When unilateral termination and penalty clauses may be unfair under the ACL
The unfair contract term regime in the Australian Consumer Law includes a non-exhaustive list of examples of potentially unfair contract terms (UCTs), which includes unilateral termination and penalty clauses.
The “grey list” provides useful guidance for businesses reviewing their standard form contracts standard form contracts in the lead up to the new UCT penalty regime coming into effect on 9 November 2023, which you can read about in our client alert here.
Section 25 of the ACL describes these two types of clauses as:
- Terms that permit, or have the effect of permitting, one party (but not another party) to terminate the contract (Termination Clauses); and
- Terms that penalise, or have the effect of penalising, one party (but not another party) for a breach or termination of the contract (Penalty Clauses).
Importantly, section 25 is only an indicative list and does not automatically result in such clauses being UCTs. Rather, courts must assess each Termination Clause and Penalty Clause individually to determine whether it is unfair (you can read about the standard test for unfairness in our previous blog post here).
Such an assessment will include consideration of whether the term causes a significant imbalance in the rights and obligations of the parties, such as where a term results in rights and obligations under the contract being significantly in the favour of one party. It will also involve consideration of whether the clause is reasonably necessary to protect the legitimate interests of the party who benefits from the clause.
Termination Clauses
If one party has complete discretion, or greater discretion, as to when a contract is terminated this may be indicative of a significant imbalance between the rights of the parties.
For example, in ASIC v Bendigo and Adelaide Bank Limited [2020] FCA 716 the Court found that the contract contained UCTs allowing the respondent to terminate if the customer did not accept changes made by the respondent to the price and services provided. Conversely, where the customer wanted to terminate, they would potentially be subject to fees and break costs. In considering the unfairness of the terms, the Court noted that they lacked transparency as they were contained under headings such as “Use of Facility”.
The unfairness of a Termination Clause can be exacerbated when included in a standard form contract alongside clauses that allow one party to unilaterally vary a contract. If one party is able to unilaterally vary a contract and the other party does not, as a result of the variation, have the ability to terminate the agreement (without penalty) then this may create a significant imbalance between the parties. You can read more about unilateral variation clauses in our previous blog post here.
Penalty Clauses
A term which penalises one party for a breach or termination of a contract, but not the other party, may also be a UCT. Such terms have been found to be unfair where they would require a party to pay all or some of the contract price upon termination regardless of the reason for terminating the contract and without receiving any corresponding benefit under the contract. In considering whether such clauses are reasonably necessary to protect the interests of the party, courts have given weight to whether an alternative method of recouping any lost value could have been utilised, such as through a legal recovery process or the imposition of interest for outstanding fees.
For example, in ACCC v Ashley & Martin [2019] FCA 1436 the impugned clause had the effect that the terminating consumer would be required to pay 25% of the contract price without having received any product or service from Ashley & Martin. Interestingly, the Court rejected the respondent’s argument that the contract’s refund clause ameliorated any potential unfairness caused by the penalty incurred as a result of termination. The limited circumstances under which a consumer could obtain a refund after termination in that case were actually found to have exacerbated the unfairness of the penalty clause.
Penalty clauses for termination are more likely to be unfair in standard form contracts that contain an automatic renewal provision. For example, in ACCC v JJ Richards & Sons Pty Ltd [2017] FCA, a standard form contract for waste management services contained provisions that meant that the contracts would automatically renew, without notice, unless cancelled within 30 days of the end of the contract term. Once renewed, customers would be bound by a termination clause preventing them from terminating the agreement if there were any outstanding payments. The Court noted that this could result in the contract being automatically renewed when a customer had sought to terminate the contract prior to its renewal but could not due to an outstanding payment. Further, once automatically renewed the customer may not be able to terminate unless they pay for the first week’s service.
Penalty Clauses are more likely to be found to be unfair when they are included alongside Termination Clauses in the same standard form contract. For example, in ACCC v Fujifilm Business Innovation Australia Pty Ltd [2022] FCA 928, the Court declared that the standard form contract terms were unfair both in that the terms provided Fujifilm with a wider range of circumstances in which it could terminate the contract and as the terms required customers to make payments to Fujifilm if they exercised any corollary right to terminate.
Each of these cases emphasises the importance of still considering the contract as a whole when advising on particular terms for compliance with the UCT regime.
When can a Termination or Penalty Clause be fair?
Termination Clauses and Penalty Clauses may be appropriate where they are reasonably necessary to protect the legitimate interests of the party and are appropriately transparent.
In ACCC v Employsure Pty Ltd [2020] FCA 1409, the Court found that a term requiring full payment upon default was not a UCT despite Employsure accepting that the term ‘operated entirely in its favour and was not reciprocal’. This was because the term was found to be necessary to protect Employsure’s legitimate business interests as:
- There was uncertainty about the revenue flow of Employsure as a young business;
- It was relevant to Employsure’s subscription model;
- The pricing model resulted in Employsure incurring significant costs for an early termination; and
- Full payment did not necessarily mean that the contract was profitable for Employsure.
The Court also placed emphasis on the transparent nature of the clause and on the fact that payment upon default did not terminate the agreement with consumers continuing to receive services from Employsure.
What should businesses do?
Without proper consideration, including Termination and Penalty Clauses in standard form contracts can be high risk and businesses should carefully consider the inclusion of such provisions in their standard terms, especially if they operate substantially in the business’ favour and place the consumer at a disadvantage.
If a Termination or Penalty Clause is to be retained or included in a standard form contract, businesses can reduce the risk of them being found to be unfair by ensuring they are:
- clearly necessary to protect a legitimate interest of the business;
- transparent and easily understood by consumers;
- included alongside clauses which protect the interests of the consumer, such as providing the consumer with partial or full refunds when a contract is terminated early.
Importantly, businesses should also consider how these Termination or Penalty Clauses operate in conjunction with other potentially unfair terms in the contract, such as unilateral variation clauses or automatic renewal provisions, and whether they cumulatively cause a significant imbalance in the rights and obligations of the parties.
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