Significant changes to unfair contract terms laws ahead

New draft laws would broaden the scope of existing laws and introduce substantial penalties 12 min read

On 9 February 2022, the Commonwealth Government tabled in parliament its reforms to unfair contract terms laws via the Treasury Laws Amendment (Enhancing Tax Integrity and Supporting Business Investment) Bill 2022 (Cth) (UCT Reform Bill). The Commonwealth earlier released the proposed reforms as exposure draft legislation in August 2021.

The proposed reforms to unfair contract terms laws represent a significant shift in regulatory risk for lenders and other businesses that rely on standard form contracts with consumers and small to medium-sized enterprises. The amending legislation is anticipated to be passed by parliament in the coming months, with the laws to take effect 12 months after the UCT Reform Bill receives Royal Assent. This provides businesses with a short period of time to ensure their contracts comply.

This Insight outlines the key areas of regulatory focus thus far in relation to unfair contract terms and gives an overview of changes proposed in the reforming legislation. Given the imminent passage of these reforms, now is the time to prepare your organisation for the changes and review and amend any potentially problematic standard form contracts.

Overview of the current regime

The Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) contains provisions regulating unfair terms in standard form contracts relating to financial services supplied to consumers and small businesses. Similar provisions are contained in the Australian Consumer Law (ACL) for non-financial services contracts.

What contracts are caught?

• A 'consumer contract' is a contract with an individual counterparty who acquires what is supplied wholly or predominantly for personal, domestic or household use.
• Currently, a 'small business' contract is a contract where the counterparty is a business that employees less than 20 people and the upfront price payable is below $300,000 (for a contract less than 12 months' duration) or $1 million (for a contract 12 months' duration or more).

What is a 'standard form' contract?

A 'standard form contract' is one where the terms and conditions are set by one party and there is little scope for the other to negotiate. While they can reduce transaction costs and provide efficiencies, an increasing regulatory focus on fairness, and the impact of such contracts on smaller parties, means standard form agreements are not a matter of 'set and forget'.

What is an 'unfair' term?

A term of a contract is 'unfair' under the unfair contract terms laws if it:

• would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
• is not reasonably necessary to protect the legitimate interests of the larger party; and
• would cause detriment to the counterparty if relied on. Detriment can be non-financial (eg using a counterparty's personal data, or a limitation on a party's legal rights to sue).

The transparency of contractual terms is also relevant when considering fairness. Contractual terms that are in plain and easy to read language, presented clearly, and readily accessible by small business and individual customers, are less likely to be considered unfair by a court.

Under the current unfair contract terms laws, terms that are found to be unfair are void and therefore unenforceable. There are no penalties for using such terms, although a court may make orders for compensation, or other orders (such as injunctive orders preventing further use of relevant terms), where a term found unfair has been relied on. ASIC and the ACCC have statutory powers to compulsorily obtain documents and information when investigating unfair contract terms matters.

Increasing regulatory focus

The Commonwealth Government and relevant regulators identified that the existing regime, which voids unfair contract terms but does not penalise their use, did not provide sufficient deterrence to businesses using such terms.¹

The ACCC and its current Chair, Rod Sims, have been particularly vocal about reforms to unfair contract terms laws for several years, and have called for prohibitions to be placed on, and penalties to apply for, unfair contract terms.

ASIC's focus

In the financial services sector, ASIC has provided guidance in relation to lending practices, most notably through its 2018 release of ASIC Report 565,² which set out the findings of its review (with the Australian Business and Family Enterprise Ombudsman) of small business lending by the big four banks. Earlier, ASIC had also released guidance regarding unconscionable conduct and unfair contract terms issues in relation to exit or early termination fees in the context of residential loans (RG 220).³

More recently, ASIC brought proceedings against Bendigo and Adelaide Bank (in 2020), and Bank of Queensland (in 2021), in relation to the following types of terms in various of their respective small business standard contracts:

• unilateral variation clauses which provided the respective banks broad discretions to vary the terms and conditions of their contracts without providing borrowers sufficient advance notice, or an opportunity to exit the contract without penalty if they disagreed with the variation;
• event of default clauses which allowed the banks to unilaterally determine if default had occurred, including in circumstances where the relevant default may not have posed a material credit risk and/or the borrower did not have sufficient opportunity to remedy the default, and therefore the enforcement action taken by the bank represented disproportionate action to the detriment of the borrower;
• broad indemnification clauses which made borrowers liable for a range of costs, including those that may have been outside borrowers' control (eg costs arising due to the banks' own error, misconduct or negligence); and
• conclusive evidence clauses which gave the banks discretion to determine matters under the contract, and issue a certificate in relation to such determination, thereby limiting the counterparty's ability to dispute the correctness of the bank's determination (eg in relation to a valuation or accounts issued regarding the loan).

Both Bendigo Bank and Bank of Queensland admitted the impugned terms were unfair and agreed with ASIC that the terms be varied. The Federal Court made orders giving effect to the parties' agreements following joint submissions in both cases.

ACCC action

The ACCC has in parallel taken enforcement action against various other (non-financial services) businesses for the use of unfair contract terms.

• Court proceedings were commenced against Fuji Xerox⁴ in 2020 regarding automatic renewal clauses which the ACCC considers to 'lock in' customers, by extending contracts without giving customers sufficient opportunity to terminate, and then imposing unilateral price increases, with onerous termination fees if the customer seeks to terminate following renewal.
• The ACCC has taken enforcement action regarding automatic renewal and excessive exit fee clauses against several other businesses,⁵ either through court proceedings or by obtaining commitments (such as court-enforceable undertakings) to amend such terms so that customers are more easily able to exit contracts without penalty if a contract is renewed or varied by the larger party.
• The ACCC has also targeted various other types of contractual terms relating to restraints of trade, unilateral rights to terminate a contract or vary its terms (eg unilateral price increases), and overly broad indemnifications and limitations of liability.

The regulators' enforcement actions illustrate sustained scrutiny of unfair contract terms under the current laws, something which is likely to increase with the passage of the UCT Reform Bill, as regulators seek to test the new penalty regime that would apply.

What is proposed to change?

The proposed reforms set out in the UCT Reform Bill follow a period of extended review and consultation on the operation of the current regime, including a review of unfair contract terms laws in 2018 by the Commonwealth Treasury, and a 2019-20 consultation on potential regulation impacts from various reform options. Treasury released exposure draft legislation for public comment in August 2021. The UCT Reform Bill is similar to the reforms proposed in the earlier exposure draft legislation, although there are some notable differences such as the removal of a 'rebuttable presumption', and the inclusion of a maximum upfront price for contracts regulated by the ASIC Act.

The UCT Reform Bill is likely to be passed in the coming months, and will take effect 12 months after Royal Assent. It will significantly broaden the scope of application of unfair contract terms laws. Substantial financial penalties will apply under the proposed laws. This materially alters the risk equation for businesses and should cause businesses to examine their standard form contracts and bring them into compliance with the new regime. We consider the key aspects of the proposed reforms below.

Increased scope: expanded definition of 'small business'

The scope of the unfair contract terms laws in relation to small businesses will no longer involve a contract value threshold under the ACL, meaning it will apply to all standard form contracts with a 'small business'. The definition of 'small business' will also expand, from a business that employs fewer than 20 people to one that has:

• fewer than 100 employees; or
• less than $10 million in annual turnover in the previous income year.

Under the ASIC Act, the same definition of small business will apply, however, the small business contract will need to be below a maximum upfront price payable of $5 million to come within the regime's scope.

Certain categories of contracts are to be exempt from the new laws, such as the operating rules of licensed financial markets (eg the ASX), operating rules of licensed clearing and settlement facilities, those relating to settlement systems of the RBA, and certain life insurance contracts.

Prohibitions introduced: potential instances of contraventions increased

The UCT Reform Bill proposes to prohibit both:

• making a standard form contract that contains an unfair term which the person proposed; and
• applying or relying on (or purporting to apply or rely on) an unfair term in a standard form contract.

Each individual unfair term in a contract, as well as each time an unfair term is purported to be relied on, would give rise to separate contraventions and so there may be multiple contraventions associated with each 'unfair' contract whenever it is used.

Financial penalties and other remedies

The penalties for contravention of these prohibitions are proposed to be aligned with the other maximum pecuniary penalties in the ASIC Act or ACL. That is, each contravention would face maximum pecuniary penalties of the greater of:

• $10 million (under the ACL) or $11.1 million (under the ASIC Act);
• three times the benefit obtained by the conduct; or
• if the court cannot determine the benefit obtained, 10% of annual turnover.

The proposed reforms also include provisions to make it easier for a court to order other remedies, including orders to void, vary or refuse to enforce contractual terms, if appropriate to prevent or reduce likely loss or damage to a party. The current law making unfair terms automatically void will be retained. Under the proposed new laws, a court may also make orders:

• preventing a term that is the same as, or substantially similar to, a term that has been declared unfair from being included in any future standard form contracts by a respondent;
• upon the application of ASIC or the ACCC, preventing or reducing loss or damage that may be caused in relation to a term that is the same as, or substantially the same in effect to, a term that has been declared unfair – including injunctive powers to restrain a party from applying or relying on a relevant contractual term;
• issuing public warning notices; and / or
• disqualifying a person from managing a corporation.

Factors to take into account to determine if a contract is 'Standard Form'

The proposed reforms also seek to clarify when a contract is 'standard form', by introducing the following factors to be taken into account when determining this issue:

• 'repeated usage of a contract' is relevant to whether it is standard form, as contracts with the same or similar terms that are repeated across different customers are more likely to be standardised;
• in considering whether a party had a genuine opportunity to negotiate a contract, a court may disregard instances where:
  • minor changes to an agreement were negotiated by the counterparty, or where a customer has been permitted to select from pre-determined terms within a contract; and / or
  • a party to another contract has been able to negotiate terms of that contract (ie, instances where some customers have been able to negotiate effectively are not necessarily an indicator of a broader group of customers' ability to negotiate).

The UCT Reform Bill abandons the 'rebuttable presumption' proposed in the exposure draft

The exposure draft legislation released in 2021 featured a 'rebuttable presumption' that certain terms are unfair, if for example they are substantially similar or the same as terms previously found unfair in the same industry, or involving the same person who proposed the term. The proposed rebuttable presumption would have reversed the burden of proof when it applied, by effectively requiring the respondent in court proceedings to disprove that an impugned term is unfair.

However, this rebuttable presumption has not made its way into the UCT Reform Bill. It appears the Commonwealth may not be proceeding with this amendment following submissions highlighting problematic aspects of such a presumption, including that it may not take into account the circumstances that apply each time a similar term is used with different customers or in different industries.

Commencement and transition period

The UCT Reform Bill is intended to commence 12 months after the bill receives Royal Assent. This 12 month period is intended to provide businesses time to review and amend relevant contracts in preparedness for the new provisions. This is longer than the six month transition period that was previously provided for in the 2021 exposure draft legislation.

The new unfair contract terms laws will apply to standard form contracts entered into following commencement of the reforms, as well as to any existing standard form contracts that are renewed after commencement. If a term of a contract is varied following commencement of the laws, the laws will apply to the term as varied (unless the variation involves renewal of the contract as a whole, in which case the entire contract will come within scope of the new regime).

Planning ahead

Now is the time to consider whether your organisation's current contracts could fall foul of the new UCT regime. Although businesses should regularly review standard form contracts to identify unfair contract terms risks, taking into account customers' circumstances and whether any potentially impugned terms can be justified on the basis of a business' legitimate interests, the likely imminent passage of the UCT Reform Bill creates a strong impetus to do so promptly and comprehensively.

Sustained advocacy for these changes by regulators and consumer groups highlights that this will continue to be an area of enforcement focus by ASIC and the ACCC. The broader scope of the laws, and the introduction of substantial financial penalties, therefore heightens the consequences of terms being found 'unfair'. The prospect of securing penalties for unfair contract terms is likely to see a wave of enforcement action by ASIC and the ACCC, which may wish to test the new penalty regime and use this to set new precedents and deter future conduct.