Panel - Katherine Forrest, Emma Curtis, Amanda Nikolaou & Daniel Tirado - The extension of unfair contract terms to small business

Unfair Contract Terms

and

Small Business

21152430_2 Unfair Contract Terms for Small Business

King & Wood Mallesons / www.kwm.com 2

Katherine Forrest

Katherine Forrest is a

partner at King & Wood

Mallesons in the Banking &

Finance team

Amanda Nikolaou

Amanda Nikolaou is a

lawyer in the Retail and

Business Banking legal team

at Westpac

Emma Curtis

Emma Curtis is a senior

manager in ASIC’s Deposit

Takers, Credit and Insurers

team, and leads a team in

ASIC’s Sydney office

Daniel Tirado

Daniel Tirado is Senior

Corporate Counsel for Toyota

Finance

Photo

King & Wood Mallesons / www.kwm.com

How did the Bill come about?

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• Unfair contract terms for consumers in place since 2011

• The Government committed to extending the consumer unfair contract term protections to the small business sector as part of the Real Solutions Small Business Policy.

• Draft legislation released 28 April 2015


Status of the Bill

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• Treasury Legislation Amendment (Small Business and Unfair

Contract Terms) Bill 2015

• Third reading agreed in House of Representatives 18 August 2015

• Third reading agreed in Senate 14 September after amendments to

(i) increase threshold application amounts and (ii) extend the period

between Royal Assent and coming into effect to 12 months

• Back in the House of Representatives to vote on those

amendments

• If amendments are approved, commences effect 12 months after

the Act receives Royal Assent


ASIC’s Approach

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ASIC will initially take a facilitative approach

• Release guidelines, engage with industry, update existing publications

• Expect industry to commence review of standard form contracts

• Liaising with ACCC on educational and compliance strategy

Compliance phase

• During and after transition – if potentially unfair terms identified with no

legitimate reason for them, ASIC will encourage business to amend

• If business is unco-operative – enforcement action considered


When will the UCT regime apply?

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• Act applies to “Small Business Contracts”

• A Small Business Contract is one where:

• At least one party to the contract is a business that

employs fewer than 20 persons; AND

• Upfront price ≤ $300,000 ($1,000,000 if contract>12

months duration)

• Those figures are the result of amendments moved by

the Greens in the Senate. Previously $100,000 and

$250,000 respectively


Case study

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Placebo Pty Ltd (PPL) is a sophisticated pharmaceutical company

specialising in the manufacture and sale of drugs to pharmacies.

PPL employs 18 full time staff and 12 casual employees. It

outsources much of its research and development and

manufacturing to a subsidiary, Placebo (Manilla) Pty Ltd, which

employs 180 people.

PPL banks with Mega Bank and currently has:

• A 25 year Term Loan facility for $8 million

• A $500,000 overdraft

• Business credit cards


A few months later, PPL is taken over and becomes a wholly owned subsidiary of

Big Fizzer. Big Fizzer is a large, global pharmaceutical company that is based

offshore.

Following the acquisition by Big Fizzer, PPL has to employ 6 more full time staff and

needs to increase its term loan to extend its warehouse, and its overdraft to fund

working capital.

The Term Loan is increased from $8m to $12m, with the financial covenants re-

negotiated and an override clause to various default events. The term is not

extended.

The overdraft is increased from $500,000 to $1.2m, and the term extended from 3 to

5 years. Big Fizzer provides a guarantee.

PPL decides they also want to start managing their interest rate exposure and

enters into an ISDA with Mega Bank with a reference value of $1,000,000.

PPL also takes a finance lease from Auto Finance Solutions.

Case study


• 18 Full Time Employees

• 12 Casual Employees

• 25 year Term Loan

facility for $8 million

(increased to $12m)

• A $500,000 overdraft

(increased to $1.2m)

• Business credit cards

• ISDA

• Following take over PPL

requires the addition of 6

Full Time Employees

Placebo Pty Ltd (PPL)

Big Fizzer (Global

Pharmaceutical –

Based Offshore)

Mega Bank

AFS

• 6 new Toyota

Corolla Ascent at

$25,000 =

$150,000


Is PPL a “small business”?

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• Includes a corporation

• Casual employees not counted

• No carve-outs or exceptions for:

• Corporate groups with a specific employer

entity

• Special purpose vehicles that are owned or

managed by larger business


Are the variations to the Term Loan and Overdraft caught?

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• The Act does not apply to contracts entered into before the Act commences

• But:

• If the contract is renewed after the Act

commences, the Act applies to the contract

• If a term is varied after the Act commences,

the Act applies to the term as varied


What is the “Upfront Price” of the Term Loan and the Overdraft?

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• The consideration provided for the supply and disclosed at or before the contract is entered into

• Does not include contingent consideration

• If credit is provided under the contract, include principal, disregard interest.

• If one letter of offer sets out the two facilities, do we consider them separately or on a combined basis?


Are PPL’s contracts Standard Form Contracts?

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The Act only applies to standard form contracts

• Not defined. Court makes its own assessment.

• Court may take into account such matters as it thinks relevant

• Court must take into account:

▪ If one party has most of the bargaining power

▪ If one party prepared the contract before any discussion

▪ Was it “take it or leave it”

▪ Was there opportunity to negotiate

▪ Did the contract take into account specific characteristics of a party or the

transaction


Standard Defences in Small Business Context

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The Act does not apply to terms that define the main subject matter, the

“upfront price” or to terms that are required/permitted by law

• These exceptions are likely to operate the same way in both consumer and small

business contracts

Significant Imbalance in parties’ right and obligations

• A term is only unfair if it causes this imbalance

• Is the imbalance calculation the same for a small business as for a consumer?

• Should small businesses be subject to a higher threshold?

Reasonably Necessary / Legitimate Interests

• A term is not unfair if it is reasonably necessary to protect the legitimate interests

of the party relying on it

• Is the reasonably necessary / legitimate interest calculation the same for a small

business as for a consumer?

• Should small businesses be subject to a higher threshold?


Case study – contract terms

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1. In the Term Loan variation, Mega Bank renegotiates the pricing so that if the

interest cover ratio drops by 25%, then the loan margin increases from 2% to

5%.

2. Mega Bank has also included these variation provisions:

PPL must not, without Mega Bank’s consent, rescind, cancel or vary this

agreement.

Mega Bank may vary any term or condition of this agreement, including any

interest rate, fee or change or payment arrangements, by giving PPL notice

in writing.



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3. The Overdraft is payable on demand.

4. The Overdraft also includes the following clause:

“You agree that transactions may be delayed, blocked or refused where we

have reasonable grounds to believe that they breach Australian law or

sanctions (or the law or sanctions of any other country). Where

transactions are delayed, blocked or refused, we are not liable for any loss

you suffer (including consequential loss) howsoever caused in connection

with any account.”



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5. AFS has included a cross-default provision in the Finance Lease:

PPL must comply with its obligations under this lease.

In addition, PPL must not cause or permit any event or circumstance to arise

which would entitle a Financier to terminate any Finance Agreement which it

has entered into with PPL or PPL’s related body corporates.

If PPL does not comply with these obligations then PPL will be taken to have

repudiated this lease.



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6. The Finance Lease has a term of 3 years and provides that if PPL wants to

terminate the lease early, PPL must pay 75% of the Net Present Value to Auto

Finance Solutions.

7. The Finance Lease also includes the following seizure of goods clause:

Auto Finance Solutions may enter the place where any item of goods is

kept to:

a) at any time on reasonable notice, inspect it or see whether PPL is

complying with its obligations under the lease; or

b) At any time, take possession of it when exercising its rights under this

lease


The UCT rules do not identify who they protect – they simply apply to a Small

Business Contract. So in theory:

• A big business dealing with a small business on the small business’s standard

terms could raise UCT

• One small business dealing with another small business could raise UCT

• A small business could argue UCT against its own terms, if it wanted to avoid

them for some reason

Some of these possibilities arise in the consumer space as well, but far less

likely to be practical issues in the consumer space

Some paradoxes


The UCT rules themselves do not impose EDR Requirements

Financial Services Providers will usually have signed up for EDR if they

provide:

• Chapter 7 Financial Services

• Consumer Credit

EDR Jurisdiction is claims with a value of $500,000 or less. But EDR Terms of

Reference go further than Corps Act / NCCC. In particular, include disputes

with:

• Small Business (slightly different test from UCT)

• Focuses more on consumers

EDR schemes can consider:

• Legal principles – so UCT terms are clearly in

• “good industry practice”

EDR schemes


• Identify small business customers and contracts

• Contract management• Categories of contracts: consumer, “small business” for UCT purposes,

other small businesses (remember that the definitions vary)

• One non-consumer standard, or a separate small business standard and

“large business” standard

• If you have one standard only, how will you deal with variations between

customer types?

• Standard approval may not work for all contracts – your interests may vary

depending on the risk, the security etc

• Extent of review of individual clauses

• Obtain legal advice when renewing or varying contracts

Managing the reforms

Law

Panel - Katherine Forrest, Emma Curtis, Amanda Nikolaou & Daniel Tirado - The extension of unfair contract terms to small business