In our last article I wrote about the toxic payment culture within Australia’s building and construction industry.
I wrote on the devastating effect of payment delays and non-payments on a contractor’s cashflow (which can threaten the very existence of the small business), resources (that are being used to pursue debts), and mental health. More broadly, late payments can also have a devastating impact across the economy as small businesses that are paid slowly, in turn pass on payment delays which impacts down the supply chain.
Security of Payment is rife in the construction industry because the industry operates on a pyramid structure, with the client at the top who enters into a head contract with the head contractor who subsequently enters into a series of subcontracts with subcontractors, consultants and suppliers. Because of the pyramidal structure, the bargaining power between the parties is highly imbalanced between contractors and subcontractors.
This pyramid structure means that financial risk is passed down to the least able to bear the burden. This is often caused by unfair contract terms.
Often the head contractor will agree to contractual terms that will have all risks on key issues transferred to the head contractor who in turn knows that it will be able to pass on its onerous contractual terms to its subcontractors by insisting that subcontractors execute a back-to-back subcontract. In this way, unfair contract terms and risks are transferred down the contractual chain with the sub-subcontractors at the base of the pyramid not only having the least capacity to bear the financial risks associated with the project but also being the least able to negotiate a set of more reasonable and balanced terms.
This article will focus on the existence and consequences of unfair contract terms (UCTs).
Australia’s two million small businesses sign an average of eight standard form contracts a year. The ACCC has found that over 60% of small businesses claim to have experienced unfairness due to contracts and 44% believed that they have experienced harm as a result of unfair terms in contracts.
Unfair contractual risk allocation is regarded as inefficient and not “best practice” because a subcontractor is often not in any position to control or manage the risk of (e.g.) a flawed set of design documents that they have not prepared or had any input into.
In addition, some contractual risk allocation conditions create risk that cannot be insured against, creating uninsurable risk. This is especially so for conditions providing unlimited indemnities in favour of the main contractor, particularly those that indemnify for consequential losses sustained by a main contractor. Further, unfair subcontract conditions (especially accuracy as to design warranties requiring professional indemnity insurance) have arguably contributed to an increase in the cost of insurance premiums in Australia.
Uncertainty of income caused by unfair contractual risk allocation acts as a disincentive to business expansion and innovation, and employment. Unfair contractual risk allocation has undoubtedly contributed to the high levels of insolvency in the Australian construction industry. In 2017/18 1642 construction companies became insolvent. This represented 22% of all insolvencies in Australia, and a far greater percentage of insolvencies than any other industry. This is because instead of the risk of cost overruns, design errors etc being properly managed by those who are able to manage and so minimise the risk, it is simply shifted onto the subcontractors at the bottom of the contractual chain who have no real ability to manage the risk of design errors, delays and cost overruns etc, or bear the financial burden.
As I wrote in my last article the Queensland Government has made real progress in addressing this situation in their State. Thankfully, the Federal Treasury is conducting a review of its Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Act and sought feedback on the extension of consumer Unfair Contract Terms protections to small business contracts.
In our submission NFIA provided 22 separate examples of some common unfair contract terms.
We argued that legislation is needed to “level the playing field”. The vulnerability of subcontractors lower down the contracting chain to the actions of those above them requires regulation to ensure that main contractors carry out business in an ethical, responsible and commercially sound manner, and so reduce insolvency events lower down the contracting chain/hierarchy – for the best interests of the construction industry in Australia as a whole.
NFIA suggests that the following clauses could be considered appropriate to be prohibited:
- Clauses which confer power to assign and/or novate that contract to the detriment of the other party without that other party’s consent
- Defects rectification by third parties clauses
- No-collusion clauses
- Payment of deposit before the subcontractor can sue
- Warranties for design and document accuracy
- Termination for convenience clauses
- Wrongful termination deemed to be for convenience
- Indemnity clauses that excessively extend liability to the subcontractor
- Release upon claim made
- Deeds of release to obtain practical-final completion
- Payment of variations on account
Unfortunately, the legislation does not define the expression ‘standard form contract’ and government is relying on the legal system to arbitrate. Most importantly, the problem unique to building and construction contracts, is not whether the contract is of a standard form but what amendments have been made to the detriment of one party based on an imbalance in bargaining power. NFIA contends that many contracts in the building industry are based on a standard form but are riddled with amendments. NFIA believes that some small businesses, when entering into a contract, may benefit from greater certainty as to whether the contract they intend to sign is likely to fall within the protections of the UCT regime where a claim that a contract is a standard form contract may be challenged.
If the requirement that the unfair contract term appear in a standard form contract was removed, it would greatly extend the scope of the legislation. Alternatively, introducing the concept of “repeat usage” would also assist a subcontractor to have a Court find that a contract is a standard form contract.
Unfair Contract Terms can have a devastating effect on a small business particularly within the construction industry where those at the bottom of the hierarchical chain have the least ability to negotiate fairer terms. Despite the efforts of various legislatures and the introduction of the unfair contract term protections for small businesses, unfair terms are still prevalent. The majority of contracts for which small businesses seek the assistance of the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) still contain clauses that the Ombudsman considered to be unfair. It is high time that these very common unfair contract terms be deemed illegal and we create an equal playing field that will allow all businesses to thrive.