Fair game: A sectoral focus on unfair terms in financial services

The unfair terms regime – a recap

In Australia, the unfair terms regime has existed in various forms since the 1970s. In the present day, it exists in multiple federal legislative regimes, such as the Australian Consumer Law, the ASIC Act and the Corporations Act. These regimes are designed to ensure the protection of small businesses and consumers in “standard form contracts”, where typically, the bargaining power of the contracting parties is asymmetrical.

In this edition of HSF FSR Australia Notes, we focus on the unfair terms regime as it applies to consumer contracts in financial services under the ASIC Act. Under section 12BF of the ASIC Act, the unfair terms regime applies in respect of a standard form contract where the contract is:

• a financial product; or
• a contract for the supply, or possible supply, of services that are financial services.

If a term is declared unfair, it is rendered void.[1] The rest of the contract will continue to bind the parties to the extent that it is capable of operating without the unfair term.[2]

It is timely to refocus on the requirements of the unfair terms regime in financial services, given the recent Federal Court decision in Australian Securities and Investments Commission v Bendigo and Adelaide Bank Limited [2020] FCA 716 (see our case note here) and the expansion of the unfair terms regime to insurance contracts from April 2021. In addition, there have been repeated calls from the Government, the Opposition and the ACCC to increase the penalties under the various unfair terms regimes (including the introduction of civil penalties), due to a view that the remedy of voiding the unfair term is largely unhelpful to consumers and not effective in deterring businesses from including unfair terms in their contracts.

The elements

The concept of a “standard form contract” is left undefined in the legislation. However, the legislation provides a list of matters that a Court must consider in determining whether a contract is a standard form contract, namely:

• whether one of the parties has all or most of the bargaining power;
• whether the contract was prepared by one party before any discussion;
• whether another party was effectively required to accept or reject the terms in the form presented (other than the terms to which the UCT provisions do not apply, such as a term that sets the upfront price payable – see below);
• whether another party was given an effective opportunity to negotiate the terms;* and
• whether the terms* take into account specific characteristics of another party or the particular transaction.

There is a statutory presumption that a contract is a standard form contract if one party alleges it to be so – it is up to the other party to prove otherwise.[3]

A contract is a “consumer contract” where at least one party is an individual acquiring the financial product or services for predominantly personal, domestic or household use or consumption,[4] and a contract is a “small business contract” if at least one party to the contract is a business that employs fewer than 20 people and either:

• the upfront price payable is $300,000 or less; or
• the term of the contract is for more than a year and the upfront price is $1,000,000 or less.[5]

A term of such a contract is unfair if the following three conditions are met:

• 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^[6] of the party who would be advantaged by the term;^[7] and
• it would cause financial or other detriment to a party if it were to be applied or relied on.

A term is not unfair to the extent that it:

• defines the main subject matter of the contract;
• sets the upfront price payable; or
• is a term that is required or expressly permitted under a law.

In determining whether a term of a contract is unfair, it is relevant to consider the extent to which the term is transparent[8] as well as the contract as a whole. For instance, unfairness can be created by a number of terms operating in conjunction to create an overall effect.[9]

Additionally, there are a number of statutory examples of the kinds of terms that may be unfair in section 12BH of the ASIC Act (and section 25 of the Australian Consumer Law). These include:

• unilateral variation clauses;
• clauses that limit performance of the contract;
• clauses that limit a party’s right to sue the other party;
• rights to terminate the contract that are given to one party only; and
• unilateral rights to vary the financial services to be supplied under the contract.

It is important to note that these examples “provide statutory guidance on the types of terms which may be regarded as being of concern. They do not prohibit the use of those terms, nor do they create a presumption that those terms are unfair”.[10]

When determining unfairness, a lower moral or ethical standard is applied than the standard applicable to the question of unconscionability.[11]

Some relevant factors identified by the Courts include:[12]

• whether the consumer can opt out of an unfair term applying;
• whether the contract confers a right on a party without imposing a corresponding duty on that party or without giving any substantial corresponding right to the counterparty (i.e. such as a unilateral price variation clause); and
• whether the party advantaged by the term is better placed to manage or mitigate the risk imposed by the term than the consumer (such as an indemnity clause which requires the consumer to indemnify the supplier where in circumstances where the risk is outside the consumer’s control and could be avoided or mitigated by the supplier).

Orders available to a Court under the ASIC Act

A Court may declare that a term of a consumer or small business contract is an unfair term, on the application by a party to the contract or ASIC.[13] If a person then seeks to apply or rely on a term of a contract declared unfair by a Court, the following orders are available to a Court on the application of a person who has or is likely to suffer loss or damage by the contravening conduct, or ASIC on such a person’s behalf: [14]

• declaring all or part of a contract (or collateral arrangement relating to contract) to be void, including from the commencement of the contract or from a date specified by the Court;
• varying a contract, again from such date the Court thinks appropriate;
• refusing to enforce some or all of the terms of a contract or arrangement;
• directing a party to refund money or return property to the injured person; and
• directing a party to provide services to the injured person at the party’s expense.

A Court may also grant an injunction in such terms as it determines appropriate where a person seeks to apply or rely on a term declared to be unfair, on the application of the Minister (the Minister currently responsible for ASIC is the Treasurer), ASIC or any other person.[15]

Further, the court may make such orders as it thinks appropriate against the party advantaged by the term – for example, to redress, prevent or reduce loss or damage to non-party consumers.[16]

Sector focus: Banks

Historically banks have had the most interaction with the UCT regime. This is because the majority of banking contracts are standard form contracts as defined in the legislation, and banks must comply with the UCT regime in relation to individual consumers as well as small businesses that enter into small business contracts as defined in the legislation (discussed above). Unlike insurance contracts, bank contracts have never been carved out from the application of the UCT regime, so banks have had to comply with the regime since it was first introduced.

We will discuss the application of the unfair contract terms regime to banks in greater detail in a subsequent article which will follow.

Recent enforcement action

ASIC recently took Bendigo and Adelaide Bank to Court over unfair clauses in the bank’s standard form small business loan contracts. On 28 May 2020, the Federal Court made the proposed orders and declared the following terms of those contracts void ab initio (i.e. from the formation of the relevant contract):[17]

• indemnification clauses – these would have made the customer liable for the bank’s losses that the customer did not cause or which were caused by the bank’s own mistake, error or negligence, and which could have been avoided or mitigated by the bank;
• event of default clauses – these clauses provided for default consequences that were disproportionate to the default event (some of which may not have involved any credit risk to the bank) and did not permit the customer to remedy a default which may be capable of remedy;
• unilateral variation or termination clauses – these clauses permitted the bank to vary the upfront price of the contract, the financial services to be supplied under the contract and other terms of the contract (including the amount of funds that the customer would be able to utilise), and provided for fees and break costs if the customer terminated the facility as a result of the bank relying on these terms;
• conclusive evidence clauses – certain clauses permitted the bank to terminate the contract if the customer failed to pay an amount stated in a certificate created by the bank by a certain date, where the certificate would be conclusive evidence of the amount claimed unless the customer could prove otherwise (or, in one standard form contract, demonstrate “manifest error”).

The Court also ordered that the contracts be varied by replacing the unfair clauses with clauses agreed between the parties. For an in depth discussion on this case, see our case note here.

ASIC Report 565

In March 2018, ASIC published Report 565 Unfair contract terms and small business loans (Report 565), which provides guidance on the kind of terms in loan contracts that ASIC considers may be unfair, and details changes made by the major Australian banks to their small business loan contracts to ensure compliance with the UCT regime.

The report lists 5 key types of terms that raise fairness concerns for ASIC and that lenders to small business customers should consider when reviewing their own small business loan contracts for unfair terms. These key types of terms are those to which the major banks agreed with ASIC to make changes in their standard form small business loan contracts, following a review into small business standard form contracts undertaken by ASIC and the Australian Small Business and Family Enterprise Ombudsman in 2017.[18]

The changes the banks agreed to were in respect of the following types of terms:

• unilateral variation clauses that gave the bank a broad discretion to vary contracts without agreement from the customer, which the banks agreed to limit to specific defined circumstances, such as interest rate changes, and to provide a grace period and allow a customer to exit the contract for a period of at least 30 days if the bank varies the contract;
• entire agreement clauses, which the banks agreed to eliminate entirely;
• broad indemnification clauses, which the banks agreed to limit significantly, including to no longer require customers to cover losses incurred due to the fraud, negligence or wilful misconduct of the bank;
• certain types of event of default clauses, namely where the customer would be in default because of any unspecified ‘material adverse change’ – the banks agreed to remove these completely – and clauses that allowed the bank to enforce a loan for certain non-monetary events of default in circumstances where such action would be disproportionate, such as the customer’s failure to maintain insurance, which the banks considerably limited; and
• financial indicator covenants, such as loan-to-value ratio covenants that could trigger a default and enforcement of the loan, which the banks agreed to no longer apply to property investment loans.

It is noteworthy that in the recent action in respect of Bendigo and Adelaide Bank (discussed above), ASIC took issue with clauses that matched 3 of these 5 key types of terms. With this regulatory focus in mind, lenders to small businesses would be well placed to undertake a review of their own standard form documentation with a focus on these 5 key types of terms.

Sector focus: Insurance

The extension of the UCT regime to insurance

From 5 April 2021, the unfair terms regime in the ASIC Act will apply for the first time to all new or renewed general and life insurance contracts other than group insurance and some other limited exempted classes of insurance.

The amending legislation is the Financial Sector Reform (Hayne Royal Commission Response—Protecting Consumers (2019 Measures)) Act 2020 (Cth), which received Royal Assent in February 2020. This legislation:

• amends the ASIC Act to:
  • provide that a term only defines the “main subject matter” of an insurance contract to the extent it defines what is being insured;
  • exclude from the ambit of the unfair terms provisions “transparent” terms disclosed prior to the formation of the contract that set out an amount of excess or deductible under the contract;
  • allow a third party beneficiary to apply for unfair terms-related relief; and
  • exclude medical indemnity cover from the unfair terms provisions; and
• amends section 15 of the Insurance Contracts Act 1984 (Cth) (ICA) to carve out the unfair terms provisions in the ASIC Act from the general prohibition against laws other than the ICA providing relief for insurance contracts.

The UCT regime for insurance does not affect:

• the existing obligation on insurers under section 14 ICA to only rely on provisions where to do so would be to act with utmost good faith; and
• the ability for insureds to rely on section 54 ICA in response to an insurer’s refusal to pay a claim in whole or in part because of a breach of a term of the policy.

What is the “main subject matter”?

In respect of limiting the extent to which a term defines the “main subject matter” of an insurance contract, examples given in the explanatory memorandum to the Bill (EM) reveal a legislative intention to limit severely the kinds of terms that would otherwise be excluded from the unfair terms regime.  This approach differs to the approach in the UK and the EU, where terms which “clearly define or circumscribe the insured risk and the insurer’s liability” are excluded from the applicable unfair terms regime.[19] In the EM, for instance, the following examples are given in respect of motor vehicle and life insurance (at paragraphs 1.36 and 1.37):

“Jess purchases car insurance. The contract describes the car as a 2018 Kia Carnival S 2.2-litre four-cylinder turbo-diesel with a modification to take wheelchairs. This description (a 2018 Kia Carnival S 2.2-litre four cylinder turbo-diesel with a modification to take wheelchairs) is the main subject matter of the contract and therefore outside of the unfair contract terms regime.

…

Yvonne buys life insurance cover for herself and her husband Bob, for the value of $100,000 for each life insured. The description of Yvonne, Bob and statement of the sum insured is the main subject matter of the contract and therefore outside of the unfair contract terms regime.”

As demonstrated by the examples above, the “main subject matter” is defined narrowly to the thing in respect of which insurance is taken out (such as a car), and not the insurer’s liability and insured risks (such as the fact that the insurer’s liability is limited to property damage caused by car accidents). The effect of this is that exclusion clauses under insurance contracts could be considered unfair unless the insurer is able to demonstrate that the clauses cover their legitimate interests.

What terms could be found to be unfair?

The EM provides three insurance specific examples of terms which could be found to be unfair, which are:

• a term that allows an insurer to elect to settle a claim with a cash payment based on the cost of the repair to the insurer rather than how much it would cost the insured to make the repair;
• a term that is linked to another contract (for example a credit contract) which limits the insured’s ability to obtain a premium rebate on cancellation of the linked contract; and
• a term that would allow the insurer to require the insured to pay an excess before the insurer pays the claim.

Based on our experience, some other insurance specific examples of terms which could be found to unfair include:

• a term which excludes liability for losses or claims that policyholders would ordinarily expect coverage for (unless the exclusion protected the insurer’s legitimate interests);
• a term which prevents or limits a policyholder from terminating the insurance contract;
• term that is an unnecessary barrier to the insured making or receiving payment for a legitimate claim;
• a term that uses an outdated, and therefore inaccurate and restrictive, medical definition;
• a term which penalises the policyholder for actions or inactions of a third party; and
• a term which gives the insurer broad discretionary powers (e.g. “you must give us all documents that we require”).

The above is not an exhaustive list of terms that could be considered to be unfair. Conversely, it could be possible to rebut the presumption that some of the terms listed above are unfair if the insurer is able to demonstrate that it is reasonably necessary to protects the insurer’s legitimate interests.

It should be noted that a court may take into account such other matters that it thinks relevant to determining whether a term is “unfair”.  This has the potential to mean that broader considerations of fairness involving factors such as community expectations, have the potential to re-write the terms of insurance contracts.

Sector focus: Superannuation

The application of the unfair terms regime is more limited in scope in the context of superannuation. This is because in large part, the relationship between the superannuation fund trustee and the fund member is governed by the SIS legislation and trust law, pursuant to the relevant trust deed.

However, it is still possible for a superannuation product to give rise to contractual relationships that exist concurrently to the trust relationship. Principally, such contractual relationships arise under the standard terms contained in product application forms. Such forms generally constitute standard form consumer contracts to which the unfair terms regime would apply.

However, it is important to remember that not all of the terms in an superannuation product application form would be subject to the unfair terms regime in the ASIC Act, as they would only be tangential to the “supply, or possible supply, of services that are financial services” under section 12BF of the ASIC Act. For example, a contractual right of the member to be admitted into the fund once the trustee has accepted their application precedes the provision of the relevant financial service (i.e. dealing in a superannuation product). The unfair terms regime in the Australian Consumer Law, however, may still apply.

Accordingly, it would be prudent for a superannuation trustee to undertake a review of its product disclosure statements and offer documentation to determine:

• whether a contract might be formed between a member and the trustee; and
• whether any of those terms are potentially unfair (either under the ASIC Act or the Australian Consumer Law).

[1] ASIC Act, s 12BF(1).

[2] ASIC Act, s 12BF(2).

[3] ASIC Act, s 12BK(1).

[4] ASIC Act, s 12BF(1).

[5] ASIC Act, s 12BF(4).

[6] “Legitimate interests” may be of a business or a financial nature and are not necessarily monetary, such as an interest in contractual performance that are intangible and unquantifiable: Paciocco v Australia and New Zealand Banking Group Ltd [2016] HCA 28, [29]; [161]; and [266].

[7] This is presumed unless proven otherwise by the advantaged party (ASIC Act, s 12BG(4)).

[8] A term is considered to be ‘transparent’ if it is legible, expressed in reasonably plain language, presented clearly, and readily available to any party affected by the term (s 12BF(3)). In other jurisdictions, courts have taken issue with commonly used legal jargon such as “consequential loss”; “liquidated damages”; and “to the extent permitted by law”. Excessive cross-referencing and the need to constantly refer to the definitions to understand the clause may also affect a term’s transparency.

[9] ACCC v Ashley & Martin Pty Ltd [2019], [160].

[10] Explanatory Memorandum to the Trade Practices Amendment (Australian Consumer Law) Bill (No 2) (Cth), cited by Edelman J in ACCC v Chrisco Hampers Australia Ltd (2015) 239 FCR 33, [44].

[11] Paciocco v Australia and New Zealand Banking Group Ltd [2015] FCAFC 50, [363]-[364].

[12] See ASIC v Adelaide and Bendigo Bank [2020] FCA 716, [24] (Gleeson J).

[13] ASIC Act, s 12GND. Note that this section does not limit the Federal Court’s wide discretionary power to make declarations pursuant to s 21 of the Federal Court of Australia Act 1976 (Cth).

[14] ASIC Act, s 12GD(9) and s 12GM(10).

[15] ASIC Act, s 12GD.

[16] ASIC Act, s 12GNB and s 12GNC.

[17] Bendigo and Adelaide Bank Limited [2020] FCA 716.

[18] ASIC media release 17-278MR Big four banks change loan contracts to eliminate unfair terms (24 August 2017).

[19] See AIA Australia Limited’s Submission to Senate Economics Legislation Committee (29 August 2019), p 4.