Are you being unfair?

Practical tips for dealing with the B2B unfair contract terms regime under the Fair Trading Act

Changes to the Fair Trading Act 1986 (the Act) came into effect yesterday, extending the unfair contract terms regime to small trade (or “B2B”) contracts that are entered, varied or renewed from now on.

The Commerce Commission has now published specific guidelines about how to interpret this legislation, so it’s a good time to offer some detailed, practical tips for reviewing your standard form small trade contracts.

Does the regime apply?

1) This part of the Act only applies to contracts that are:

• “standard form” – contracts where there is little or no real opportunity to negotiate the terms;
• “trade” – business-to-business contracts (the unfair terms regime already applies to business-to-consumer contracts); and
• “small”– where the contract is part of a trading relationship that is worth $250,000 or less per year.

Standard form

2) You probably have a good idea whether your contracts are “standard form”, but it might not always be obvious. It turns on the level of effective negotiation the contract is subject to. If the Commerce Commission (which is the enforcement agency) alleges that your contract is standard form, the onus will be on you to prove otherwise. Practically, this would mean having evidence to show that each party had some opportunity to influence the agreed terms.

3) Many businesses use standard form terms that either sit online or are otherwise provided on a “take it or leave it” basis (often in a PDF or other “locked” document). These are likely to be standard form, unless the counterparty requests and is given a genuine opportunity to negotiate them. But it’s also important to remember that any agreement can be considered standard form if it is not subject to effective negotiation, regardless of whether it is a traditional, locked-down standard form document.

4) If you have an agreement that has not been reviewed for unfair contract terms compliance and a counterparty that is willing to sign the terms without negotiation, you should consider actively inviting them to review it and raise any issues with you – and then document this correspondence so there is evidence that an opportunity to negotiate has been provided.

Trade

5) A person or supplier is in trade if they undertake any trade, business, industry, profession, occupation, activity of commerce or undertaking relating to the supply of goods or services or interests in land.

Small

6) Whether the standard form trade contract is “small” depends on the annual value of the trading relationship when the relationship first arises. This is an important new concept in the Act so let’s unpack it:

• The “trading relationship” refers to all the contracts (current and prospective) between the same parties that are on the same or substantially similar terms (disregarding the upfront price and subject matter of the contracts).
• The trading relationship “first arises” when the first or only contract of the relationship is entered into.
• The annual value threshold has been set at $250,000 (including GST, if applicable).

7) So, when a trading relationship first arises, if that trade is worth $250,000 or more per year, then this new regime will not apply to the underlying contracts. This is the case even if the trading relationship decreases in value and becomes “small” in any subsequent year – its value originally exceeded $250,000 per year, so the unfair contract terms provisions of the Act don’t apply. The converse is also true. If the trading relationship when it first arises is worth less than $250,000 per year, then the new regime can apply. And it will continue to apply even if the annual value of that trading relationship subsequently grows to exceed $250,000.

8) It will be easy to assess whether the value threshold is met if a single contract entered at the beginning of a trading relationship provides transparently for consideration of $250,000 or more per year to be paid. But what about a new trading relationship made up of contracts (and prospective contracts) to be entered into over time? The test is whether consideration of $250,000 (or more) is “more likely than not” to become payable under the relationship over any annual period.

9)The Commission’s guidance is that if a business knows, or it is more likely than not, that the value of its trading relationship with a party will exceed $250,000 in any year in the future (even if not in the first year of a trading relationship), the regime will not apply to standard form contracts with that party on the same or substantially similar terms. Similarly, if a business does not know (and it is not more likely than not) that the value of the trading relationship will exceed $250,000 in any year in the future, then even if the trading relationship grows in the future, the regime will apply to any standard form contracts entered into between the parties that meet the other requirements of the Act.

10) This value threshold into the future could be difficult to assess given that, by definition, the trading relationship will have only just arisen. The Commission’s guidance is that what is “likely” will be situation-specific but may be influenced by factors such as:

• previous communication between the parties regarding their intentions;
• the supplier’s output capacity; and
• the purchaser’s previous rate of use or on-sale of the particular good or service.

If there is real doubt about the size of the trading relationship, we suggest erring on the side of caution and treating your standard form contracts as if the new regime applies.

11) Remember that standard form small trade contracts entered into before 16 August 2022 will become subject to the Act if varied or renewed after 16 August 2022 (with the exception of insurance contracts). To assess the annual value of the trading relationship, the date of variation or renewal will become the date that the trading relationship “first arises” (even if the relationship has already existed for many years).

Are any terms unfair?

12) Once you know you have a standard form, small trade contract, you need to consider whether any term is “unfair”. A term is unfair if it:

• would cause a significant imbalance in the parties’ rights and obligations under the contract;
• would cause detriment (financial or otherwise) to a party if enforced; and
• is not reasonably necessary to protect the legitimate interests of the party with the bargaining power.

This is a cumulative test – all parts of it must be made out to establish unfairness. The Commission is required to prove a significant imbalance and the potential for detriment. The onus to prove that a term is reasonably necessary falls on the party trying to enforce it.

13) When assessing your terms for potential unfairness, think about the following:

• Is the term written in “reasonably plain language” (the transparency test under the Act)? Terms should be legible, presented clearly and readily available to any party affected by them. They shouldn’t be “hidden” in fine print or obscured with jargon. And bear in mind that an unfair term may also breach other provisions of the Act if it is false, misleading, or deceptive.
• How does the term fit within the contract as a whole? There should be a mutuality in the nature and effect of the terms overall. Other terms can provide a reasonable counterbalance to a term that, by itself, is significantly imbalanced in favour of one party.
• Are all terms reasonably necessary to protect the legitimate interests of your business? Terms that take advantage of your bargaining power to obtain benefits to the maximum extent possible (beyond what is reasonably necessary to protect your interests) may be deemed unfair.
• Can your legitimate interests be protected by fairer means? Terms that require the other party to bear inappropriate risks (particularly where they could instead be insured against to protect your legitimate interests) may be deemed unfair.
• Think about who has control of what happens under your contracts. Terms where a party is required to assume risk for circumstances over which they have little control (e.g. to indemnify the other party when a situation they did not cause and cannot control arises) may be deemed unfair.
• Penalties (i.e. terms that provide for consequences of a breach that are out of all proportion to the legitimate interests of the innocent party) will likely be unfair terms under the Act, and should be avoided in your contracts in any event as they are generally unenforceable as a matter of contract law.
• Terms should always be justifiable by reference to the legitimate interests of your business – and you need to be able to evidence this. Think about and document the reasons that a potentially unfair term is a reasonable necessity. The Commission’s guidance is that this might include evidence relating to your business costs, operations, business structure, regulatory or contractual obligations, and risks and methods of mitigating risks. For example, many unilateral indemnities may appear unfair in isolation but could be justified in the context of the overall commercial bargain and risk profile. Common examples include indemnities protecting against third party IP infringement, data loss or other third-party claims against one party caused by the conduct of the other party.
• It will be difficult to justify an otherwise unfair term based on an argument that no detriment is caused to the other party.  Relevant international case law and the Commission’s guidance suggests there is likely to be a low bar for proving detriment, although it needs to be more than purely theoretical.
• The Commission has indicated that it intends to pay particular attention to contractual terms that: allow a business to make unilateral variations to a contract; limit (or have the effect of limiting) a business’ liability; or limit (or have the effect of limiting) a customer’s right of redress under the contract. The Commission’s view is that these are terms that have a real tendency to be unfair as, by their nature, they are likely to create a significant imbalance in the parties’ rights and obligations (assuming the affected party has no counterbalancing and practicable right, such as a right to exit the contract or to receive a compensating benefit).
• Again, seemingly unbalanced terms may not always be unfair. For example, liability limitations are common in most commercial contracts, and limitations that are not completely mutual may be justified if the risk profile under the contract (or in relation to specific types of loss) differs significantly between the supplier and customer.

What happens if a term is unfair?

14) The Commission can commence Court proceedings to stop the use of a term it considers unfair. Until a term is declared unfair by the Court, it can still be relied on and enforced. But once a Court determines that a term is unfair under the Act, it becomes unenforceable and must be removed from the contract.

15) This is important. Unfair contract terms are not “read down” by the Court in a way that keeps them in the contract but makes them fair – they simply become unenforceable. The whole term becomes unenforceable (not only the parts of it that are unfair) and the remainder of the contract remains binding.

16) So there is a judgement call to be made about the value of using terms in your contracts that could be deemed unfair even if they offer commercial benefits to your business. The risk is that a term becomes unenforceable in its entirety, and you end up in a worse contractual and commercial position than a more moderate (but enforceable) term would have achieved. If a term is important to your business but there is a real risk that it may be deemed unfair, consider either modifying it or at least ensuring it is clearly separated from the other terms in the contract.

17) The Commission also takes the view that if the same contract has been used with multiple counterparties, a declaration of unfairness is likely to extend to all of the same terms contained in all of those contracts. A declaration may also extend to other kinds of contracts containing the same term and involving at least one of the parties, depending on the contract’s content and the terms of the Court declaration. The Commission has noted that the wider impact and effect of a Court declaration is likely to be an issue on which case law can helpfully be developed.

18) Standard form contracts are often used repeatedly, so if one standard form B2B contract is found to have unfair terms this could impact many others. An unfair term could become generally unenforceable in your existing standard form contracts, potentially affecting a large number of transactions. And unfair terms can’t be used in the future unless they are redrafted in a way that complies with the Court’s decision.

The last word

This is a challenging area. Businesses will need to carefully weigh the risk of retaining terms in their standard form contracts that could be deemed unfair but are commercially beneficial. Businesses that are proactive and review their contracts upfront – to make changes or justify positions before any complaints are made – will be best placed to avoid unfair terms, and to deal constructively with the Commerce Commission if a complaint is made.