Last year, we reported that the corporate regulator ASIC had affirmed its commitment to enforcing compliance with the unfair contract terms (UCT) regime. Partnering with ASBFEO, ASIC obtained a commitment from the major banks to amend their loan contracts to remove potential UCTs in small business loans (see article here).
ASIC has now released its report (Report 565 – Unfair contract terms and small business loans) (Report) which details the changes that the banks have now made to ensure they comply with the UCT regime. The report also helpfully outlines the key categories of terms that ASIC is warning other lenders should remove from their small business contracts to avoid breaching UCT laws.
SMALL BUSINESS LOAN CONTRACTS – WHAT CAN STAY AND WHAT MUST GO
While ASIC has historically focussed on the major financial institutions, they have nonetheless warned in the Report that that they intend to review contracts from other lenders to ensure compliance with the UCT regime. The UCT provisions apply to small business contracts entered into or renewed on or after 12 November 2016 where the upfront price payable is less than $300,000 (or $1 million for contracts longer than 12 months). A contract is a 'small business contract' if at the time of contracting, one party is a business that employs less than 20 people. Lenders should review their agreements to ensure they are in compliance with the UCT provisions of the ASIC Act.
The changes that the major banks have made – from completely removing certain clauses, to limiting the use and reliance on clauses that may operate unfairly against small businesses – are summarised below.
|Type of Clause||Review or Remove||Implication|
|Entire agreement clause||Remove||Lenders may wish to ensure they have clear procedures governing staff communications with customers and have adequate records of customer correspondence to identify any representations or statements made before the execution date for the loan.|
|Broad indemnity clauses||Review||
These terms are high-risk because the clause shifts responsibility for losses within the control of the lender, its officers/employees, or receivers to the small business borrower.
Consequently, the major banks have now committed to ensuring their indemnity clauses in small business loan contracts will not cover fraud, negligence or wilful misconduct of the lender or any receiver it appoints. ASIC has taken this to mean that borrowers are no longer responsible for conduct of people or entities who act under the lender's directions or are otherwise outside the borrower's control.
|Events of default clauses||Review||
These clauses tend to nominate a broad set of circumstances that would constitute default and which then entitles the bank to exercise a broad range of possible consequences to impose on the borrower – from varying the terms of the agreement, to a unilateral power to claw back funds lent.
Lenders should consider whether these broad events of default clauses can be limited to cover items that present a credit risk to the lender (i.e. actually affecting the borrower's ability to meet their loan repayment obligations) and ensure that consequences of default are not disproportionate to the risk.
|Unilateral variation clauses||Remove or review||
The parties are at a significant imbalance if one is entitled to unilaterally vary the terms of the contract, including, for example, unilaterally changing the contract price payable by the other party (see ACCC v JJ Richards1 as an example).
To ameliorate the unfairness, banks have chosen to either:
|Financial indicator covenants||Review||
Financial indicator covenants allows for default consequences to apply if the borrower fails to meet a financial position (e.g. failure to meet the interest cover ratio).
ASIC acknowledges that these financial ratios may be helpful to signal to the lender the borrower's financial performance. This is particularly so for property investment/development loans and 'specialised lending transactions' (e.g. property development, SMSF loans, margin lending and foreign currency loans).
These covenants will not breach the UCT regime if the lender demonstrates that the nature of the transaction is such that indicators are necessary to protect the legitimate interests of the banks. Reasons may include the fact that the asset value of the security provided for the loan can fluctuate significant in a short time (e.g. LVR in margin lending facilities) and banks must be able to manage the risk of failure to repay the loan should this occur.
Lenders may also implement a materiality threshold such that default consequences only apply if there is a material breach of the financial indicator covenants.
|Material adverse change clauses and non-monetary defaults||Review||
The UCT risk here is if the clause describes an adverse event (which triggers default consequences for the borrower) that does not actually constitute a material risk to the lender.
To this end, the banks have agreed to limit enforcement action to defaults arising from specific categories (including for example: insolvency, unlawful behaviour, change of beneficial ownership of the company other than as permitted, loss of licence to conduct business, failure to provide proper accounts and failure to maintain insurance). Notwithstanding this, ASIC warns that such clauses still present a UCT risk – particularly where the consequences for the borrower's default is disproportionate to the risk for the banks.
ASIC encourages banks to instead provide a reasonable period of time for borrowers to remediate a breach (where possible) or otherwise implement a materiality threshold such that enforcement rights are only triggered if there has been a breach of an event presenting a material risk to the lender.
|Cross default clauses||Review||
ASIC has warned that these clauses would be unfair if it means the lender can enforce default consequences for non-monetary defaults in another agreement which is not one of the categories of non-monetary defaults which the banks have agreed to limit such clauses to – these being:2
Note however that even where the default clause falls within one of the above categories, it may nevertheless be deemed a UCT if it the consequences of default are disproportionate to the risk to the lender.
LENDERS SHOULD REVIEW THE TERMS OF THEIR LOAN, GUARANTEE AND SECURITY DOCUMENTS
While these obligations are not new it would be prudent for lenders to ensure that that their loan contracts, guarantees and security documents comply with the industry standards that have been established through ASIC's Report.
1 FCA 1224.
2 Report 565: Unfair contract terms and small business loans .
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.
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