In Short
- Early termination fees must reflect a genuine pre-estimate of loss, such as lost profits or wasted costs.
- Unfair fees that penalise customers or small businesses may be unenforceable.
- Ensure fees are calculated properly to avoid legal issues.
Tips for Businesses
When drafting early termination fees, ensure they represent your actual loss, such as missed profits or preparation costs. Avoid fees that go beyond your losses, as they may be seen as penalties and could be unenforceable. If unsure, seek legal advice to avoid disputes
If your business uses fixed-term contracts, you may have encountered consumers who request to terminate before the contract term is up. Businesses often use termination fees to recover losses when a customer prematurely seeks to terminate a fixed-term contract. This article will consider when consumers have the right to terminate early and when businesses may be able to charge early termination fees for a fixed-term contract.
Consumer Right to Cancel Services
If the services you provide do not meet the consumer guarantees that the Australian Consumer Law outlines, the consumer has the right to cancel the service contract, request that you re-supply the services or ask for a refund. Some failures to meet the consumer guarantees may include where the services are:
- provided with an unacceptable level of care and skill;
- unfit for the purpose asked for; or
- not deliverable within a reasonable time when there is no agreed end date.
However, a consumer cannot cancel (and must pay for) services received under a contract that worked as expected. A consumer cannot cancel a service contract or get a refund if the problem is outside the control of the provider or if they:
- changed their mind;
- insisted on having a service provided in a particular way, against your advice; or
- failed to explain their needs clearly to you.
Early Termination Fees
Early termination fees come in many forms. They can be a fixed sum payable for cancellation at any stage of the contract or a pro-rata sum which decreases as the contract end-date approaches. For an early termination fee to be valid, it must be a genuine pre-estimate of the loss you will suffer due to the early termination. You must calculate the estimate at the time of signature of the contract (not at the time of the cancellation). You can calculate a genuine pre-estimate using your lost net profit or wasted costs.
Continue reading this article below the formWasted Costs
Wasted costs consist of the:
- fees and up-front costs for preparing or setting up the contract, including any incentives to retain the customer; and
- cost of performing the service under the contract up to the termination date. This excludes any fixed or overhead costs you incur regardless of the early termination.
You then calculate wasted costs by taking these costs and subtracting the costs you recouped. For example, any costs you recovered through payments already received under the contract.
Lost Net Profit
Lost net profit is the unpaid amount of the contract price, less:
- the costs you would have incurred in performing the remainder of the contract;
- any discounts on the remainder of the contract price; and
- the cost of any reasonable steps you took to mitigate your loss.
Furthermore, you must take reasonable steps to mitigate your loss under the law. Therefore, if you wish to charge early termination fees, you must ensure the fees reflect a genuine pre-estimate cost by using the above guidelines. This ensures that you can enforce any early termination fees you charge.
Accelerated Payments
An accelerated payment is an early termination fee that requires paying the remainder of a contract price. Accelerated payments are invalid because they are not a genuine pre-estimate of your costs. This is because they fail to consider the costs you would no longer incur in performing the remainder of the contract after cancellation.
Unfair Contract Terms
Changes to the unfair contract term regime included the introduction of penalties for unfair contract terms (UCTs) in standard-form consumer contracts. Many online, ‘click-to-accept’ contracts fall into this category. As a result of these changes, regulators will penalise businesses that include unreasonable or unfair termination fees in fixed-term contracts, which means it is particularly important to ensure early termination fees are:
- a genuine pre-estimate of the loss the business may suffer; and
- reasonably necessary to protect the legitimate interests of the business.
Key Takeaways
You can charge an early termination fee if a customer cancels. However, if you charge an early cancellation fee that is not a genuine estimate of your cost, it may be unenforceable. You can calculate a genuine pre-estimate of cost using either your wasted cost or lost net profits.
If you need help with early termination fees, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
A service has a major problem if consumers would not have acquired it had they known about the nature and extent of the failure. A common example is when the service does not meet the description provided to the consumer and cannot be easily fixed. In the case of a major failure, consumers can choose whether they want the service to be resupplied, or if they prefer a refund or compensation for the drop in value of the service. You, as the business, must comply with the consumer’s request.
A service has a minor problem if you can fix the issue within a reasonable time. What is considered ‘reasonable’ will depend on the context of the service. While consumers can choose their preferred remedy for a major problem, they generally do not have such rights for services with a minor problem. Rather, you, as the business, will decide whether to resupply the service or offer a refund.
Regardless of how consumers accept your contract (either by signature or online acceptance), the same rules apply regarding whether you can charge an early termination fee. Any termination fee must be a genuine pre-estimate of the loss you will suffer due to the early termination and must be calculated at the time of acceptance, not at the time of cancellation. Consider a termination fee that uses a sliding scale based on how long is left in the contract.
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