However, this provision is merely indicative – it does not prohibit the use of these terms, or create a presumption that such terms are unfair (ACCC v Chrisco Hampers Australia Ltd FCA 1204). Furthermore, a clause must be considered in the context of the entire contract – therefore the mere provision of a list of common clauses is not particularly helpful.
Boilerplate clauses, such as entire agreement clauses may be unfair. Where fundamental representations are made prior to an agreement being executed and are not incorporated into the agreement, a clause which negates the impact of such representations may be unjust.
Various clauses that are standard in IP licences may be held to be unfair. For example, IP licences commonly provide that where a licensee makes improvements to the IP being licensed that ownership of such improvements must be assigned to the licensor. Such clauses will need to be constrained to situations where it is reasonably necessary to protect the legitimate interests of the licensor. Where the licensee is paying an excessive licence fee and makes an improvement that has no effect on the field in which the licensor operates it is unlikely that a compulsory assignment of improvements will be considered fair.
ACCC's enforcement action
To date the ACCC has commenced two sets of Federal Court proceedings under the UCT in relation to business to business contracts.
The first legal action under the amended regime is the proceeding against waste management company, JJ Richards & Sons. The ACCC has challenged eight clauses that appear in JJ Richards’ standard form contracts with small businesses, alleging that they are unfair. These include terms which:
- provide JJ Richards’ with the ability to increase prices unilaterally;
- bind customers to subsequent contracts unless they cancel within 30 days of the end of term;
- require the small business to grant an unlimited indemnity for loss in favour of JJ Richards even if the loss is not caused by the small business; and
- require the small business to pay accounts within seven days, failing which JJ Richards may suspend the services but continue to charge fees.
The ACCC is seeking declarations that these terms are void and injunctions to prevent JJ Richards from using the terms in contracts with small businesses.
The ACCC has also instituted proceedings against the office service company, Servcorp Ltd and two subsidiaries in relation to their standard form agreements with small businesses. The clauses challenged for being unfair include terms that enable Servcorp to:
- automatically renew the contract and unilaterally increase the contract price post renewal and without prior notice;
- unilaterally terminate and apply unreasonable termination fees;
- unilaterally determine if the contract has been breached;
- unilaterally acquire the customer’s property without notice; and
- impose unreasonable liability on the customer or unreasonably limit Servcorp’s liability.
The ACCC is seeking declarations that these terms are unfair and void, injunctions, publication orders, compliance program orders and costs.
What should contract drafters do?
These two proceedings serve as a reminder to businesses that use standard form contracts with small businesses to review their terms – including those operating in the IP space.
If a clause is held to be unfair it will be void and struck out, provided that the contract can continue to operate without the term. The unfair term will not be read down. This can have serious ramifications where the clause in issue is fundamental.
One option for the contract drafter is to use cascading clauses, each containing varying degrees of fairness. The contract will need to be capable of operating without the more onerous versions of this term. Whilst cascading clauses which provide for different periods and distances of a restraint of trade are common in employment agreements, it is unclear whether equivalent clauses will be upheld as valid under the UCT provisions. It does however seem in the spirit of the UCT that a clause imposing obligations on the small business only be as broad as reasonably necessary to protect the drafting party’s legitimate interests.
Any terms that may be considered to be unfair, which are not necessary to protect a business's legitimate interests, should be amended. Where relevant, broadly drafted clauses should be narrowed in scope, unreasonable clauses should be made more balanced and notice given to small businesses that the terms of the contract are negotiable.