Australia: New small business unfair contract terms regime - Your franchise agreements could become unenforceable

Legislation has been passed to extend the unfair contract term protections to small business contracts.¹ Prior to being passed, the legislation was amended to capture contracts of higher value so it is now anticipated that 95% of contracts with small businesses will be the subject of the new laws. See here for the article we wrote just prior to the bill being originally introduced.

The new law allows unfair contract terms to be declared void. The contract will then only continue to bind the parties if it can operate without the unfair term.

The legislation will apply in addition to existing industry regulatory protections, such as the Franchising Code of Conduct.

Ensure you review and update your standard form contracts within 12 months

The extended unfair contract term regime will come into effect 12 months after it receives royal assent (effective date). Businesses now have a one year grace period to review and amend their standard form contracts in order to comply.

Importantly, the new regime will apply to existing contracts if they are renewed after the effective date or will apply to a particular term of the contract where that term is varied after the effective date.

What contracts are 'small business contracts'?

Small Business Contracts in standard form

Contracts affected are those where:

• at least one party is a business that employs less than 20 people;
• the upfront price payable under the contract is:
• • $300,000 or less; or
  • $1,000,000 or less, if the contract is for more than 12 months; and
• subject to limited exemptions, the contract is a standard form contract (ie a pre-prepared contract that is not generally negotiated) for the supply of goods or services or grant of an interest in land.

Counting employees

A head count approach will be used to determine the number of people a business employs at the time the contract is entered into. This head count doesn't take into account an employee's hours or workload. Casual employees are counted if they are employed on a regular or systematic basis.

Monetary thresholds

The "upfront price payable"² is the total consideration payable under the contract which is disclosed at or before the time the contract is entered into, excluding:

• amounts that are contingent; and
• for contracts regulated under the ASIC Act, interest payments.

For example, where a franchise agreement provides for payment of an initial franchise fee on signing and ongoing payment of annual fees, the upfront price will include the total amount of disclosed fees payable for the life of the contract. However, amounts that are contingent and may not become payable are not included, for example, early termination fees or late payment fees. It appears that amounts which may not be calculable or capable of disclosure at the outset eg royalties on sales, would not generally be considered under the monetary threshold, but may be appropriately included if a minimum or floor price is disclosed.

What is an 'unfair term' in a small business contract?

A term of a small business contract is unfair if it:

• causes a significant imbalance in the parties' rights and obligations;
• is not reasonably necessary to protect the legitimate interests of the benefited party; and
• causes detriment (financial or otherwise) to the other party.

In order for the term to be unfair, it must satisfy all three criteria. In determining whether a contract term is unfair a court may take into account the contract as a whole and the extent to which the term is transparent.

Terms that are required by law or which define the main subject matter of the contract or set the price are exempt from being declared unfair.

What terms will be subject to most scrutiny?

Terms that enable only one party to:

• avoid or limit performance of the contract, or limit liability;
• vary or terminate the contract;
• renew or not renew the contract;
• vary the price or characteristics of what is to be supplied (without the other party being able to terminate the contract);
• assign the contract without consent;
• impose an evidential burden on the other party in proceedings or limit the other party's right to sue or adduce evidence;
• determine if a breach has occurred or impose a penalty for a breach or termination,

will come under close scrutiny, and in order to rely on such provisions there will need to be a legitimate business need and a reasonable balance struck. Making the provisions clear and transparent will also assist.

What should you do now?

Franchise agreements which fall within the definition of a small business contract will need to be reviewed to ensure they will be compliant. Starting early is advisable to ensure that any changes can be socialised and legal advice obtained.

Our key compliance tips are:

• conduct a legal risk review on existing standard form contracts used in the franchise system (eg franchise agreements, confidentiality agreements, guarantees, restraints, leases, supply contracts);
• carefully consider the basis on which a unilateral power is to exist and be exercised and document the rationale (eg protection of reputation or network consistency) to test it is legitimate and extends no more than is reasonably necessary;
• identify the consideration (monetary and otherwise) payable under standard form contracts and which elements form part of the upfront price payable; and
• ensure your Disclosure Document transparently addresses renewal and end of term arrangements as well as unilateral variation rights.

Footnote

¹By the Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act 2015
²Section 26(2) Competition and Consumer Act 2010 (Cth) (Schedule 2)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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