The prohibition on unfair contract terms in the construction industry

Overview

The restriction on unfair contract terms being included in standard form consumer contracts will shortly also apply to prohibit such terms being included in standard form contracts with a small business as well. This is most likely to affect companies in the construction industry who enter into standard form contracts such as subcontracts, supply agreements, consultancy agreements, plant hire agreements, minor works and purchase orders with small businesses.

It is now time to review standard form contracts and the tendering process that participants in the construction industry use. Terms that are most likely to be unfair and which are discussed in this client update include time bars, variations to scope, termination and assignment provisions.

From 12 November 2016, a standard form contract that is entered into, extended or varied (to the extent it is varied) with any small business will be subject to the requirement that it must not contain any unfair terms. Construction industry participants should note in particular that the concept of ‘standard form contracts’ is not limited to unamended contracts produced by industry associations such as Standards Australia or the Master Builders Association. While there are a variety of factors in determining what a standard form contract is, it may include any amended or bespoke form of contract that is prepared by one party and presented to the other essentially on a ‘take it or leave it’ basis.

What is a small business contract?

A “small business contract” is a contract where at least one party is a small business (it does not matter whether they are the supplier or the purchaser of the goods or services). A small business for the purpose of the Australian Consumer Law (ACL) is a business with less than 20 employees.  A casual employee is not to be counted unless employed by the business on a regular and systematic basis.

There is also a monetary threshold for the purposes of the ACL, so that the protections are only available for relatively low value contracts, being:

• a contract with an upfront price (which comprises the clearly disclosed price that is payable over the term of the contract, but does not include any contingency elements, such as a bonus, interest or other potential revenue) that does not exceed $300,000; or
• a contract with a duration in excess of 12 months with an upfront price that does not exceed $1 million.

Contracts in the construction industry with no lump sum price (such as those based on a schedule of rates) are likely to be treated as falling below the threshold and requiring compliance.

What is an unfair term?

The ACL provides a number of examples of potentially unfair provisions and specifies that a provision is unfair if it:

• causes a significant imbalance in parties’ rights and obligations under the contract (Significant Imbalance);
• is not reasonably necessary to protect the legitimate interests of the advantaged party (Legitimate Interests); and
• it would cause detriment to the small business if relied on (Detriment).

If a standard form contract includes a term that a court or tribunal decides is an unfair term, then that term is void and cannot be relied upon by either party. If the unfair term is severable, then it will be excised from the contract and the balance of the contract will still apply.

There are some excluded contracts (including those entered into before 12 November 2016, unless renewed or altered after this date), however many of those are covered by other regulatory protections. The most relevant exclusions for the construction industry are certain contracts of insurance and shipping contracts.

Unfair terms in the construction industry

Whether a specific term is unfair will depend on the circumstances, including the context of the contract as a whole. However, the following are some common provisions of terms in contracts across the construction industry that are most likely to be considered unfair.

1. Time bars

Time bars are a common requirement in contracts across the construction industry, as they stipulate a fixed period of time within which the supplier of goods or services (e.g. the contractor) must provide notice of a potential claim. It usually specifically relates to claims for extensions of time, delay costs, variations and other specific entitlements. There is often also a general bar on claims provision that includes a time bar in respect of any other claims for which there is no other specific notice period. The contract will usually stipulate that compliance with the notification requirements (both as to time and content) is a precondition to entitlement.

The inclusion of time bars in standard form contracts may cause a Significant Imbalance as the burden of compliance with time bars is imposed on the supplier of goods or services. The Detriment that would be suffered by the supplier of goods or services if the time bar is relied upon is the purported loss of their entitlement to claim time, cost or other relief. The recipient of the goods or services (e.g the principal or head contractor) will need to carefully consider whether each time bar protects a Legitimate Interest. Relevant considerations in deciding whether each time bar is reasonably necessary include the:

1. period of time provided for by the time bar and when it runs from;
2. (nature and extent of the notification requirements (including whether the level of required documentation to be prepared by the supplier of goods or services is reasonable); and
3. purpose of the time bar, which is usually to allow the recipient of the goods or services to respond to the events that may have occurred and assess the circumstances of the claim at the time the claim arises.

2. Variations to scope

The power to unilaterally vary the characteristics of the goods or services to be supplied is identified in the ACL as an example of a term in a standard form contract that is potentially unfair. In the construction industry context, this relates to the power to vary the scope of works or services to be supplied. The element of the variations power that is most at risk of being unfair is whether there is a requirement to comply with a variation direction before there is agreement on its consequences (including as to price and time).

While some contracts provide the supplier of goods and services with the opportunity to confirm whether the proposed variation can be effected, and if so, to provide a proposal for the cost and time impacts, other contracts include the power for the recipient of the goods or services to direct a variation with which the supplier must comply, with such consequences to be agreed or determined subsequently.

Where a party wishes to include the variation direction power, it should consider whether the power is restricted to ordering more goods or services of the same characteristics (to which an agreed  schedule of rates could apply) or extends to new goods or services that are different. In some circumstances, in order to not be unfair, the variation power will need to provide the supplier of goods or services with an opportunity to confirm whether the proposed variation can be effected and what the applicable time and costs consequences are prior to proceeding with the variation to scope.

3 .Termination

The ACL also identifies as potentially unfair, a term permitting one party (but not the other) to terminate a contract. Contracts in the construction industry often include broad powers for the recipient of goods and services to terminate, but more limited powers for the supplier to also terminate. This Significant Imbalance and Detriment causes a potential risk in the context of standard form contracts with small business where the Legitimate Interests are not proportionate.

Aspects of the termination power that should be carefully considered include:

1. whether the process for termination on default is mutual (including the relevant grounds of default, the applicable time periods and the steps prior to termination – including whether it is a show cause regime or requires the default to be remedied);
2. whether the power to terminate for insolvency is mutual; and
3. what entitlements the supplier can claim on termination for convenience.

4. Assignment

The power to assign a contract to the detriment of the counterparty, without the other party’s consent is identified in the ACL as an example of a term in a standard form contract that is potentially unfair.

In the construction industry it is common that a double standard applies to assignment, novation or other dealings with such contracts, whereby the recipient of goods or services can assign or novate the contract without the consent of the counterparty (it is usually effected by providing notice) but the supplier of goods or services is required to obtain the other party’s prior written consent to any proposed assignment or novation.

Such assignment provisions impose a Significant Imbalance, due to their lack of reciprocity and may cause Detriment to the supplier (depending on the entity to whom the contract was transferred). In most cases it is likely to be beyond the Legitimate Interests of the recipient of goods or services to burden the other party with allowing it to transfer or deal with the contract at its election, without the corresponding benefit of equal treatment.

Assignment provisions in standard form contracts should either be made mutual, or the Legitimate Interest (such as a defined class of associates or related bodies corporate) identified to justify the inclusion of such a broad power. Other relevant factors could include whether the proposed incoming party has the financial capacity to meet the remaining obligations and whether or not they are a direct competitor of the supplier.

Recommendation

We strongly recommend that a risk assessment is conducted of the applicable pre-contract or tender process and a review is conducted of all of the terms of any standard form contracts (such as subcontracts, supply agreements and consultancy agreements) that may be used with a small business in advance of the implementation date of 12 November 2016.