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Unfair Contract Terms and the Construction Industry

New Laws Commence on 16 November 2016

New legislation commencing on 16 November 2016 will prohibit unfair terms in Standard Form Contracts with small businesses.

The reform is an extension of unfair contract legislation which currently applies to financial services and consumer contracts where consumers are protected from unfair terms in circumstances where they have little or no ability to negotiate the terms of their contracts.

The current reform is part of an initiative to extend the protections given to consumers to small businesses which are also vulnerable to unfair terms in Standard Form Contracts provided on a “take it or leave it basis”.

The effect of the reform is to render unenforceable, terms of the contract which a Court determines unfair.

Unfair Contract Laws will affect The Construction Industry

The new unfair contract laws will have a serious impact on the construction industry and the construction supply chain, and are likely to affect Standard Form construction contracts such as Subcontracts, Supply Agreements, Consultancy Agreements, Minor Works Agreements and Purchase Orders with small businesses.

With not much time left before the new laws commence, participants in the construction industry should review Standard Form Contracts and, in particular, terms including time bars, variations, delay claims, liquidated damages and termination.

 What is a Small Business Contract?

The prohibitions against unfair terms will apply to small business contracts where:

  1. the Contract is for the supply of financial goods or services or for the sale or grant of an interest in land;
  2. at least one of the parties is a “small business”(a business employing fewer than 20 employees); and
  3. the upfront contract price payable under the Contract does not exceed $300,000 or $1 million for Contracts which are 12 months or longer.

 What is a Standard Form Contract?

The small business protection only applies in respect of a Standard Form Contract.

The legislation, however, does not define a Standard Form Contract.

In determining whether a contract is a Standard Form, a Court must take into account whether:

  1. one of the parties has all or most of the bargaining power relating to the transaction;
  2. the Contract was prepared by one party before any discussion relating to the transaction occurred between the parties;
  3. another party was in effect required either to accept or reject whether a contract is a Standard Form Contract;
  4. another party was given an effective opportunity to negotiate the terms of the Contract; and
  5. whether the terms of the Contract take into account the specific characteristic of another party or particular transaction.

Although there are clearly a variety of factors that will determine what constitutes a Standard Form Contract, the new laws are likely to apply to any form of amended or bespoke Contract that is presented on an “take it or leave it basis”.

 What is an unfair term?

There is no express list of “unfair terms”.

A Court, however, will consider a term to be unfair if the term:

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

In determining whether a business contract is unfair, a Court must take into account the extent to which the term is transparent and the Contract as a whole.

A term is transparent if the term is:

  1. expressed in reasonably plain language; and
  2. legible;
  3. presented clearly; and
  4. readily available to any party effected by the term.

Examples of unfair terms

There is no list in the legislation as to what constitutes an unfair term ,however, the legislation does provide various examples of an unfair term, which include a term in a contract that permits, or has the effect of permitting one party:

  1. to avoid or limit performance of the Contract;
  2. to terminate the Contract;
  3. to vary the terms of the Contract;
  4. to renew or not renew the Contract;
  5. to vary the upfront price payable under the Contract without the right of another party to terminate the Contract;
  6. to vary the characteristic of the goods or services to be supplied unilaterally to:

a)determine whether the Contract has been breached; or

b)to interpret its meaning; or

c)to assign the Contract to the detriment of another party without that other party’s consent.

Other examples include:

  1. a term that penalises or has the effect of penalising one party (but not another party) for a breach or termination of the Contract;
  2. a term that limits or has the effect of limiting one party’s right to sue another party.

How do the unfair contract terms affect the Construction industry?

In a Standard form Construction Contract, there are a number of provisions that could foreseeably be considered to be unfair and are at risk of being unenforceable.

Examples of terms which may be held by a court to be unfair in construction contracts include:

  1. Unilateral variation clauses which provide that a contractor is bound to execute variations to Scope of Work if directed by a Principal;
  2. Extension of Time and Delay claim clauses especially where Standard Form Contracts contain onerous and unnecessary preconditions or bars on claims for delay or for disruption caused by the Principal;
  3. Termination for convenience clauses that only allow for one party to terminate the Contract;
  4. Termination clauses generally where powers are provided to the recipient of goods and services to terminate but more limited powers are conferred on the supply of those goods and services to terminate. Clauses of this type result in a significant imbalance and risk where the legitimate interests and rights are not proportionate;
  5. Time bars or other conditions precedent to claiming Variations or Extensions of Time particularly when there are unreasonably short timeframes or provisions which deem that a party has foregone its entitlement to claim if a Notice of Claim is not provided within a prescribed time;
  6. Clauses which entitle a Principal or Head Contractor to exercise its absolute discretion against the interests of another party;
  7. Liquidated damages especially in the case of residential building work which underestimate the home owner’s loss due to delay caused by the builder or construction company; and
  8. Clauses which confer power to assign and/or novate that Contract to the detriment of the other party without that other party’s consent.

Consequences if a Court finds that a term is unfair

Where a term is found by Court to be unfair, the clause will be void ab initio (as if the clause never existed) and will be unenforceable.

A finding by the Court that a clause is void and unenforceable does not necessarily mean that the whole of the Contract is unenforceable.

If, however, the void clause goes to the heart of the Contract, there is a risk that the whole of the Contract can also be declared void and unenforceable.

How the new laws can affect you

The unfair contract legislation for small businesses has a significant implications for the construction industry from a risk, commercial and reputational point of view.

The key concern for the Construction Industry is that a term relied upon by a Principal or Head Contractor may be held to be unfair and declared void and unenforceable.

This will mean that contractual clauses once relied upon by Principals and Head Contractors to defeat claims by Subcontractors may no longer be enforceable.

Given the imminence of the commencement of the legislation, Principals and Head Contractors should, as a minimum:

  1. make enquiries in the early stages of engagement and prior to the letting of Contracts as to whether the other party is a small business;
  2. review Standard form Contract terms now. Any contractual terms which may be considered unfair may need to be amended and steps may need to be implemented to bring those clauses to the attention of the other party;
  3. Contracts will need to include effective severance clauses which allow for the Court to declare unfair terms void without affecting the rest of the Contract;
  4. consider preparing alternative Standard form Contract suites with one suite tailored and reserved for use when contracting with small business; and
  5. develop an internal and administrative and risk mitigation procedure to:

a)identify when and where there is a risk that the Act may apply;

b)review and adjust how Standard form Contracts are negotiated with small business; and

c)where appropriate, dilute the harshest terms in Standard Form Contracts.

If a term of the Contract is declared void by a Court, the decision of the Court will be published. This may result in reputational damage for the Principal or Head Contractor if the Court makes findings that the Principal or Head Contractor have acted unfairly against a small business.

It may also be possible that Subcontractors may seek to take advantage of the unfair contract laws in Security of Payment adjudications.

Although only the Court has the power to declare that a term is unfair, the legislation does state that an unfair contract term is void if the terms are unfair and the contract is in a Standard Form.

It will not be surprising if Subcontractors will seek the apply the unfair contract laws in Security of Payment adjudications to overcome harsh contractual terms such as time bars which could otherwise operate to defeat payment claims.

The legislation may also empower subcontractors to be more proactively engaged in the negotiation of the terms of the Subcontract.

How Kreisson can assist

Kreisson has expertise and experience in advising Principals and Head Contractors as well as Subcontractors of their rights and entitlements and can provide assistance in revising and amending Standard Form Contracts and in the development of risk mitigation strategies.

David Glinatsis is Solicitor Director of Kreisson.

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