Extension of unfair contract terms protection to small businesses - Many franchise agreements likely to be caught

5 May 2015

The Federal Government has released an exposure draft of proposed legislation that would extend consumer protections against unfair contract terms to small business contracts that are standard form and valued less than a prescribed threshold (the Exposure Draft). You can find a copy of the Exposure Draft and other key documents here.

Given the definition of a “small business contract” in the Exposure Draft, it is likely that many franchise agreements (which are often presented by franchisors to franchisees as standard form contracts) will be subject to the new regime.

Notwithstanding the protections already afforded to franchisees under the Franchising Code of Conduct (including the new good faith obligation and provision for compensation for goodwill), the Government has formed the view that there is still the need for a mechanism that provides for a general review of unfair contract terms.

The effect of the proposed changes

If the Exposure Draft (which proposes amendments to the Competition and Consumer Act 2010 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth)) is ultimately passed, enforcement action may be taken in respect of any “unfair” terms in standard form small business contracts.

If a court finds that a term is unfair it is open to the court to make a range of orders, including declaring the term or (if the contract cannot operate without the term) the entire contract to be void.  Civil penalties are not available.

Contracts that will be captured

Only “standard form” “small business contracts” will be affected by the proposed changes.

The factors that may be taken into account in identifying a “standard form contract” are already set out in section 27 of the ACL and include whether the contract was prepared prior to any discussion of the transaction between the parties and whether the other party was given an effective opportunity to negotiate the terms of the contract.

A contract for the supply of goods or services (or the sale or grant of an interest in land) will be taken to be a “small business contract” where the following two criteria are satisfied:

Either party to the contract employs fewer than 20 people (at the time the contract is executed)

Full-time, part-time and casual employees (employed on a regular or systematic basis) are counted on a head count basis (regardless of hours worked or workload).

The “upfront price” payable under the contract:

  • does not exceed $100,000; or
  • if the contract duration is more than 12 months, the upfront price payable does not exceed $250,000.

The “upfront price” is defined in s 26(2) of the ACL to mean “consideration that:

  1. is provided, or is to be provided, for the supply, sale or grant under the contract; and
  2. is disclosed at or before the time the contract is entered into,

but does not include any other consideration that is contingent on the occurrence or non‑occurrence of a particular event.”

On this basis, the “upfront price” payable under a franchise agreement could include any fees or other consideration:

  • payable on execution of the contract (for example, an initial franchise fee and contributions to fit out);
  • payable over the life of the contract, as long as it is disclosed on (or before) execution of the contract and not contingent on some later event (for example, a specified annual training fee, although it seems that a royalty payable as a percentage of revenue may not be taken to be an “upfront price” as its dollar amount is not known on execution); and
  • payable to a third party under the franchise agreement (for example, licence fees for third party software provided they are payable under the franchise agreement and not under a separate licence agreement).

In considering the impact of the proposed new regime, franchisors will need to identify the “upfront price” payable under their franchise agreements and whether they or their franchisees would be taken to be a “small business”. 

If the two criteria are satisfied then any unfair term in a standard form franchise agreement will be at risk of being unenforceable.

Examples of unfair contract terms

Section 24 of the ACL defines an “unfair” term as one that:

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

Section 25(1) of the ACL also already includes a list of the sort of terms that may (depending on the circumstances) be unfair.

The Explanatory Materials released by the Government with the Exposure Draft also includes examples of the sorts of contract terms which were identified as potentially being unfair by parties making submissions on the proposed new regime. In the context of franchise agreements, these include terms permitting:

  • the franchisor but not the franchisee to terminate the contract;
  • compulsory acquisition of a franchise by a franchisor at less than market rate;
  • liquidated damages payable to a franchisee that do not reflect a genuine pre-estimate of loss; and
  • the franchisor to unilaterally change obligations under the contract.

The process from here

The closing date for submissions on the Exposure Draft is 12 May 2015.

Following the consultation process, the draft legislation will be finalised and introduced into Parliament.  On the current drafting of the Exposure Draft, if the legislation is passed a 6 month transition period will be allowed from the date of Royal Assent. 

The Government has indicated that it expects the amendments will be in effect by early 2016.

The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.

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Frances Wheelahan

Partner. Melbourne
+61 3 9672 3380