Unfair Contract Terms – What lenders need to know

28 July 2023

Australia’s new unfair contract terms (UCT) laws will take effect from 10 November 2023. The changes will apply to all finance documents signed after this date, and all finance documents signed prior to 10 November, if varied or renewed on or after 10 November 2023.

The key changes

  • Increased Scope of “Customers” – under the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act), the UCT laws apply to standard form contracts that are consumer contracts (with an individual) or that are small business contracts. From 10 November 2023, a contract is a small business contract if:
    • the upfront price payable under the contract does not exceed $5,000,000;
    • at least one party is a business that employs fewer than 100 people or has less than $10 million annual turnover; and
  • Increased Range of Transactions – the UCT laws will broaden the definition of a ‘standard form contract’. Considerations include whether a lender has repeatedly used a finance document or made contracts on the same or substantially the same terms, and whether a borrower has a meaningful opportunity to negotiate terms.
  • Increased Penalties for breaches of the ASIC Act – for corporations the maximum penalty is $50 million or x3 the value of the benefit obtained that is reasonably attributable to the breach (or if the value cannot be determined, 30% of the adjusted turnover during the breach turnover period for the act or omission).

How does this impact Lenders?

Lenders need to be aware that a contract will be presumed to be a standard form contract unless the lender can prove otherwise. Even if the borrower had an opportunity to negotiate minor or insubstantial changes, select a term from a range of options offered, or negotiate the terms of the contract, a contract can still be considered a ‘standard form contract’.

The laws apply to loan contracts that are small business contracts (ie where the borrower is a business that employs fewer than 100 people or has less than $10 million annual turnover and where the loan (being the principal not including interest payable) does not exceed $5 million).

Lenders also need to be weary of the imbalance in bargaining power when entering into transactions with small businesses and whether the terms of the contract consider the specific characteristics of the borrower or the particular transaction.

What terms could be considered unfair?

The following table outlines contract terms that Lenders should be cautious about.

DescriptionContract Term
Imbalanced termination rightsEnabling the lender to terminate the contract at their discretion, but not allowing the borrower similar rights.
Unilateral variation clausesEnabling the lender to vary the terms of the contract without agreement from the borrower or without reasonable notice or the ability to terminate without penalty.
Broad or one-sided indemnity clauses and limitation of liabilityProviding the lender with a broad unilateral indemnity or the ability to avoid or limit their obligations under the contract. This includes an uncapped heads of loss, unilateral indemnity for risks outside the indemnifying party’s control or a unilateral indemnity for breach of contract.
Unfair payment termsEnabling the lender to unilaterally vary fees or charges without a right for the borrower to terminate without penalty.

Enabling the lender to charge excessive early termination fees.
Entire agreement clausesRequiring the borrower to warrant that it has read each document forming part of the contract and warrant that it entered into the contract solely on the contents of the contract (excluding any the lender's liability regarding any pre-contractual representations).
Penalty clausesEnabling the lender to penalise the borrower by imposing liquidated damages or amounts for breaching the contract that are not a genuine
pre-estimate of loss suffered, and not allowing the borrower with similar rights against the lender.
Event of default clausesInaccurate representations - Giving the lender discretion to claim the borrower is in default due to minor misrepresentations (eg incorrect date of birth on application).

Material adverse change - Giving the lender a broad discretion to claim the borrower is in default without justification.

Financial indicator covenants - Giving the lender discretion to claim the borrower is in default due to breach of loan-to-valuation ratio (LVR) where there is no material credit risk to the lender.

 What can Lenders do to mitigate the risk?

Lenders should take a proactive approach and consider whether any terms in their standard contracts:

  • cause significant imbalance between the parties (unilateral rights and obligations);
  • cause unfair detriment to the borrower (payment terms, penalty clauses); or
  • are not reasonably required to protect the lender’s interests (event of default clauses).

Unfair contract terms could be potentially mitigated by incorporating some or all of the following terms into contracts and finance documents:

Potential mitigations to unfair terms

  1. Inclusion of mutual termination rights.
  2. Inclusion of a borrower’s right to terminate if fees are increased.
  3. Inclusion of mutual indemnities and limitations of liability or removal of unilateral terms.
  4. Inclusion of a borrower’s right to receive either a full or partial refund of pre-paid fees on termination.
  5. Inclusion of a requirement the lender must give notice of default and the borrower has an opportunity to remedy any breach prior to before termination.
  6. Inclusion of a requirement that the lender must obtain borrower consent prior to varying a contract.

Importantly, UCT laws will be enforceable even where lenders have not relied upon or caused loss or damage to the borrower. The Australian Securities and Investments Commission has already expressed its willingness to enforce and prosecute breaches of the UCT laws, so it is imperative that lenders are informed about their responsibilities and take pre-emptive action.

HWL Ebsworth can help Lenders to understand the new obligations under the UCT laws and update your loan and security documents accordingly.

This article was written by James Fleetwood, Partner and Mark Lighfoot, Partner. 

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