Corrs High Vis: Episode 58 – Expanded UCT regime: implications for construction industry

Jey Nandacumaran, Partner, Projects

Cameron Inglis, Associate, Projects

Larissa Broadbent, Graduate, Projects

So Jey what is the UCT regime and what are these new reforms everyone has been talking about?

Jey: Thanks Larissa. We are today talking about the expanded UCT regime. So that’s a regime that came into force in November of last year and that’s the regime that we say has potential application and implications for the construction industry, although it is important to note at the outset that the unfair contracts terms regime has lived in the Australian Consumer Law and in other bits of Federal legislation, in respect of small business contracts for – Cameron will correct me, but I think it is something like three or four years, and has applied to consumer contracts for even longer than that. But again, the thing that we are concerned with is the unfair contracts terms regime as it applies as of November last year and Cameron maybe you can tell us a little bit more about that.

Cameron: Sure thing Jey. So the UCT regime falls under the Australian Consumer Law and it applies to small business contracts that are also standard form contracts. So, I’m sure you are all familiar with what a standard form contract is – things with boilerplate clauses that aren’t heavily negotiated. Now, under the ACL there is a presumption that contracts are standard form and that presumption can be rebutted under the legislation. For example, by evidence that there have been genuine negotiations or that the contract was customised, although the legislation also says that those negotiations are inconclusive. So under the old regime, the concept of a small business contract was pretty confined to quite a limited class of businesses. It was only companies with up to 20 employees and with a contract value of less than $1 million. With these new reforms, that class of businesses has now been greatly expanded, so it now applies to companies with either less than 100 employees or an annual turnover of up to $10 million and, significantly, the reforms have also removed the contract value threshold, so it can now apply to any contract regardless of the monetary value. And as a result of that, the reforms have really expanded the regime’s protections to a much broader class of small businesses who are engaged in standard form contracts.

Larissa: Thanks for that Jey and Cam. So Cam, tell us, what is the consequence of having an unfair term?

Cameron: So the other key change that was introduced with these reforms was the maximum penalties for unfair terms have been significantly increased. Previously when a term was declared unfair, it would become void but the court could not impose any additional penalties. And now including an unfair term actually contravenes the Act and that exposes parties to severe penalties which can be up to $2.5 million to individuals who are knowingly concerned in a breach of the Act. With companies, the maximum penalty is the greater of $50 million or three times the value of the benefit that is gained by the unfair term, or 30% of the company’s turnover over the relevant period. So as you can see from that, really significant penalties, and the whole idea behind that is to create a much greater deterrent so that parties don’t include unfair terms in their contracts. That’s the purpose behind that reform in the legislation.

Larissa: So the consequences are pretty severe then, right?

Cameron: Absolutely. Now, section 23 still renders any unfair term void and, in doing so, the High Court has said that it actually imposes a statutory norm of conduct by prohibiting parties from proposing, applying or relying on an unfair term. There is also a section that says a breach of that norm allows courts to impose a separate penalty for each unfair term that was proposed and in light of those significant penalties that are available, that can add up to a really significant amount that parties can face. So in addition to imposing those financial penalties, courts also have a broad range of remedies at their disposal, what one court has described as a remedial smorgasbord of remedies, and that includes the power to award compensation for lost cause by the unfair term and the power to avoid, vary or refuse to enforce any or all contract provisions. So, in a nutshell, there are these really significant remedies available, in addition to the financial penalties, that are there for courts to apply. So essentially, what these reforms do is create a really big deterrent now for parties not to include these terms in their contracts.

Larissa: How is it that you think these reforms will impact the construction industry?

Cameron: So the real reason we think this could have a really big impact on the construction industry is due to the pass through of terms through chains of contracting. When contracts are formed between large, sophisticated parties at the top end of contracting chains, those are not likely to get captured by the UCT regime, either because those companies are too large to fall within the thresholds for employee numbers and annual turnover. But what happens is that when those contractors pass through their terms down the chain to subcontractors and subsequent subcontractors, it is quite likely that somewhere further along the chain one of those parties will be engaged under a standard form contract and it is that contract that could well be captured by the UCT regime following these new reforms, and that could have really big consequences. Because it means that unfair terms that are baked into the contracts at the top of the chain, can unwittingly cascade down through that whole chain and suddenly be triggered down the bottom end, and that means the new regime could affect a really broad range of projects. It might not only capture subcontractors and consultants of course but also entities like joint ventures and special purpose vehicles, which are entities that are often created with far less than 100 employees and sometimes with no real working capital. So they can easily fall within those thresholds for being a small business and that is significant because there are some really large multi-billion dollar, mega projects out there that are administered by entities like JVs and SPVs. So in theory, even those, if they enter into a subcontract, even those entities can trigger this new regime and potentially be challenged for containing unfair contract terms and that has the potential to cause enormous disruption for these projects if you have disputes around unfair terms and as a result, in our view, no one in the construction industry can really ignore these reforms to the regime because all parties have to ensure, even the large parties, they have to ensure that the obligations they sign up for can be safely passed downstream and not fall foul of the regime.

Jey: And I wonder too by expanding the class of contracts to which this regime applies, there’s what behavioural economists would describe as nudging. So it might not apply to all contracts, at the very top of contracting chains, the regime might not apply, but by expanding the scope of contracts which are captured, what parliament is seeking to achieve is by sort of moving parties, moving big state governments, developers, tier one contractors, to these norms of fairness.

Larissa: Thanks for that Cam and Jey. So how do these regimes work and how do you determine whether a term is unfair?

Jey: Yes, that’s the $50 million question, and the thing to firmly keep in your minds is that what is unfair doesn’t come down to the subjective assessment of a decision maker. So, not a judge applying his or her own notions of what is fair or unfair. Instead in order for a term to be unfair it needs to meet the three statutory criteria in section 24 of the Australian Consumer Law.

So, to summarise, they are, would the term create a significant imbalance in the parties rights and obligations – that’s the first one. The second one: is the term reasonably necessary in order to protect the legitimate interests of a party who would otherwise be vantaged by the term?

And the third is, would it cause detriment whether financial or otherwise?

It is only if you satisfy those three criteria will a term be unfair. The other important thing to bear in mind is whether or not a term is unfair, must be assessed on its proper construction. That is not just a plain reading of what the term says, but what is its proper legal meaning and secondly, in the context of the relevant legal landscape, that is having regard to available rights and entitlements of statute, common law, and equity.

As to the legitimate interest element, what’s relevant is the proportionality of the term measured against the interest to be protected, or the risk to be managed. The defendant bears the onus of establishing this element, and that’s provided for in the Act itself.

Detriment is the element that’s probably most easily satisfied but again, you need to meet all three of the criteria that I’ve just mentioned before a term will be deemed to be unfair.

The other thing is that the term needs to be considered in the context of the contract as a whole. So Cam, you and I have spoken about this before, it’s both the express and implied terms in the contract, and one must also have regard to the context of the relevant legal landscape. So that is, you need to have regard to other available rights and entitlements that might be available under statute, the common law, and equity.

There is a case that we deal with in quite some detail in our paper, and that’s a reasonably recent decision from earlier this year from Justice Jackman in the Federal Court. It was a case that ASIC brought against an insurer, and it’s a helpful decision in that it sets out in quite a lot of detail the sorts of things that judges will consider in assessing the three statutory criteria. And it’s in the context of that case that Justice Jackman explains that the assessment of whether or not a term is unfair requires consideration of the whole of the contract and, in that case, relevant provisions that exist in the Insurance Act.

Larissa: So what kinds of terms might be scrutinised in a construction contract then?

Jey: The statute, by which I mean the ACL, gives us a bit of a heads-up. In section 25 there are what are described as “examples of unfair contract terms”. Justice Edelman, while he was sitting as a judge of the Federal Court, described the list of example terms in section 25 as a ‘grey list’. So an example is section 25 sub (b) which says that “a potentially unfair contract term is one which permits or has the effect of permitting one party, but not the other, to terminate the contract”. Now, the list of unfair terms in section 25 is not exhaustive and it’s not determinative. Whether or not a term is unfair will again depend on satisfying the three criteria in section 24 of the Australian Consumer Law.

And so Cam and I have given some thought to the common types of clauses you see in construction contracts, and which are the ones that are likely to be found to be unfair, and you could quickly come up with a couple that sort of don’t pass the ‘pub test’. So for example, time bar provisions which give a party very little time in order to put on a fully substantiated claim. Alternatively, or perhaps draconian, exclusional limitation of liability clauses. But to reiterate the point we’ve made a couple of times, these causes will not be found to be unfair if they don’t satisfy the three criteria in section 24 of the Act. So, you might find yourself with a time bar provision, or even an exclusion of liability clause – which actually does serve to protect the legitimate interests of one of the parties, and is proportionate to the risk that clause seeks to address. And then linking these potential clauses that you see in construction contracts back against the grey list in section 25 of the ACL, a time bar-type provision you may fall foul of section 25(k) which is a term that limits one party’s right to sue another party; while on the other hand, an exclusion of consequential loss, for example, doesn’t neatly fall into one of the categories, or one of the example clauses in section 25, but may, nonetheless, be deemed unfair, again, if it meets the three statutory criteria.

Larissa: So Cam, how should lawyers think about drafting their contracts to comply with the new UCT regime and avoid these issues?

Cameron: So from the case law, we’ve sort of distilled three broad considerations to think about when drafting clauses to ensure that terms will be compliant with the new regime. Those three factors are: proportionality, business context and transparency.

Now with the first one of proportionality, a clause is more likely to satisfy the legitimate interest test in section 24 where it can be considered proportionate to the risk that it seeks to address. So it might be relevant for a front-end contract drafter to ask themselves: are there alternative ways of drafting the term that are less onerous, whilst still maintaining adequate protections for their client; or can the term be counter-balanced by other terms or pricing arrangements elsewhere in the contract to reduce the burdens that are being imposed on the other counter-party?

For example, if a principal has a liability cap on liquidated damages, they might ask: can we lower that cap, or include extra carve-outs so that the liability cap better reflects the possible detriment that the other party might suffer? In terms of that second consideration of business context, the case law says that unfairness is always highly contextual, so it’s relevant to consider what risks affect a party’s business and genuinely need protection, such as safety risks and compliance risks with regulatory requirements. And, as a result, a principal might be asking themselves: is this clause really necessary due to the structure of my business and the costs that are imposed on me, and does the clause accord with common industry practice?

And then the third consideration is transparency, where it’s relevant to question whether the clause’s purpose can be clearly understood to justify that the clause serves a legitimate aim. So for example, transparency can be used to identify how the contract price may have been altered to compensate a party for taking on unfair terms that impose additional risks and burdens on them. And that means, in theory, it may be fair to include a very onerous and one-sided term where the legitimate purpose of that term is made abundantly clear in the contract. And there’s at least one case which noted that an appreciable change in the contract price, in exchange for an unfair term, may demonstrate that there’s no significant imbalance of rights. And that’s being the 2008 case of Jetstar Airways and Free, where the Victorian Supreme Court held that an extremely low contract price for airfares may have counter-balanced allegedly unfair terms. And that’s a really interesting case because it reveals that parties may potentially remain free to effectively pay for unfairness, provided they make that transparent enough in the contract.

Larissa: Thanks, Cam.

Jey, do you have any thoughts on whether this is good for the industry or not?

Jey: It’s a bit hard to say, isn’t it? I mean, on the one hand, you’ve got this new regime that comes in, and it’s a form of legislative paternalism in telling parties what is, and isn’t fair in their own contracts, and it has a risk, potentially, of up-ending parties’ agreed contractual risk allocations. So that’s obviously a bad thing.

But then, on the other hand, there is the very real and, I suppose, aspirational objective, of seeking to introduce minimum safeguards and increase and improve the way in which parties’ contracts with one another.

I’ll pass to Cam to describe what has been the anecdotal experience in our own practises, and the way that our clients have adopted and adapted their contracts in order to comply with the new UCT regime.

Cam: So you’re right, based on the feedback that we’ve got from clients where we reviewed their suite of standard form subcontracts, we found that the contracts we re-drafted in order to be UCT compliant, have actually ended up with risk allocations that are fairly similar to sophisticated, commercial contracts. In other words, principals have ultimately agreed to terms and risk allocations which they would comfortably accept with more sophisticated counter-parties. So, from that experience, what we’ve seen so far is that principals have not had to concede too much ground in order to comply with the UCT regime. They’ve been able to reach outcomes that suitably protect their interests without needing to make extraordinary compromises. And this suggests that the UCT reforms are already starting to raise standards and improve behaviour towards more vulnerable small businesses within the Australian construction industry. And it’s obviously at an early stage, we still need to see how things play out, but from that limited, anecdotal experience, it seems to be moving things in a positive direction.

Larissa: That’s so interesting. It really does sound like this has the potential to impact the Australian construction industry.

Well, I think that’s all we’ve got time for today. Thank you very much for joining us, Jey and Cameron, and thanks to everyone listening.

This podcast is for reference purposes only. It does not constitute legal or other advice and should not be relied upon as such. You should always obtain legal advice about your specific circumstances.