The new amendments to Unfair Contract Terms legislation will apply to commercial and retail leases

Introduction

The Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act (Cth) (UCT Act) comes into effect on 12 November 2016 and introduces amendments to the current Australian Consumer Law regime contained in Schedule 2 of the Competition and Consumer Act 2010 (Cth) (ACL).

The effect of these amendments is to extend the prohibition of unfair contract terms in standard form contracts beyond the ambit of consumer contracts.  From 12 November 2016 onwards, the prohibition of unfair contract terms will also apply to standard form contracts where at least one party to the contract is a small business.  

This article discusses the potential impact that these amendments may have on leases.

Application of the UCT Act

The UCT Act will apply to all small business contracts (including contract variations) made on or after 12 November 2016.  In the leasing context, this will catch all extensions of leases and those assignments of leases that vary any term of a lease.

What is a small business contract?

A ‘small business contract’ is defined by the UCT Act as a contract:

• that is for the supply of goods or services, or a sale or grant of an interest in land;
• where at least one party to the contract is a business that employs fewer than 20 persons; and either:
  • the upfront price payable under the contract does not exceed $300,000; or
  • where the contract has a duration of more than 12 months, the upfront price payable under the contract does not exceed $1,000,000.

What is a standard form contract?

The UCT Act defines ‘standard form contract’ by reference to the criteria contained in section 27 of the ACL.

A contract alleged to be a standard form contract will be presumed to be a standard form contract unless proven otherwise. (s27(1), ACL)

Section 27(2) of the ACL provides a list of factors that may be taken into consideration in determining whether a contract is indeed a standard form contract.  These factors include:

• the bargaining power of the contracting parties;
• whether the contract was prepared by one party before the parties began discussing the transaction;
• whether one party was required to either accept or reject the terms of the contract in the form presented to them;
• whether the parties were given an effective opportunity to negotiate the contract terms;
• whether the contract takes into account the specific characteristics of the parties to the transaction; and
• any other matter prescribed by the regulations[1].

What terms are considered ‘unfair’?

If a small business contract is considered to be a ‘standard form contract’, the next question is determining whether the contract contains an ‘unfair’ term.

A term is ‘unfair’ if:

• ‘it would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
• it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
• it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on’.

(s24(1), ACL)

In determining whether a term is an ‘unfair’ contract term, a court has a wide discretion to consider all such matters as it thinks relevant.[2]  However, it must consider the following:

• the extent to which the term is transparent;[3] and
• the contract as a whole.[4]

A term is not necessary in order to protect the legitimate interests of a party who would be advantaged by the term, unless proven otherwise. (s25(4), ACL)

Section 25 of the ACL provides a non-exhaustive list of examples of ‘unfair terms’, including terms which:

• allow only one of the contracting parties to avoid or limit their contracted obligations;
• allow only one of the contracting parties to terminate the contract;
• penalise only one of the contracting parties for breaching or terminating the contract; and
• enable only one of the contracting parties to vary the contract terms.

The effect of a term being deemed an ‘unfair’ term is that the term will be void.  However, the contract will continue to be binding on the parties if it is capable of operating without the ‘unfair’ term.

Exemptions

Certain contract terms cannot be challenged as being ‘unfair’.  These include terms which:

• define the main subject matter of the contract;
• set the upfront price payable under the contract; or
• are required, or expressly permitted, by a law of the Commonwealth, a State or a Territory.[5]

How do these amendments impact leases?

Despite the fact that retail leases are already extensively regulated by the relevant retail legislation of each Australian State and Territory, the amendments introduced by the UCT Act will mean that retail leases which are considered to be small business contracts and a standard form contract will also need to comply with the unfair contract terms regime in the ACL.

The ACL will also apply to commercial leases.  Commercial leases have largely been unregulated.  As a consequence, the ACL may have a more profound effect on commercial leases.

The commercial leases that will be affected are those with relatively low rents.

Could a retail lease be considered to be a ‘small business contract’?

The threshold for determining whether a contract is a small business contract is detailed above. 

As a lease necessarily involves the grant of an interest in land, the question as to whether a retail lease is a small business contract for the purposes of the ACL rests on determining the following:

• does the retail lease involve at least one party who employs less than 20 people (i.e. small business); and
• is the upfront price payable less than $300,000 or, where the lease term is beyond 12 months, less than $1,000,000.

If the answer to the above is in the positive, then the lease would be considered to be a small business contract for the purposes of the ACL.

Does the relevant retail lease involve a small business?

It is possible for either a retail tenant or landlord to be considered to be a small business.  It is not uncommon for retail tenants to employ less than 20 people.  Alternatively, some landlords could be considered to be a small business, including where they are landholding trustees or special purpose entities which do not directly employ people.  Syndicators are a good example.

What is the ‘upfront price payable’ under a retail lease?

The ‘upfront price payable’ is the consideration provided (or to be provided) for the supply, sale or grant under the contract that is clearly disclosed at or before the time the contract is entered into.

The ‘upfront price payable’ does not comprise any other consideration that is contingent on the occurrence or non-occurrence of a particular event.

The Australian Competition and Consumer Commission (ACCC) provides some guidance as to which payments under a lease would be considered to form part of the ‘upfront price payable’.  This is particularly important given that leases often involve contingent payment amounts.  For example, rent increasing by CPI, rent payable by reference to turnover, and operating expenses to name a few.

Whilst not determinative, the ACCC suggests that ‘contingent payments which are referable to the supply, sale or grant under the contract which are disclosed at the time the contract is entered into will be included in the upfront price payable’.[6]  Therefore, whilst certain payment amounts are unknown at the time that the parties enter into a lease, if the manner in which these contingent amounts are to be calculated is agreed to before or at the time that the lease is entered into, then these amounts will form the ‘upfront price payable’.  For example, a lease may set an agreed percentage or formula by which rental payments are to be increased over the term of the lease, or by which contributions to a shopping centre marketing fund or operating expenses are to be paid.[7]

The following would be included in the upfront price for a lease:

• The rent (including the increases in the rent over the term if clearly calculable, such as fixed increases).
• Operating costs.
• Potentially, security deposits.

Could a lease be considered to be a ‘standard form contract’?

As referred to above, in the absence of an express definition for ‘standard form contract’, whether a lease is considered to be a standard form contract would be determined by reference to the factors listed in section 27 of the ACL.

Impact of the UCT Act amendments on retail leases

We can expect that the impact that the UCT Act amendments will have on retail leases will be unique as compared to other small business contracts on account of the way in which retail leases have historically been negotiated and prepared as under the Commercial Tenancy (Retail Shops Agreement) Act 1985 (WA).

This section discusses a number of key impacts that the UCT Act amendments will likely have on retail leases.  

Risk of double regulation

Although the introduction of the UCT Act would bring about more protection for retail tenants, there could also be a risk of double regulation in the retail leasing industry.

Retail leases are currently subject to extensive regulation by the Commercial Tenancy (Retail Shops) Agreements Act 1985 (WA).  This Act specifies detailed rules on a number of key issues, including disclosure requirements, rent reviews and renewals, termination rights, and mechanisms for dispute resolution.  These rules set the minimum conditions of a retail lease as a means of protecting retail tenants in a relationship that inevitably involves an imbalance in bargaining power between tenant and landlord.  

It is possible that double regulation will be avoided by virtue of section 26(1)(c) of the ACL, whereby a term contained in a standard form contract will not be considered ‘unfair’ if it is a term that is ‘required, or expressly permitted, by a law of the Commonwealth, a State or Territory’. 

However, there is a risk that courts may read this exemption literally.[8] 

The concern is that the Commercial Tenancy (Retail Shops Agreement) Act 1985 (WA) provides minimum standards by which retail leases are to comply, as opposed to expressly permitting certain terms to be included in a retail lease.  As such, terms which are permissible under the Commercial Tenancy (Retail Shops Agreement) Act 1985 (WA), as they do not fall foul of the minimum standards and rules set by such legislation, could still be considered to be ‘unfair’ pursuant to the UCT Act for lack of being ‘expressly permitted’ by legislation.[9]  In effect, a term which is permitted by a state parliament, and therefore not considered ‘unfair’ by that parliament, could be considered by a federal court judge to be unfair and declared void.

If such a literal meaning is adopted by courts, leasing parties will need to be extra prudent in ensuring that their retail lease complies with not only the relevant retail legislation but also the unfair contract terms regime under the ACL.  This will necessarily, as with any double regulation of industry, increase the time involved in progressing transactions as well as significantly increasing the legal costs incurred by both landlord and tenant in ensuring compliance with both regulatory regimes.

Impact of lack of ‘standard form contract’ definition

The lack of a definition of ‘standard form contract’ in the context of leases could also pose a number of issues in practice.

The lack of a definition of ‘standard form contract’ makes it unclear as to how much a standard lease needs to be varied in order for it to no longer be considered a ‘standard form contract’.

Whilst the criteria provided in section 27 of the ACL are helpful in determining whether a consumer contract is a standard form contract, they may not be as helpful or even appropriate in the context of leases.

For example, one of the factors listed in section 27 as being indicative of a standard form contract is whether the contract was prepared by one party before the parties began discussing the transaction.[10]  

It is common practice for landlords to develop standard lease documents to serve as the starting point for negotiations with potential tenants.  This practice affords efficiencies in time and cost for both landlord and tenants.

For landlords who often contract with small business tenants, the issues with the lack of a definition of ‘standard form contract’ are warranted.  This is especially given that there is little guidance in the ACL and from the ACCC as to how much a standard contract would need to be varied to no longer be considered to be a ‘standard form contract’ as well as the fact that, under section 27, the burden of proving that a retail lease is not a ‘standard form contract’ would more often than not rest on the landlord.

Issues with determining what lease terms are ‘unfair’

In determining whether a term in a lease is ‘unfair’, a court will consider:

• the relative bargaining power of the parties to the lease;
• whether the term is reasonably necessary to protect the interests of the party relying on it; and
• whether it causes detriment to the other. 

The reality is that, in most cases in the small business context, the landlord has a superior bargaining position to that of the tenant. 

The difficulty with applying the above criteria to leases is that it is industry practice to include particular terms in a lease as experience has found them necessary to protect the lessor’s legitimate interests.  It could prove very challenging for a landlord, bearing the onus of proving that a relevant term is not ‘unfair’, to establish that the term is reasonably necessary to protect its interests.  

Another concern with the criteria used to determine whether a term is ‘unfair’ is in relation to the court’s wide discretion to ‘take into account such matters as it thinks relevant’ under section 24(2) of the ACL.  Arguably, section 24(2) grants courts too wide a discretion in deciding what matters it may consider in determining whether a term is ‘unfair’.  That is, it allows judges, whom may not have the benefit of commercial experience, to make determinations on the basis of their own perceptions and personal notions of fairness, rather than clear and consistent standards.[11]   

Examples of unfair clause could include:

• Market rent review clauses:
  • that contain ratchet clauses (which are not permitted in the retail context); and
  • with respect to the inclusions and exclusions to be taken into account in making the calculation.

• Fit out arrangements that can be altered unilaterally by the landlord.
• Building or shopping centre rules that can be unilaterally changed by the landlord.
• Rent abatement provisions that are too biased in favour of the landlord.
• Insurance and indemnity provisions that are in excess of those reasonably necessary to protect the landlord’s legitimate interests.
• Electricity costs where electricity is supplied by the landlord.
• Relocation provisions.

One of the key objectives of the ACL is to create “transparency” in these contracts.  This could be achieved by stating in leases the reasons why certain provisions have been included in the lease.

A limiting factor in potential claims by tenants against landlords under this legislation is that the proceedings must be commenced in a “Court” (that is the Federal Court of the Supreme Court) and not the SAT.  The Federal Court and the Supreme Court are “cost” jurisdictions – meaning that the unsuccessful party can be required to pay the cost of the other party.  We think this could be a significant inhibitor to tenant actions under this legislation. 

What landlords should do

We recommend landlords consider doing the following in order to comply with the ACL (as expanded by the UCT Act):

• Keep good records of the lease negotiations.  This can go a long way in supporting an argument that a lease is not a standard contract.
• Consider reviewing leases to provide transparency in respect of those provisions that are most at risk of being regarded as unfair.
• Consider avoiding market reviews of leases as far as possible.