In May 2014, the Commonwealth Treasury, on behalf of Consumer Affairs Australia and New Zealand (CAANZ), published a consultation paper seeking the public’s views on a number of proposals designed to protect small businesses from unfair contract terms (UCTs) in standard form contracts (Consultation Paper).1

What are unfair contract terms?

Under Part 2-3 of the Australian Consumer Law, a term in a standard form consumer contract is void if it is unfair.  A contract is a ‘consumer contract’ if the contract is for the supply of goods, services or an interest in land to an individual, where the individual is acquiring  the goods, services or interest in land for predominantly personal, domestic or household purposes.  Whether a contract is a ‘standard form contract’ depends on a number of factors, including whether it was prepared by one party before the parties discussed the transaction, whether one party was required to either accept or reject the terms in the form provided to them, and the relative bargaining power of the parties.

A contract term is ‘unfair’ if it would cause a significant imbalance to the parties’ rights in the transaction, if it is not reasonably necessary to protect the interests of the party relying on it, and if the term was applied or relied on, it would cause detriment to one of the parties.  Examples of UCTs include terms that:

  1. allow one party to unilaterally vary the terms of a contract, or unilaterally decide whether to renew or terminate the contract;
  2. allow one party to unilaterally interpret the contract, including whether or not the contract has been breached; or
  3. limit one party’s right to sue the other.

How does CAANZ propose to extend the protections to small businesses?

The Consultation Paper puts forward a number of models for protecting small businesses from UCTs, including non-legislative responses such as industry self-regulation through codes and initiatives, and legislative responses, such as requiring all small business contracts to be negotiated on request.  However, the Consultation Paper’s preferred model is to extend the existing UCTs provisions of Part 2-3 of the Australian Consumer Law to small businesses.

The Consultation Paper also suggests extending the protections to small business and proposes a number of different definitions of a ‘small business’, including:

  1. all businesses except for publicly listed companies;
  2. all business-to-business transactions below a certain value threshold, in a similar manner to that in which a ‘consumer’ is defined in some parts of the Australian Consumer Law;
  3. all businesses that have less than a certain annual turnover, for example, $2 million, in the same way theIncome Tax Assessment Act 1997 (Cth)defines a ‘small business entity’; or
  4. all businesses which have less than a certain number of employees, in the same way the Fair Work Act 2009(Cth) defines a ‘small business employer’.

In our view, some of these proposed definitions could be problematic.  A definition of ‘small business’ based on the turnover of a party or the number of people one party employs carries a degree of uncertainty, and would require contracting parties to inquire into the inner workings of  the other party’s business (though arguably no more than the current definition of ‘consumer’ requires inquiry in relation to consumer contracts).  A definition based on transaction value might be more clear, but choosing a value might be arbitrary and might exclude the most critical or long-term small business transactions from its operation.  A definition encompassing all businesses is clearer still, but such a definition would hardly accord with most people’s understanding of what a small business is.

The Consultation Paper also considers whether contracts between small businesses should be covered by UCTs protections, and whether contracts where a small business is supplying, rather than acquiring, a good or service should be covered by the protections.  CAANZ is seeking submissions from the public on whether the protections should apply in these situations. 

Should unfair contract term protections be extended to small businesses?

Small businesses clearly see UCTs as a real issue – the Consultation Paper reveals that between 1 January 2011 and 25 November 2013, the ACCC received 894 complaints from small businesses in relation to UCTs, primarily in relation to terms that:

  1. automatically extended the term of the contract (148 complaints);
  2. restricted the small business’ right to terminate the contract (136 complaints);
  3. permitted the other party to unilaterally vary the contract (91 complaints); and
  4. limited the other party’s liability or restricted the small business’ ability to enforce their rights under the contract (85 complaints).

In some ways, small businesses are like consumers when entering into contracts.  Small businesses lack negotiating power when contracting with much larger businesses, as well as the time and legal or technical expertise to read and understand all of the terms.  There may also be a cost disincentive to obtaining legal advice on a contract for a comparatively low value. 

Small businesses may also be focused more on the commercial terms of the contract rather than on more ‘legal’ issues like termination, variation and allocation of liability, which are often the subject of UCTs complaints.  As such, these contract terms are less likely to play a significant role for a small business when it is deciding with which business it wants to contract.  For this reason, the Consultation Paper argues, competition between large businesses may not guard against UCTs.

There are obvious costs to small businesses that are bound by UCTs, but the Consultation Paper also argues that UCTs have other costs as well.  For example, UCTs may shift larger risks to the small business, even where the small business is ill-equipped to manage those risks compared to the large business.  This may result in risks passing on to the customers of small businesses, and increase risk in the market overall. 

The Consultation Paper recognises that some large businesses will incur compliance costs as a result of reviewing  their processes, policies and standard form contracts to comply with the extension of UCTs protections.  However, the Consultation Paper makes a number of valid points about how those costs could be minimised:

  1. as an extension of the consumer UCTs protections, businesses won’t have to learn about an entirely new prohibition;
  2. studies in the United States have shown that businesses that supply to both consumers and small businesses rarely have separate contracts for each, so those businesses would either already be compliant, or already be non-compliant, under the existing UCTs protections;
  3. when consumer UCTs protections were introduced, there was little evidence of significant compliance costs or an increase in litigation; and
  4. the cost of reviewing and amending contracts will be limited because, even if businesses decide not to review or amend the terms of their standard form contracts, they will not be penalised for the inclusion of an UCT unless they try to rely upon it.

What are the arguments against extending unfair contract terms protection to small business?

While the Consultation Paper puts forward some interesting arguments about the management of commercial risks and costs, in our view, there are a number of reasons why extending the UCTs protections to small businesses might increase the cost of doing business, not just for large businesses but for small businesses as well. 

An immediate concern might be that large businesses will back away from supplying small businesses, or acquiring goods from small businesses, rather than risk the compliance cost.  The Consultation Paper argues that such a scenario is unlikely because it didn’t happen when UCTs protections were introduced for consumers.  However, that is not a perfect analogy – it would have been unthinkable for large telcos, for example (which routinely use standard term contracts)  to stop supplying an enormous consumer market, but it might be a much easier decision to make for a large retailer to stop buying goods from a range of small businesses and move to one large wholesaler.  That possibility becomes even more likely if that large retailer starts to see an appreciable increase in the risk and cost it bears when contracting with small businesses despite the contracts being on “fair” terms.

We consider that there may also be significant compliance costs for reviewing and amending standard form contracts to comply with the extension.  Those costs would include reviewing and amending standard form contracts, but also might include changes to business processes if UCTs are entrenched in existing arrangements. We also should not accept (without evidence) that the US practice of businesses using their standard business consumer contracts for small businesses is also or would likely be the practice in Australia.

Some of arguments made in the Consultation Paper as to why costs and disruptions to business will be minimal (identified above) have greater appeal than others.  We are concerned that the suggestion that large businesses could keep UCTs in their contracts and simply not rely on them is one that carries a substantial degree of legal risk – the assertion that one party has a right or a liability under a contract that would not actually be enforceable at law may well be misleading and deceptive.

Further, we do not believe that the UCTs experience in the consumer space is necessarily the best analogy for the small business space.  While there are no doubt businesses that supply both consumers and small businesses, some suppliers – like providers of business software and systems, wholesalers, labour hire agencies, and a whole range of other business services providers – will likely never have encountered UCTs protections before.  If the protections were extended to contracts where small businesses are supplying goods, then there could be a greater impact to business processes as a result of the changes.  These are the kinds of issues that will benefit from elaboration throughout the consultation process.

Finally, it’s questionable how beneficial an extension of UCTs protections will really be for small businesses, in light of existing protections.  For example, the Australian Consumer Law already prohibits unconscionable conduct in all transactions, whether with consumers or with small businesses (though not with publicly listed companies).   In determining what constitutes unconscionable conduct, courts can have regard to many of the circumstances relevant to UCTs, such as:

  1. the relative bargaining positions of the parties;
  2. the extent to which one party was prepared to negotiate the terms of the contract with the other;
  3. whether one party was able to understand the terms and conditions of the contract; and
  4. whether a party was required to comply with conditions not reasonably necessary for the protection of the interests of the other party.

The scope of protection afforded by these provisions is currently being tested in litigation commenced by the ACCC against Coles.  In those proceedings, the ACCC alleges that the major supermarket chain engaged in unconscionable conduct with some of its smaller suppliers.  Coles denies the allegation.

It should be noted when discussing unconscionable conduct that, despite the content of these provisions, courts have typically found unconscionable conduct to have occurred because of procedural unfairness, in negotiations or some other pre-contractual process, rather than because of the unconscionability of individual contract terms, and the Consultation Paper recognises this.  Nevertheless, in our view the unconscionable conduct regime does provide a disincentive to large businesses to include the more egregious forms of UCTs in contracts with small businesses.  While the distinction between procedural and substantive unfairness might be a highly relevant distinction in defended litigation, it may be less relevant when drafting a standard form contract.

The Government has invited interested parties for submissions on the proposal (until 1 August 2014) and its Consultation Paper is available to read here.