Unfair contract terms and the penalty doctrine – ACCC v Employsure Pty Ltd [2020] FCA 1409 (1 October 2020)

When deciding whether a contractual term is unfair, a Court will likely consider if the term would cause a significant unbalance, if it is not reasonably necessary to protect legitimate interests, or if it would cause detriment.  Careful consideration should be given to the inclusion of clauses of this nature in standard form contracts, especially if their operation favours the issuer of the contract.

What is an automatic renewal clause?

An automatic renewal clause is a clause in a contract that renews and “rolls the contract over” for a new period, unless either party gives notice (within the period specified) that it does not want to renew the contract.  The effect of a notice period clause is that unless a party provides notice in the specified period the contract automatically renews.  Meaning, if either party does not want to renew and forgets to give notice the contract will automatically renew.

What is a termination clause?

Termination clauses allow parties to terminate or end an agreement without being in breach of contract.  Terms that allow one (1) party to terminate the contract at their convenience may be an unfair contract term if that term is not necessary to protect the legitimate interest of the advantaged party.

To reduce the risk of a termination clause being an unfair contract term, the clause should provide a reasonable notice period and allow for reasonable compensation.  The inclusion of termination fees also require careful consideration, because if the amount is unreasonably high, then it is not a genuine pre-estimate of the non-breaching party’s actual losses resulting from the early termination.  This would result in the term being considered a penalty – meaning it will be unenforceable.

What is an acceleration clause?

An acceleration clause is a provision which allows lenders to demand payment of any outstanding debt is obligations are not met.  The case of O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359 considered whether an acceleration clause could be struck down as a penalty.  It was held that if the purpose of the clause was to punish an obligor for bringing about the termination of a contract within a specified time period, it would be considered a penalty.  In addition, the clause must not propose a payment that is “out of proportion to the protection of the legitimate interest”.  Therefore, businesses must consider the predominant purpose of the clause, in light of the sum demanded, to ensure that the acceleration clause is enforceable.

What is the penalty doctrine?

A penalty clause is term in a contract that states that one party will have to pay certain sum to the other if the contract is breached.  Penalty clauses are designed to deter breaches of contract, regardless of the actual harm suffered.  As found in Paciocco v Australia and New Zealand Banking Group Ltd (2016) 258 CLR 525, a contractual term “will not be a penalty if it protects the legitimate commercial interests of the non-defaulting party”.  Therefore, a contractual term will be considered a penalty clause and be unenforceable if they act as a form of punishment that imposes disproportionately high financial fees on a breaching party.

Relevant cases

Employsure Pty Ltd, an Australian provider of workplace advisory services had previously included clauses in their standard form contracts that had the effect of locking in their small business customers for up to five (5) years.  In 2018, a contract issued by Employsure would often contain a five (5) year term which would require an employer to pay out 100% of the balance of the contract in the event of an early termination.

The question as to whether the early termination clause was a penalty was considered by the Court in the case of Zintix (Australia) Pty Ltd v Employsure Pty Ltd [2018] NSWCA 924 (Zintix v Employsure).  In this case, the early termination term was deemed an unenforceable ‘penalty’ and Zintix was not required to pay the termination payment because it was not a “genuine pre-estimate of loss and damage” suffered by Employsure.

Since the case of Zintix v Employsure, Employsure updated their contract terms to a five (5) year period and a 30% termination payment of the remaining contract value after the first year.  Ultimately, this term was then challenged by the ACCC in the case of Australian Competition and Consumer Commission v Employsure Pty Ltd [2020] FCA 1409 (1 October 2020).  Here, the Australian Competition and Consumer Commission (ACCC) claimed that contrary to sections 23 and 24 of Australian Consumer Law:

 “Employsure included unfair contract terms in three versions of its standard form contract in the period from 12 November 2016 to October 2018.  The terms related to the clauses of those contracts concerning no provision for early termination, unilateral price increases on automatic renewal and a penalty provision.”

However, the Court found that updated Employsure’s contract terms were in fact not ‘unfair’ and were necessary to protect its legitimate business interests therefore making it enforceable.  This was the result of customers having the right to give notice if they did not wish for contract renewal, with the notice period reflecting the term of the contract itself.  Employsure also had an obligation to obligation to give the employer written notice of automatic renewal.

In addition, the Court found that a term requiring full payment upon default was not an unfair contract term despite Employsure accepting that the term “operated entirely in its favour and was not reciprocal”.  This was because the term was found to be necessary to protect Employsure’s legitimate business interests because:

  • “There was uncertainty about the revenue flow of Employsure as a young business;
  • It was relevant to Employsure’s subscription model;
  • The pricing model resulted in Employsure incurring significant costs for an early termination; and
  • Full payment did not necessarily mean that the contract was profitable for Employsure.”

What does this mean for your business?

Businesses must carefully consider the inclusion of automatic renewal, termination or penalty clauses in contracts.  If such clauses are to be included in a standard form contract, businesses can reduce the risk of them being found to be unfair by ensuring they are:

  • necessary to protect a legitimate interest of the business; and
  • are transparent and easily understood by all parties;
  • included alongside clauses which protect the interests of the recipient of the contract, such as providing them with partial or full refunds when a contract is terminated early.

In addition, businesses should also consider how these clauses operate alongside other potentially unfair terms in the contract, such as unilateral variation clauses or automatic renewal provisions, and whether such terms cause a significant imbalance in the rights and obligations of the parties.

Links and further references

Related articles

Unfair contract terms – automatic renewal clauses.

Amendments to unfair contract terms.

Federal Court rules on unfair contract terms.

Unfair contract terms, small businesses and changes to the Australian Consumer Law.

Cases

Australian Competition and Consumer Commission v Employsure Pty Ltd [2020] FCA 1409 (1 October 2020).

O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359.

Paciocco v Australia and New Zealand Banking Group Ltd (2016) 258 CLR 525.

Zintix (Australia) Pty Ltd v Employsure Pty Ltd [2018] NSWCA 924.

Further information

If your business need advice on reducing the risk of potential unfair contract terms, contact us for a confidential and obligation free and discussion:

Malcolm Burrows Lawyer

 

 

Malcolm Burrows B.Bus.,MBA.,LL.B.,LL.M.,MQLS.
Legal Practice Director
Telephone: (07) 3221 0013 (Preferred)
Mobile: 0419 726 535
e: mburrows@dundaslawyers.com.au

 

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances

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