If your business uses fixed-term contracts, you may have come across consumers who request to terminate before the contract term is up. Businesses often use termination fees to recover their losses when a customer seeks to terminate a fixed-term contract prematurely. This article will consider when consumers have the right to terminate early and when businesses may be able to charge early termination fees for early termination of a fixed-term contract.

When Are Consumers Permitted to Cancel Services?

The Australian Consumer Law states that if there is a major problem with a service or a minor problem that cannot be fixed within a reasonable time, consumers have the right to cancel a service contract when the service is:

  • 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 service contract that worked as expected. A consumer cannot cancel a service contract or get a refund if the problem was 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 as a result of the early termination. You can calculate a genuine pre-estimate by using either your lost net profit or your wasted costs. If the fee is disproportionate to your loss and not a genuine pre-estimate it may be considered a penalty and be unenforceable.

What Are Wasted Costs?

Wasted costs consist of the:

  • fees and up-front costs for preparing or setting up the contract; and

For example, the cost of any incentives you used to get the customer to enter the contract.

  • cost of performing the service under the contract up to the date of termination. This excludes any fixed costs or overhead costs which you would 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.

What Is 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.

Note that you must take reasonable steps to mitigate your loss under law.

Therefore, if you wish to charge early termination fees, you need to ensure they are a genuine pre-estimate of cost using the guidelines above. This ensures that any early termination fees you charge are enforceable.

Are Accelerated Payments Valid?

An accelerated payment is essentially an early termination fee that requires the paying out of 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 take into account the costs you would no longer incur in performing the remainder of the contract once the consumer has cancelled.

Key Takeaways

You can charge an early termination fee if a customer cancels. However, if you charge a fee for early cancellation 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 have any questions about early termination fees, get in touch with LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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