Unfair Contract Terms in the Construction Industry – You Need to Take Action

Unfair Contract Terms in the Construction Industry – You Need to Take Action

In November 2016 new legislative changes will see negotiating power swing away from larger businesses towards small businesses.

This article looks at:

• the changes to the Australian Consumer Law which will extend unfair contract protections to small businesses (less than 20 people employed);

• the impact the changes will have on contractors and subcontractors; and

• the action that principals, contractors and subcontractors who are contracting with small business should take to prepare for the changes, including undertaking a review of procurement policies and contract terms when it comes to contracting with small businesses.

What are the changes unfair contract protections legislation?

On 12 November 2016, the existing ‘unfair contract protections’ in the Australian Consumer Law will extend to small businesses and will impact upon all legal relationships. The new provisions will apply to all industries; not just the construction industry. Currently, the unfair contract term protections only apply to consumers.

These provisions are designed to protect small businesses from being strong-armed by unfair terms in ‘take it or leave it’ deals. These changes should signal the necessity to review the terms of any standard form contracts that may be ‘unfair’ and address them before the law comes into place. It may also require you to review your company policies and ‘standard form‘ contracts when it comes to contracting with small businesses. These provisions will apply to any ‘standard form’ contracts entered into or renewed on or after 12 November 2016.

What is a standard form contract?

The legislation does not provide a clear definition of a standard form contract. However, it does require the court to consider a multitude of factors such as:

• whether the contract was prepared before the parties began discussions; and

• whether the contract was presented to the other party on a ‘take it or leave it’ basis.

Conceptually, this new prohibition will apply to numerous contracts, subcontracts, supply agreements and consultancy agreements used in the construction industry.

 Does this affect you?

Any standard form contracts that:

• are entered into with a small business (fewer than 20 employees); and

• have an upfront price of up to $300,000, or up to $1 million for contracts with a term greater than 12 months,

will be covered by the changes to the legislation.

Importantly, any agreement with a defects liability period of 12 months or more will be subject to the limit of $1,000,000. As a result, most contracts and subcontracts with an upfront price payable of less than $1,000,000 will be covered by the change in legislation.

What ‘unfair terms’ could you look out for?

Again, the legislation is unclear when it comes to what constitutes an ‘unfair’ contract term. The guidance provided by the legislation indicates that a term within a standard form contract will be ‘unfair’ if it:

• would cause a significant imbalance between the party’s rights and obligations; or

• is not reasonably necessary to protect the legitimate interests of the party that will benefit from its inclusion; or

• would cause detriment to the other party (financial or otherwise).

However, terms that define the main subject matter of the contract or simply state the upfront price payable are exempt from these changes.

These changes may void certain terms typically found in construction contracts, such as:

• liquidated damages provisions;

• novation clauses;

• time bars, particularly those with short notice periods

• certain termination for convenience clauses;

• warranties in design and construct contracts that make a contractor liable for preliminary design work by others; and

• certain indemnity clauses.

The decision as to whether a term is ‘unfair’ will ultimately be made by a court or tribunal. In deciding whether a term is unfair, the court or tribunal must consider how transparent the term is, as well as the overall rights and obligations of each party under the contract. Upon deeming a term as ‘unfair’ the term will be void, or if the term cannot be severed from the contract, the contract as a whole will be void.

What to do

We recommend that principals, contractors and subcontractors that contract with small businesses take action now to ensure they are prepared when the changes to the ACL come into effect.

While the precise impact of these changes won’t be clear until tested by the courts, there are certain proactive actions that can be taken by contractors and subcontracts to prepare for the most likely eventualities. The actions include:

1. undertaking a review of your procurement systems to:

• ensure you identify proposed subcontractors who are small businesses during the tender process – this could include adding requiring subcontractors to disclose whether they have less than 20 employees as part of their tender submissions;

• provide the subcontractor with an opportunity to review your subcontract as part of the procurement process; and

• where possible, consider whether you may be better served by avoiding contracting with small businesses. For example, if a ‘small business’ has a cheaper tender price than a larger business, consider whether the up-front saving available from the small business will adequately compensate your business for the increased risk it will take on; and

2. obtaining advice on the terms of your standard form contract to identify which terms may be ‘unfair’ under the Act. This is important – some of the key risk allocation clauses in construction contracts will be impacted, and you will need to ensure they are amended to be ‘fair’. Obtaining this advice should allow you to remove any unfair contract terms, such as by preparing:

• special conditions of contract, to be used when contracting with small businesses, that replaces the potentially ‘unfair’ contract terms in your standard form contracts; or

• an alternative form of agreement to be used when contracting with small business which does not include ‘unfair’ terms.

To prepare your company for the changes, please contact Martyn Cutler on +61 2 9261 5900.