04 Feb 2021

Unfair contract terms 01: Getting ready for a big year of reforms

By Peter Sise

Since 2021 will be a big year for unfair contract terms laws, we'll publish a series of articles to bring you up to speed on them.

2021 is set to be a big year for unfair contract term (UCT) laws, as a result of two major reforms.

The first reform concerns insurance contracts. On 5 April 2021, the UCT laws will (for the first time) apply to insurance contracts that are subject to the Insurance Contracts Act 1984 (Cth). This is a major extension of the UCT laws' reach, as it makes common forms of insurance, such as car insurance, house and contents insurance, travel insurance and life insurance, subject to the UCT laws

The second reform is a suite of proposed changes that will commence on a date that's yet to be set. The two most significant proposed changes are:

  • the introduction of penalties for using an unfair term; and
  • the expansion of the definition of "small business contract" so that the UCT laws apply to a greater number of business-to-business contracts.

At present, there are no penalties for using an unfair term. The only consequence is the unfair term will be declared void and any action taken under it may need to be unwound – for example, refunding money paid under the now-void term  – so the proposed penalties is a significant increase to the risk of using an unfair term. Draft legislation is yet to be released for this suite of proposed changes even though it has been agreed by all State, Territory and Commonwealth fair trading ministers. So, we don't yet know the details of how the changes will be implemented.

Since 2021 will be a big year for UCT laws, we'll publish a series of articles to bring you up to speed on the UCT laws. In our first instalment, we'll give you a general refresher on the UCT laws, and then in subsequent instalments, dive into specific types of terms that may be unfair. But for now, let's get refreshed!

Where can I find the UCT laws?

The UCT laws are found in the Australian Consumer Law (ACL) and the Australian Securities and Investments Commission Act 2001 (ASIC Act). The provisions in the ACL and ASIC Act are largely the same. The main difference is the ASIC Act applies to contracts which are "financial products" or contracts for the supply of "financial services" while the ACL does not.

Which contracts do the UCT laws apply to?

The UCT laws do not apply to all contracts. Instead, they are limited to "standard form contracts" which are either "consumer contracts" or "small business contracts". So, establishing that there's a standard form contract is the first threshold that must be cleared to rely on the UCT laws.

What's a "standard form contract"?

A "standard form contract" is a defined term in both the ACL and ASIC Act, but strangely neither Act provides a clear definition. Both the ACL and ASIC Act say that a "standard form contract has a meaning affected by" section 27 of the ACL or section 12BK of the ASIC Act, as the case may be. Those sections say that a contract is presumed to be in standard form unless proven otherwise and then provide a list of factors which a court must consider when determining whether a contract is in standard form. Neither section actually defines what a standard form contract is.

This absence of a definition has left various questions unanswered. For example, does a standard form contract cease to be a standard form contract simply because one term is negotiated? If yes, would that only be the case if the term was highly significant to the contract?  Although the definition of standard form contract is a little unhelpful, there is still one useful aspect: there is a rebuttable presumption that a contract is in standard form.

"Consumer contract" or "small business contract"?

If there is a standard form contract, the next question is whether it is a "consumer contract" or "small business contract". Under the ACL, a "consumer contract" is a contract for the supply of goods or services or the sale of an interest in land to an individual who acquires the goods, services or interest in land wholly or predominantly for personal, domestic or household use. This definition is substantially the same under the ASIC Act except that it applies to contracts which are "financial products" or contracts for the supply of "financial services".

It is important to note two things about the definition of a "consumer contract". First, the acquirer must be an individual, not a corporation. Second, the concept of a "consumer contract" should not be confused with the concept of a "consumer", which also exists in the ACL. They're quite different. A "consumer" does not need to be an individual. Also, a person can acquire goods or services as a "consumer" even if they do not use those goods or services for personal, domestic or household use, provided the goods or services:

  • are of a kind ordinarily acquired for personal, domestic or household use;
  • did not cost more than $40,000 (which rises to $100,000 on 1 July 2021); or
  • are a vehicle or trailer acquired for use principally in the transport of goods on public roads.

For a "consumer contract", the individual must actually acquire the goods or services for personal, domestic or household use. The concept of a "consumer" is irrelevant to the UCT laws. The relevant concept is a "consumer contract".

A "small business contract" is a contract where:

  • at least one party to the contract "is a business that employs fewer than 20 persons" at the time the contract is entered into; and
  • the "upfront price payable under the contract" does not exceed $300,000 for a contract with a duration of up to 12 months or $1 million for a contract with a duration of more than 12 months.

A casual employee is not counted towards the requirement of "fewer than 20 persons" unless they are employed by the business on a regular and systematic basis. If the contract is for the provision of credit, any interest payable on principal is not included in the "upfront price". The definition of "small business contract" is proposed to be changed in two ways: (i) to remove the limit on the upfront price payable under the contract and (ii) to allow any businesses to rely on the UCT laws if it employs up to 100 employees (instead of 20) or its annual turnover is no more than $10 million.

The UCT laws only apply to "small business contracts" that were entered into on or after 12 November 2016 or varied or renewed after that date.

There are several unanswered questions about the definition of a "small business contract", such as:

  • whether the phrase "employs fewer than 20 persons" means you only count employees towards the 20 persons or also count independent contractors;
  • how does a "business" employ people when a "business" is not a legal entity and cannot enter into contracts; and
  • how is the term "business" applied to corporate groups where one corporate entity may enter into contracts of employment with hundreds of staff while another corporate entity enters into none and hence may fulfil the requirement of "fewer than 20 persons".

Now is not the time to consider these questions, but they are likely to be grappled with by a court at some stage.

Are there any specific carve-outs from the UCT laws?

Certain types of contracts are excluded from the UCT laws even if they are "consumer contracts" or "small business contracts" in standard form. Contracts of service are excluded because the definition of "services" in the ACL specifically excludes work performed under a contract of service. The other categories of excluded contracts are:

  • certain marine contracts;
  • constitutions of companies, managed investment schemes and other bodies; and
  • certain insurance contracts.

Insurance contracts require specific mention. At present, insurance contracts that are subject to the Insurance Contracts Act 1984 (Cth) are not subject to the UCT laws, but from 5 April 2021, they will be. The result of this reform is that all insurance contracts will be subject to the UCT laws except for certain contracts of insurance providing medical indemnity cover for medical practitioners and registered health professionals. Of course, an insurance contract must still be a "consumer contract" or "small business contract" in standard form to be captured by the UCT laws.

There are some terms which are not subject to the UCT laws even if they are part of a standard form "consumer contract" or "small business contract":

  • a term that "defines the main subject matter of the contract";
  • a term that "sets the upfront price payable under the contract"; and
  • "a term required, or expressly permitted, by a law of the Commonwealth or a State or Territory".

There is no specific carve-out for contracts entered into with the Crown. The UCT laws apply to the Crown in right of the Commonwealth but only so far as it carries on a business. For the Crown in right of a State or Territory, check the legislation which implements the ACL in the particular State or Territory; for example, section 16 of the Australian Consumer Law and Fair Trading Act 2012 (Vic).

When is a term unfair?

Now that we know when the UCT laws apply, when is a term "unfair"? A term is "unfair" if it fulfils all of the following three requirements:

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

The meaning of "unfair" is strictly defined. This was recently noted by Justice Beach of the Federal Court who said the UCT law "clearly sets out the three factors which cumulatively must be satisfied for a term to be "unfair"" and "there is no scope to interlard other feel good factors or niceties" (Dialogue Consulting Pty Ltd v Instagram, Inc [2020] FCA 1846).

In cases about the UCT laws, the main area of dispute is often whether the term would cause a significant imbalance in the parties' rights and obligations. This raises the question: When is an imbalance "significant" as opposed to insignificant? Unfortunately, the test in case law is not particularly helpful. The test is whether the "term is so weighted in favour of the supplier as to tilt the parties' rights and obligations under the contract significantly in his favour." "Significant" has been referred to as meaning "sufficiently large to be important" and "not too distant from substantial".

There is a rebuttable presumption that a term is not reasonably necessary to protect the legitimate interests of a party, but there is no such presumption for the other two elements of the test for unfairness.

When determining whether a term is "unfair", a court may consider anything it considers relevant but must consider the contract as a whole and the extent to which the impugned term is "transparent". A term is "transparent" if it is all of the following: "expressed in reasonably plain language", legible, "presented clearly" and "readily available to any party affected by the term". It is unclear how "transparency" is always relevant to the test for whether a term is unfair. For example, how does the legibility of a term affect whether it is "reasonably necessary to protect the legitimate interests" of a party or whether "it would cause detriment … to a party"? There is currently no authoritative answer to these questions.

Fair minds may differ on whether a term is unfair. To provide some guidance, the UCT laws contain a list of 14 terms which may (not must) be unfair, colloquially known as the "grey list". It focuses on terms that grant a right to one party but not the other; for example, "a term that permits … one party (but not another party) to terminate the contract". For this reason, the terms in the "grey list" are more likely to fulfil the first requirement of the test for unfairness, being that the term would cause a significant imbalance in the parties' rights and obligations arising under the contract. It's important to note there is no presumption that any of the terms in the grey list are unfair.

What happens if a term is declared unfair?

If a court declares a term unfair, it is automatically void under section 23 of the ACL or section 12BF of the ASIC Act. The contract will continue to bind the parties if "it is capable of operating without the unfair term". This is likely since a term which "sets the upfront price payable under the contract" or which "defines the main subject matter of the contract" is beyond the reach of the UCT laws. If such significant terms could be avoided under the UCT laws, it is likely that a contract may become inoperative without them. The automatic avoiding of an unfair terms is one matter that is proposed to be altered by the suite of proposed changes mentioned earlier.

Various compensatory orders may be made once a term is declared unfair; for example, refunding money paid under the now-void term. No sanctions (such as penalties or disqualification orders) may be imposed, but as already noted, this is expected to change in 2021.

Peter is an editor of the Australian Competition and Consumer Law Commentary provided by Wolters Kluwer Australia ǀ CCH

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.