Lenders may be familiar with the recent warnings regarding upcoming changes to the laws regarding unfair contract terms. In this article we discuss how these laws affect private mortgage funds and what you should do to ensure compliance.

From 9 November 2023, the prohibitions on unfair contract terms, as contained in the Australian Consumer Law section of the Competition and Consumer Act 2010 (the 'ACL') and the Australian Securities and Investments Commission Act 2001 (the 'ASIC Act') will change to:

  • broaden the definition of a 'small business' to capture more customers;
  • broaden the definition of a 'standard form contract' to capture more transactions; and
  • substantially increase penalties and other remedies for non-compliance.

In the writer's opinion, most Australian businesses will be affected by these changes, including private mortgage funds, whose loan transactions will fall under the ASIC Act.

What is the law in relation to unfair contract terms?

In brief, the law prohibits the use of 'unfair contract terms' in 'standard form contracts' with either 'consumers' or 'small businesses'. Whilst both the ACL and the ASIC Act contain provisions regarding unfair contract terms, it is the ASIC Act that deals with unfair contract terms in contracts for financial products and services, which, for the purpose of these laws, includes all manner of credit, including unregulated business loans.

For business loans purposes, from 9 November 2023, a contract is a 'small business contract' to which these laws apply if:

  • at least one party to the contract is a business that employs fewer than 100 employees or has a turnover for the prior financial year of less than $10 million; and
  • the upfront price of the contract does not exceed $5 million.

The 'upfront price' is the total consideration payable by the customer for the service. For credit contracts, this includes the total amount of principal repayable, but for the purpose of determining the threshold of $5 million, does not include the interest payable under the contract.

There is no strict definition of a 'standard form contract'. Under section 12BK of the ASIC Act, the Court must consider:

  • whether one party has all or most of the bargaining power;
  • whether the contract was prepared by one party before any discussion relating to the transaction occurred;
  • whether another party was, in effect, required either to accept or reject the terms of the contract (other than terms as to the subject matter or upfront price) in the form in which they were presented;
  • whether a party was given an effective opportunity to negotiate the terms of the contract (other than terms as to the subject matter or upfront price); and
  • whether the terms of the contract (other than terms as to the subject matter or upfront price) take into account the specific characteristics of another party or the particular transaction.

From 9 November 2023, the Court will also be asked to consider how many contracts have been made on the same or substantially the same terms by the subject party. In addition, the Court will be permitted to make a finding of a standard form contract even if:

  • the customer had an opportunity to negotiate minor or insubstantial changes;
  • the customer had the opportunity to select a term from a range of options offered; or
  • any other customer has had the opportunity to negotiate the terms of the contract.

The legislation contains a presumption to the effect that, if a party alleges that a contract is a standard form contract, it will be presumed to be so unless another party proves otherwise.

Section 12BG of the ASIC Act provides that a term in a standard form contract will be considered 'unfair' if:

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

In determining whether a term is unfair, the Court must take into consideration:

  1. the extent to which the term is 'transparent', defined as expressed in reasonably plain language, legible, presented clearly and readily available to any party affected by the term; and
  2. the contract as a whole.

Section 12BH of the ASIC Act contains a list of examples of terms that may be considered unfair. Those examples focus on one party having unilateral rights under the contract, such as to avoid or vary the contract, or to shift the burden of obligations or limit the rights of the other party, particularly without corresponding rights or a termination right by the other party.

Again, the law presumes that a term is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by it, and it will be up to that party to prove otherwise.

All of this is important because, from 9 November 2023, the consequences of breaching the unfair contract terms laws are increasing substantially. Firstly, the Court will have a broader choice of orders in connection with unfair contract terms, which include voiding a contract, ordering injunctions and orders for redress. Secondly, the making of a contract containing unfair contract terms or reliance upon an unfair contract term will attract a civil penalty of a maximum of:

  • for individuals: the higher of 5,000 penalty units ($1.11 million) or 3 times the benefit derived from the contravention; or
  • for corporations: the higher of 50,000 penalty units ($13.75 million), 3 times the value of the benefit derived from the term, or 10% of the annual turnover of the corporation for the previous 12 months up to 2.5million penalty units ($687.5 million).

Each unfair term in a contract will be a separate contravention and the subject of its own penalty.

What terms have been determined unfair in credit transactions?

In 2018, ASIC conducted a review of the 'big four' banks' credit terms and conditions and made several recommendations that resulted in changes to those terms. In ASIC's Report 565: Unfair Contract Terms and Small Business Loans, ASIC outlined the following as being areas of concern in small business loan contracts:

Entire agreement clauses "Clauses that prevent lenders from being held contractually responsible for conduct, statements or representations made to small business borrowers outside the written contract are likely to be unfair."
Broad indemnification clauses "Clauses that require borrowers to cover losses, costs and expenses incurred due to the fraud, negligence or wilful misconduct of the bank, its employees or agents or a receiver appointed by the bank are likely to be unfair."
Event of default clauses "Material adverse change events of default—Clauses that allow lenders to treat a loan as being in default because of any unspecified "material adverse change" are likely to be unfair. These clauses gave the banks a very broad discretion to call a default against the borrower without giving the borrower any clarity about what types of change could result in a default. The banks have confirmed that these clauses have been removed or will no longer be applied to their small business loan contracts."

"Specific events of non-monetary default— The wording of these specific events may still be broad enough for an event to trigger a disproportionate enforcement action by the lender. For example, even though "misrepresentation" is listed in small business loan contracts as a specific event of default, if a minor misrepresentation by the borrower such as an incorrect date of birth, led to a default and enforcement under the loan contract, this could be a disproportionate enforcement action."
Financial indicator covenants "The use of a breach of some financial indicator covenants such as loan-to-valuation ratio (LVR) in small business loans to trigger a default and enforcement of the loan could be unfair where a breach of a particular covenant by a small business borrower does not present a material credit risk to the lender."
Unilateral variation clauses "Clauses that give lenders a broad ability to vary contracts without agreement from the small business borrower have a high risk of being unfair as they cause a significant imbalance in the rights of the lender and small business borrower (in favour of the lender) and are unlikely to be reasonably necessary to protect the legitimate interests of the lender if they can be used in a broad range of circumstances to make a broad range of variations to the contract."

Since then, the Federal Court has had the opportunity to consider unfair contract terms in credit contracts on at least two occasions, being ASIC v Bendigo and Adelaide Bank [2020] FCA 716 and later ASIC v Bank of Queensland Limited [2021] FCA 957.

The Court found unfair contract terms in credit contracts to generally fall into four broad categories:

  1. unfair indemnification clauses, such as indemnity by the customer in circumstances where the customer did not cause the loss;
  2. unfair event of default clauses, such as clauses which:
    1. allow the bank to unilaterally determine if a default has occurred;
    2. do not permit the customer to remedy the default; or
    3. create defaults based on events which may or may not cause material damage to the bank;
  3. unfair unilateral variation and termination clauses, such as terms allowing the bank to reduce funds available to the customer or terminate the facility without the customer being at fault; and
  4. unfair conclusive evidence clauses, which shift the evidential burden of matters to the customer.

In the Bendigo Bank decision, the Court also commented on transparency issues including:

  1. multiplicity of cross-references making it difficult read and comprehend terms;
  2. use of improper defined terms, for example use of the term 'periodic review' when its definition did not contain any periodic element;
  3. the use of clause headings and clause positioning having the result of important terms being not readily identifiable, for example a termination right being found under a clause headed 'use of facility'; and
  4. the use of technical legal language, such as the terms 'in the absence of manifest error' and 'legal expenses on a full indemnity basis', which have specific legal meanings the customer could not be expected to know.

What can private lenders do?

If you are a private mortgage fund who lends to consumers or small businesses using template loan documentation, the unfair contract terms laws may very well apply to you. Although many private lenders will argue that their loan documentation is individually prepared for each deal and wholly negotiable, this may not be so obvious.

Lenders wanting to remain outside of the unfair contract terms regime will need to take extra steps to make it clear that they do not offer 'take it or leave it' contracts. However, even with the taking of additional steps to show a willingness to negotiate any aspects, it may be difficult for some lenders to rebut the presumption of a standard form contract under the new increased standard. It is thus wise for all lenders to review their documentation and reduce the level of possible unfair contract terms contained therein.

Unfair contract terms do not extend to terms which address the main subject matter of a contract or the upfront price, so these laws do not relate to the agreed offer terms such as the loan duration, facility limit or interest rate. They relate to the bulk of the rights and obligations of the parties contained in the loan documentation, which may include terms giving the lender th e ability to vary the offer terms, such as variations in the interest rate or facility limit.

Some of the terms which have been identified by the Court in the Bendigo Bank and Bank of Queensland decisions to be unfair will most certainly appear in a number of private lenders' loan documents, as many of those terms would be considered industry practice. This does not mean that all such terms should be deleted. The Court must look at the overall contract, and there may be good reason for certain rights to exist depending on the nature of the transaction, particularly in the context of private finance.

It may be difficult for lenders to decide how to amend their template documentation if it is used for a variety of transactions, but some improvements will almost always be possible, such as:

  • avoiding the use of language indicating a standard form contract such as the obligation to sign loan documents on the lender's standard terms within a specified time, as is sometimes contained in letters of offer;
  • including statements offering or acknowledging the opportunity to negotiate in the letter of offer, documents covering letter, or the loan documentation;
  • amending rights clauses to insert parameters or clarify when or how the right may be used, rather than reserving absolute rights;
  • considering where corresponding rights or termination rights can be offered to the borrower to reduce the impact of the lender's rights; and
  • improving document layout, clause headings and positioning, and redrafting terms in plainer language to improve transparency.

These are only some of the steps which a lender could take to improve their position in case of a claim of unfair contract terms. Your legal counsel should conduct a comprehensive review of your documentation suite and recommend improvements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.