Unfair Contract Terms

The regulation of Unfair Contract Terms is about to change. In November 2023 the 12 month transition period for the Treasury Laws Amendment (More Competition, Better Prices) Act 2022 (the Act) will come to an end.

The Act amends the current unfair contract terms regime contained in the Australian Consumer Law (the ACL). After 9 November 2023 franchisors may face heavy penalties under the ACL if:

1. an agreement is a small business standard form contract; and
2. the agreement contains unfair terms.
   
   

This marks a significant shift from the current scenario where an unfair contract term may be declared void (and consequently may not be enforced by a Court), without any additional penalties being imposed.

Franchisors must prioritise a thorough review and revision of their agreements (including their franchise agreements) and their systems and processes to ensure compliance with the new legislation and mitigate the risk of potential penalties.

Current Position - unfair contract terms

Currently, section 23 of the ACL provides that a term of a small business contract is void (and consequently unenforceable) if:

1. the term is unfair; and
2. the contract is a standard form contract.
   
   

While the ACCC has previously sought undertakings from franchisors that they will not enforce or seek to rely on certain provisions in their standard form franchise agreements, the following note appears on the ACCC website:

Under the Australian Consumer Law and the Franchising Code of Conduct, there is no prohibition on businesses including or relying on unfair contract terms against franchisees. Although courts can declare terms to be unfair, with the result that they are void and unenforceable, penalties cannot be imposed on companies using these unfair terms.

However, when the transition period for the Act comes to an end in November 2023, franchisors will face substantial penalties if they include unfair contract terms in small business standard form contracts.

The Treasury Laws Amendment (More Competition, Better Prices) Act 2022

 On 9 November 2022 the Treasury Laws Amendment (More Competition, Better Prices) Act 2022 received Royal Assent.

The Act introduced a civil penalty regime prohibiting the use of and reliance on unfair contract terms in standard form small business contracts.

The Act also broadened the definition of a small business contract.

Under the new section 23(2A) of the ACL, a person will contravene section 23 of the ACL if:

                     (a)  the person makes a contract; and

                     (b)  the contract is a consumer contract or small business contract; and

                     (c)  the contract is a standard form contract; and

                     (d)  a term of the contract is unfair; and

                     (e)  the person proposed the unfair term.

Section 23(2A) is a penalty provision.

Under the new section 23(2C), a person will contravene section 23 of the ACL if:

                     (a)  the person applies or relies on, or purports to apply or rely on, a term of a contract; and

                     (b)  the contract is a consumer contract or small business contract; and

                     (c)  the contract is a standard form contract; and

                     (d)  the term is unfair.

Section 23(2C) is also a penalty provision.

Additionally the new section 23(2B) of the ACL provides that a contravention of the ACL is committed in respect of each term that is unfair. Consequently each term that is unfair in a small business standard form contract will attract a penalty.

What is a Small Business Contract?

Up to 9 November 2023
Currently, under section 23(4) of the ACL, a small business contract is defined as a contract that meets the following criteria:

1. the contract must involve the supply of goods or services, or a sale or grant of an interest in land. This means that any agreements related to the exchange of goods or services, or the purchase or lease of land, fall under the scope of a small business contract.
2. at least one party involved in the contract must be a business that employs fewer than 20 individuals at the time of entering into the agreement. This criterion ensures that smaller businesses are protected under the unfair contracts regime, as they may be more vulnerable to unfair terms imposed by larger entities.
3. there are two options that determine the maximum upfront price payable under the contract. If the contract has a duration of less than 12 months, the upfront price must not exceed $300,000. On the other hand, if the contract extends beyond 12 months, the upfront price cannot exceed $1,000,000.

This definition of small business contract will apply up to 9 November 2023.

From 9 November 2023
From 9 November 2023, section 23(4) of the ACL will define a contract as a small business contract if:

1.   the contract is for a supply of goods or services, or a sale or grant of an interest in land; and
2.    at least one party to the contract satisfies either or both of the following conditions:

   (i)  the party makes the contract in the course of carrying on a business and at a time when the              party employs fewer than 100 persons;

            (ii)  the party's turnover, worked out under subsection (6) for the party's last income year (within                        the meaning of the Income Tax Assessment Act 1997 ) that ended at or before the time when                    the contract is made, is less than $10,000,000.

Consequently, most franchise agreements fall within the definition of a small business contract.

What is a Standard Form Contract?

Up to 9 November 2023
While the ACL does not provide a specific definition for a standard form contract, section 27(2) of the ACL outlines certain factors that a Court must consider when determining whether a contract is a standard form contract. These factors include:

1. The relative bargaining power of the parties: A Court will assess the level of negotiation and power imbalance between the parties. If one party has significantly more power and control over the terms of the contract, it may indicate that the contract is a standard form contract.

2. Whether the contract was prepared by one party before any discussion took place: If one party has already drafted the contract without any input from the other party, it suggests that the contract is a standard form contract. This is often the case in situations where one party presents a pre-drafted contract to the other party for acceptance.

3. Whether the contract was offered on a "take it or leave it" basis: If one party presents the contract to the other party with little or no opportunity for negotiation or amendment, it indicates that the contract is a standard form contract. This commonly occurs in situations where the terms of the contract are non-negotiable and the other party must either accept or reject the contract as a whole.

4. The extent to which the party was given an opportunity to negotiate the terms of the contract: A Court will consider whether the party had a reasonable opportunity to negotiate or influence the terms of the contract. If one party had limited or no opportunity to negotiate, it suggests that the contract is a standard form contract.

5. Whether the terms of the contract take into account the specific characteristics of another party or a particular transaction.

6. Any other matter prescribed by the regulations.

From 9 November 2023

From 9 November 2023, in addition to the matters already to be taken into account, the Court must also take into account:

7. Whether one of the parties has made another contract, in the same or substantially similar terms, prepared by that party, and, if so, how many such contracts that party has made.

In addition, the new section 27(3) of the ACL provides that a contract may be determined to be a standard form contract despite the existence of one or more of the following:

(a)  an opportunity for a party to negotiate changes, to terms of the contract, that are minor or insubstantial in effect;

(b)  an opportunity for a party to select a term from a range of options determined by another party;

(c)  an opportunity for a party to another contract or proposed contract to negotiate terms of the other contract or proposed contract.

Is A Franchise Agreement A Standard Form Contract?

Typically, franchisors adhere to a standard franchise agreement which they offer to potential franchisees. Historically, franchisors have been hesitant to entertain negotiations regarding the terms of the standard franchise agreement, adding weight to the argument that a franchise agreement is a standard form contract. However, more recently franchisors have become increasingly willing to negotiate amendments to franchise agreements on a case by case basis.

If a franchise agreement has been amended as a result of negotiations between the parties, the franchise agreement will be less likely to be considered a standard form contract. Although, the Court will need to have regard to all of the circumstances of the case, noting the new ACL provisions stating that:

• the Court must take into account whether one of the parties has made another contract in the same or substantially similar terms, and if so, how many contracts has the party made;
• a contract may be determined to be a standard form contract even if there was an opportunity for a party to negotiate changes to the term of the contract that are minor or insubstantial in effect. 

Moving forward, franchisors should provide opportunities for their prospective franchisees to negotiate changes to the franchise agreement. These negotiations should not be limited to minor or insubstantial amendments.

What is an Unfair CONTRACT Term?

Section 24(1) of the ACL provides that a term of a small business contract is unfair if:

1. it would cause significant imbalance in the parties’ rights and obligations arising under the contract; and
2. it is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the term; and
3. it would cause detriment to a party if it were applied or relied on.

While a court must be satisfied that all three elements exist for the term to be considered unfair, it is also important to take into account the overall context of the contract and the level of transparency pertaining to the specific term in question.

Section 24(2) of the ACL provides that a Court must take into account:

1. the extent to which the term is transparent; and
2. the contract as a whole.

By considering the contract as a whole, including the surrounding terms and conditions, the court can determine whether there is a significant imbalance in the rights and obligations of the parties involved.

Additionally, the extent to which the relevant term is transparent plays an important role in assessing its fairness. Transparency refers to how clearly and openly the term is presented to the party who would be bound by it. If a term is hidden or difficult to understand, it may indicate that the contract is biased towards one party and lacks fairness.

Moreover, it is essential for the party who benefits from the term to demonstrate that it is reasonably necessary to protect their legitimate interests. This means that the term should be justifiable for safeguarding the rights and interests of the party who would be advantaged by its inclusion in the contract. The onus is on this party to provide evidence supporting the necessity of the term.

Penalties

In addition to having the authority to declare an unfair contract term as 'void,' from 9 November 2023 the Courts will also possess the capability to impose monetary penalties for the inclusion or reliance on such terms.

We note that in addition to reviewing their franchise agreements, after 9 November 2023 franchisors must also be careful when seeking to rely on a clause in a franchise agreement that may be considered an unfair contract term. The franchisor will need to consider:

1. whether the franchise agreement in question is a standard form business contract;
2. whether the clause creates a power imbalance;
3. what purpose the clause serves; and
4. whether the clause is reasonably necessary to protect the franchisor's legitimate business interests.

• $50 million;
• three times the value of the benefit (if able to be determined); or
• 30% of the company's adjusted turnover during the period of the breach, or the previous 12 months, whichever is longer.

For individuals involved in the conduct, the maximum penalty will be $2.5 million.

TAKEAWAYS

Unfair contract terms in franchise agreements may have significant implications for franchisors after 9 November 2023.

It is important for franchisors to be proactive in providing opportunities for prospective franchisees to negotiate changes to the franchise agreement.

In addition franchisors should ensure that any terms in a franchise agreement are transparent, reasonably necessary to protect their legitimate business interests, and do not create a significant imbalance in the parties' rights and obligations.

With the courts being empowered from 9 November 2023 to impose monetary penalties for the inclusion or reliance on unfair contract terms, it is vital for franchisors to review and revise their franchise agreements accordingly. 

Disclaimer

The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.