Building towards a fairer future: construction contracts and the unfair contract terms regime

This article explores the implications of Australia's strengthened UCT regime on the construction industry and takes a closer look at the potential unfairness of common construction clauses.

The unfair contract terms (UCT) regime in Australia underwent significant reform on 9 November 2023, following the royal assent of the Treasury Laws Amendment (More Competition, Better Prices) Act 2022 (Cth). The reform expanded the application of the UCT regime and increased the penalties imposed on offenders, ultimately strengthening protections for consumers and small businesses against unfair terms in standard form contracts.

As a result of the new definition of ‘small business’, many businesses in the construction supply chain may now be captured under the UCT regime. This article explores the potential implications for the construction sector and identifies some clauses often found in construction contracts that may be considered unfair under the new regime.

What are the key changes under the new UCT regime?

Under the new UCT regime, there is now:

• an expanded definition of a ‘small business’ to mean either a business that employs fewer than 100 persons or that has an annual turnover of less than AUD $10,000,000 in the previous income year;^[1]
• no contract value threshold meaning standard form contracts of any value may be subject to the UCT regime;^[2]
• broader enforcement powers of the court to void, modify, or decline to enforce unfair terms;^[3] and
• more severe penalties imposed on parties that propose or attempt to rely on unfair terms.^[4]

What is a ‘standard form contract’?

The UCT regime aims to protect consumers and small businesses in dealing with businesses that use standard form contracts.

In determining whether a contract is a ‘standard form contract’, a court considers a range of relevant matters including:

• whether there is an imbalance or unequal bargaining power between the parties;^[5]
• whether the parties were given a genuine opportunity to negotiate the terms of the contract;^[6] and
• whether the contract has been used previously in similar transactions on substantially the same terms.^[7]

A contract alleged to be a standard form contract will be presumed to be a standard form contract. The onus is on the party seeking to rely on the clause to prove otherwise.^[8]

What is an ‘unfair’ term?

A term of a consumer contract or small business contract is unfair if it:

• would cause a significant imbalance in the parties’ rights and obligations arising under the contract;^[9]
• is not reasonably necessary to protect the legitimate interests of the party relying on the term;^[10] and
• would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.^[11]

The assessment of whether a term is unfair takes into account the transparency of the term and the broader context of the contract as a whole.^[12]

How does the UCT regime apply to the construction industry?

Due to the nature of construction projects, template and pro forma contracts are extensively used throughout the industry. For example, many construction projects use a standard form Australian Standards (AS) contract. However, the standard form nature of such contracts gives rise to concerns as to whether and how they may fall foul of the UCT regime.

There remains some uncertainty regarding how the UCT regime may deal with the use of the AS contracts without negotiation or modification given they are the product of extensive industry consultation. Regardless, parties should ensure there are genuine opportunities to negotiate the terms of the contract and that the terms are amended to reflect the specific requirements and characteristics of the project and the parties involved.

There are a number of terms commonly found in standard construction contracts that may be susceptible to being classified as ‘unfair’. The contractual terms set out below are examples and are not an exhaustive list of terms to consider.

Termination for Convenience

While there may be legitimate reasons why a principal may need such a broad right, a termination for convenience provision could be unfair where:

• there is no notice period or the termination notice period is short (particularly if the contractor needs to demobilise ongoing site activities); or
• the contractor is unable to recover the reasonable costs associated with such termination.

Businesses may mitigate the risk of unfairness in termination for convenience provisions by:

• including a notice period that allows a reasonable amount of time for demobilisation;
• ensuring the contractor has a corresponding right to recover or seek compensation for reasonable costs associated with the termination (common terms around negative variations could be applied to mitigate the risk of unfairness); and
• limiting the principal’s discretion to terminate by specifying clear and reasonably grounds for termination.

Superintendent or Principal’s Representative Determinations

Most construction contracts incorporate a role of superintendent or principal’s representative to oversee the project and make determinations on claims made by the contractor under the contract. While the degree of independence of this role varies between projects, the appointed person tends to be a person engaged by the principal. There is a risk that a contract term may be unfair if it gives the superintendent sole authority to:

• decide whether an extension of time should be granted;
• assess whether a ‘material breach’ has occurred; or
• instruct a variation (without giving the other party a chance to dispute it).

These terms may be unfair as they permit one party to unilaterally determine breach or interpretation of the contract.

Businesses may mitigate the risk of unfairness in these circumstances by:

• including an obligation for the superintendent to act honestly and fairly when exercising its role as assessor;
• setting out the objective parameters by which the superintendent may determine claims made under contract (i.e., drafting clear, objective delay events that give rise to extensions of time that are not solely in the superintendent’s discretion); and
• ensuring there is a mechanism to dispute decisions of the superintendent.

Liquidated Damages

Construction contracts often incorporate a liquidated damages (LDs) clause which sets out a pre-agreed amount or rate to be paid as compensation to the party in event of breach (e.g., delay to practical completion). LDs are compensatory in nature and should be a genuine pre-estimate of loss. The LDs amount or rate depends on an assessment of what the greatest conceivable loss could be as a result of the breach. The potential losses resulting from delays are wide-ranging and not restricted to only those losses flowing immediately from the breach.^[13] Relevant losses may include ongoing site-related costs and overheads, loss of opportunity, loss of anticipated profit and loss of revenue.^[14]

Liquidated damages may be unfair if the pre-agreed amount or rate is ‘extravagant and unconscionable in amount, and out of all proportion in comparison to the greatest conceivable loss which may be suffered’.^[15]

Businesses may reduce the potential unfairness of liquidated damages provisions by:

• ensuring there is a record at the date of contract of the calculation of the liquidated damages rate evidencing that it is reasonable estimate of expected loss, and not extravagant or out of proportion;
• including a cap on liquidated damages (typically 10% of the contract fee); and
• considering whether alternative contractual mechanisms such as performance bonds, milestone payments or specific performance obligations could provide protection and minimise reliance on liquidated damages.

Issues specific to construction

Long contract chains that engage a range of business sizes are typical in the construction industry. As such, it may be the case that some contracts in the chain are subject to the UCT regime while others are not. Businesses should be alert to potential gap risks that may arise if they are not able to pass on certain risks to downstream contracts by reason of them being unfair.

Parties should also be aware of contracting with businesses that may operate through special purpose vehicles (shell companies) under a corporate group. In these circumstances, the UCT regime would still apply to the special purpose vehicle as it falls under the definition of a ‘small business’.

Consequences of Unfair Contract Terms

If a court finds that a term in a standard form contract is unfair, that term will be declared void and unenforceable, though the overall contract can still be binding without the unfair provision. The court has broad powers in such cases, including ordering the removal of the unfair term, preventing its future use, and providing remedies for any losses caused.^[16] Any term declared void will affect every standard form contract that uses that term.

The stakes are high for businesses that rely on unfair contract terms. Corporations can face penalties up to $50 million or 30% of their adjusted turnover. Individuals can be fined as much as $2.5 million.^[17]  It should also be noted that each unfair term included in a standard form contract may attract a separate penalty.^[18]

What’s next?

Unfair contract terms in consumer and small business contracts remains one of ACCC’s enforcement and priorities for 2024-2025. Following the expanded scope and application of the unfair contracts regime and the increased enforcement rights and remedies, ACCC can be expected to full take advantage of the reform.

Construction projects operate with low margins triggering a high rate of insolvency in the industry. This quality, including the number of small businesses operating in the sector, may draw the ACCC’s attention in the future. For that reason, we are encouraging clients to:

• Review their standard form contracts with a lens of mitigating UCT risk, which involves avoiding terms that would create significant imbalance in the rights and obligations between the parties. Clients are encouraged to consider whether any potentially unfair terms can be revised to mitigate the risk of unfairness.
• Justify the necessity of each term by assessing whether the term genuinely protects the legitimate interests of the business. This assessment should be done at the time of contract and will not be an argument against unfairness if done as a retrospective.
• Consider alternative protective mechanisms as a means to protect legitimate business interest such as whether the risk can be insured.
• Provide a genuine opportunity to negotiate the contract with the counterparty. This means inviting consideration from the counterparty, considering amendments proposed by the counterparty and, where a term is necessary, explaining why that term is necessary to protect the businesses’ legitimate business interests.