Unfair Contract Terms (Small Business Loans) Update

By William Riddle, Law Graduate, MST Lawyers

Since November 2016, the unfair contract terms provisions (UCT provisions) in the Australian Consumer Law have covered not only standard form contracts given to consumers but also those provided to small businesses.

The Australian Securities and Investment Commission (ASIC) recently released ‘Report 565’ outlining the commitment the ‘big 4’ banks have made to update the standard form loan agreements they have with small businesses to comply with these provisions.

ASIC has stated that the report is relevant for all lenders who have loan agreements with small businesses and have encouraged all lenders to implement similar changes. The UCT provisions generally cover small business loans for amounts of up to $1 million.

Below is a summary of the standard form clauses that have been affected.

Entire Agreement Clauses

These clauses restrict the contract between the lender and small business to only what is contained in the written agreement.

The banks have committed to removing these clauses which are now likely to be considered unfair. All pre-contractual communications should, therefore, be carefully recorded.

Broad Indemnification Clauses

Those are clauses that are so broad that they make the borrower liable for losses from the fraud, willful negligence or misconduct of its bank or agents (such as receivers).

These terms are now considered unfair. Generally, borrowers will not be liable for events that are beyond their control.

Events of Default Clauses

Ordinarily, a lender can call a default on a borrower when they fail to satisfy repayment terms.

Events of default clauses are clauses which allow the lender to call a default for specified events which fall outside non-payment of a loan.    For example – a failure to maintain insurance or a change in the beneficial ownership of a borrower company.

Previously, ‘material adverse effect’ clauses allowed lenders a very broad discretion to call a default on a loan agreement. Essentially, any event which in the lender’s opinion would jeopardise the borrower’s ability to repay a loan (for example – a dispute with a third party) could trigger the lender calling a default.

These are now also considered unfair. All events of default clauses must relate to a specific event. The specified events allowed as events of default have narrowed and any enforcement action must be proportionate to the risk taken on by the lender if they are to avoid the UCT provisions.

For example, a minor misrepresentation such as providing an incorrect date of birth on loan documents may be insufficient for a bank to rely on a ‘misrepresentation clause’ when calling default. ASIC has recommended banks provide a reasonable time for borrowers to remedy any default or only call default when there is a ‘material risk’ to the lender.

Financial Indicator Covenants

These covenants are used as indicators as to how a particular borrower is performing financially. If a particular covenant is breached (for example, if the ratio of the value of the loan to the value of the secured property falls below a certain level), the bank can call a default.

These covenants may be considered unfair if a default is called despite the fact the breach of the covenant did not present a material risk to the bank. However, ASIC has recognised the use of these covenants for loans involving securities whose value can fluctuate heavily (such as margin lending or foreign currency loans) is reasonable.

Unilateral Variation Clauses

These clauses give lenders the power to vary the terms of contracts without the consent of the borrower. Unless they confine the variation to specific terms in a specific set of circumstances or give borrowers at least 30 days to accept the variation or exit a loan without incurring additional fees, they will likely be considered unfair.

A recent case, Australian Competition and Consumer Commission v JJ Richards & Sons Pty Ltd [2017] FCA 1224 illustrates the strict approach the courts are taking to these types of clauses. Its relevance is not confined to only a lending scenario, but it is also relevant to all forms of small business standard form contracts. 

JJ Richards, a national waste management company, was pursued by ASIC because of a number of terms in their standard form contracts that ASIC considered were unfair. One of the terms of their contracts – which they issued to over 26,000 small businesses – allowed them to raise the price of their services without the consent of the customer for any reason. The term was considered unfair.

Other clauses that JJ Richards used in their standard form contracts that were considered unfair related to:

• an unlimited indemnity clause in the favour of JJ Richards;
• a clause which automatically renewed any contract with a customer unless the customer cancelled within 30 days of the end of the initial contract; and
• the ability to stop their service to a customer unless invoices were paid within seven days.

Consequently, JJ Richards were required to remove these clauses from their contracts.

Takeaway

If you are a small business and borrow from banks, you should be wary of the changes made by this report. If you think a bank is relying on a term in a loan agreement that may be considered unfair, you should seek legal advice.

If you are a lender that provides small business loans, you should review your contracts to ensure they comply with the new standards in this report. Do not wait for ASIC to come knocking.

Indeed, any terms in a contract regularly issued to small businesses which may not adequately balance the rights between parties should be removed or amended to ensure compliance with the extended scope of the UCT provisions.

If you have any concerns about your contracts, please contact our Corporate Advisory team by email. You can speak to a lawyer directly by calling +61 3 8540 0200.