How Unfair Contract Rules Will Impact Construction Contracts

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Thursday, October 13th, 2016
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As happens within any industry, smaller parties within the construction sector suffer from an imbalance of power when it comes to negotiations with larger and more powerful parties.

From November 12, however, a new law aims to eliminate the most extreme effects of this.

From that date, the unfair contracting provisions of the Australian Consumer Law will apply to small business. These provisions will dictate that any contractual terms contained within a standard form contract which are considered by a tribunal or court to be unfair will be deemed to be null and void.

The provisions will apply where at least one of the parties is considered to be a ‘small business’ (fewer than 20 employees) and the up front price payable is less than $300,000, or less than $1 million in the case where the contract extends for a period of longer than 12 months.

In deciding whether or not a particular clause is considered to be unfair, the new law outlines three factors which the court or tribunal will consider. These include whether or not the term in question will create a significant imbalance between the parties (one party doing all the work but the other party reaping the benefit), whether or not it causes detriment to one of the parties and whether or not the term is reasonable in terms of one party protecting a legitimate area of its interests.

Raymond Frangi, an associate at Coleman Greig Lawyers, wrote recently on his company’s blog that a number of forms of clauses which are commonly found in standard form construction contracts could potentially be considered to be unfair. These include:

  • Termination for convenience clauses, which give one party the universal right to terminate a contract at its own convenience irrespective of whether or not the counter party has indeed committed a default or breach of contract.
  • Superintendent or principal discretion clauses, which give the principal the exclusive right to make critical decisions as to matters such as whether or not a contact has been breached, work has been defective or how a variation claim should be valued.
  • Time bars, which prevent one party from being entitled to a claim for variation or an extension of time in cases where the claim has not been brought within a standard time frame and/or a stringent notification procedure has not been complied with. Where time frames in question are unduly short or notification procedures are unduly onerous, these conditions may be considered to be unfair.
  • Any clauses which give one party (typically the principal or head contractor) the right to unilaterally direct a variation to the work or to particular terms of the contract.

In terms of those who gain or are disadvantaged from this, Norton Rose Fulbright special counsel Sefton Warner says the most important winners will be smaller subcontractors, suppliers and consultants who meet the threshold and are thus afforded new protections under the Act.

By contrast, head contractors are likely to find themselves in a situation whereby many of their subcontractors, consultants and suppliers qualify for protection under the Act yet they themselves will typically be too large to qualify for the same protection in terms of their own dealings with the principal.

Warner suggests that those who engage suppliers or subcontractors who will qualify for protection under the legislation conduct a review of their standard form contracts to look at any high risk clauses which might be considered to be unfair. They should think about how these provisions can be adapted and modified so that they can be considered to be fair and thus stand a better chance of being enforceable when subject to challenge.

He says this reflects a more straightforward approach than to attempt to devise methods by which to sit outside of the new regime through methods such as raising the contract value above the threshold limits or using individual contracts for every subcontractor and supplier rather than standard form contracts.

“That looks like really hard work and somewhere, you will trip up in the implementation of that strategy,” Warner said, referring to efforts to ensure that contracts skirt the new law.

“I would definitely look to review the standard terms and revise them (where appropriate) as the most appropriate strategy.”

Warner says subcontractors would be advised to raise the fairness of a term or provision in the contract during tender negotiations or renegotiations. He says they would be more likely to get a better hearing at this stage than after the contract is signed, where costs associated with hearings from courts or tribunals mean disputes about unfair contract provisions would typically only rear their head in light of a much broader area of dispute.

Frangi, meanwhile, suggests that for contracts that fall within the transaction values under the new legislation, head contractors should make enquiries prior to contracting with their subcontractors, suppliers or consultants to determine whether or not they are considered small business in the context of the new law.

In cases where they are, he says head contractors may consider preparing alternative contracts suited and reserved for use when contracting with small business or otherwise consider allowing a counterparty the ability to reasonably negotiate terms that it considers unfair.

For those afforded protection under the new law, Frangi acknowledges the law puts them in a stronger negotiating position compared with before. Nevertheless, he adds adds that such parties would likely weigh up the commercial benefits associated with pursing their rights under the new law against the potential costs of protracted negotiations, the expenses associated with bringing court action against a head contractor under the new law, and the potential jeopardisation of future contractual opportunities with the head contractor in question.

Around Australia, smaller subcontractors and suppliers have always been in a difficult position when negotiating with larger parties.

Thanks to the new law, it seems that they will be in a slighter better position come November compared with what had previously been the case.

The new law at a glance

  • From November 12, the new law applies to contracts for the supply of goods and services or the sale or grant of an interest in land where:
    • The contract is a standard form contract
    • One of the parties is a small business (fewer than 20 employees); and
    • The upfront price payable under the contract is equal or less than $300,000 in the case of a contract which lasts for one year or less or $1 million for contracts of longer than 12 months
  • A ‘standard contract’ is a contract which has been prepared by one party and presented to the other party on a ‘take it or leave it’ basis with the other party having little or no opportunity to negotiate the terms.
  • Any terms contained within the contracts which are considered by a court or tribunal to be unfair will be void and thus will not be binding on either party.
  • Whether or not a contract is ‘unfair’ will be decided by taking into account (a) whether or not they create a significant imbalance between the parties (b) whether or not they work to the detriment of one party, and (c) whether or not they serve a genuine purpose in protecting the interests of one party.
  • Examples of terms which may be unfair (as set out in the law) include those which enable one party but not the other to avoid or limit their obligation under the contract, terminate the contract or vary the terms of the contract as well as those which penalise one party but not the other for breaching or terminating the agreement. Examples of construction contract clauses which may be considered to be unfair are outlined above.
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