Fixed term contracts, as disturbing as they are for the non-committal types out there, have many advantages both for consumers and for businesses. Consumers are advantaged because businesses can offer discounted prices to consumers who commit to a set or fixed term contract. Businesses benefit because they get guaranteed payment for a set term – a guaranteed flow of revenue on their books.
But what happens in cases where consumers want to terminate early? If a discounted price has been is offered, then a business loses out on the fee they would have charged if the consumer was only going to commit to it until the termination date. Early termination fees are one way a business can recoup some of their costs, but these can be contentious, as seen in successive stoushes between the ACCC and various telcos. We’ll consider when consumers are permitted to cancel services and when businesses might be permitted to charge early termination fees for early termination of a fixed term contract.
When Are Consumers Permitted to Cancel Services?
Under the Australian Consumer Law (ACL), if there is a major problem with a service or a minor problem that cannot be fixed within a reasonable time, then you have the right to cancel a service contract (if you fall under the definition of ‘consumer’), when it is:
- provided with an unacceptable level of care and skill;
- unfit for the purpose you asked for; or
- not deliverable within a reasonable time when there is no agreed end date.
However, a consumer cannot cancel services and must pay for services received under a service contract that worked as expected. You can not cancel a service contract or get a refund if the problem was outside the control of the provider or if you:
- changed your mind;
- insisted on having a service provided in a particular way, against the provider’s advice; or
- failed to explain clearly your needs to the provider.
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 perhaps a pro rata sum which decreases as you approach the contract end date. For an early termination fee to be valid, it must be a genuine pre-estimate of the loss the service provider suffered as a result of the breach. A genuine pre-estimate can be calculated by either the supplier’s lost net profit (sometimes referred to as ‘loss of bargain damages’ or ‘expectation loss’) or its wasted costs (or ‘reliance loss’).
Payment acts as a ‘penalty’ and unenforceable as held in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 (per Lord Dunedin at 86-7).
If I’m a Supplier, What Are Wasted Costs and Lost Net Profits?
“Wasted costs” are composed of:
- The fees and up-front costs for preparing or setting up the contract such as the cost of inducements to enter into the contract;
- the costs incurred in the course of the performance of the contract to the date of termination (excluding any components for fixed costs/overheads, which would have been incurred regardless of the early termination) – less the extent that those costs are recouped, for example by payments under the contract.
Lost net profit is the unpaid amount of the contract price:
- less the costs that would have been incurred in performing the remainder of the contract;
- less the discount for the value of the receipt of the remainder of the contract price; and
- less the value of the supplier’s obligation to take reasonable steps to mitigate its loss.
Therefore if, as a supplier, you would like to charge an early termination fee, you need to ensure that it is a genuine pre-estimate of cost using the guidelines above, to ensure that any early termination fees you charge are enforceable or stand up in a court of law.
What About Accelerated Payments?
An Early Termination Fee that simply requires the paying out of the remainder of a contract price, sometimes called an ‘accelerated payment’ clause, cannot be a genuine pre-estimate of a supplier’s lost net profit. This is because it does take into account the fact that the supplier would have had to incur costs to perform the rest of the contract and that the supplier no longer has to incur this, as the consumer has cancelled.
Key Takeaways
What we can conclude is that a supplier can charge an early termination fee if a customer cancels. However, suppliers must be aware of charging an early termination fee that is basically a penalty for terminating early. If a supplier charges a fee for early cancellation which is not a genuine estimate of the cost to the supplier of early cancellation, then the supplier risks this fee being unenforceable.
Two methods of calculating an early termination fee that is a genuine pre-estimate of cost are by looking at wasted cost or lost net profits. Wasted costs include the costs of setting up the contract (including any discount the supplier offered, to induce the consumer entering into the contract) plus any costs incurred in performing the contract, up to the date of termination. Lost net profits are the unpaid amount of the contract price (less cost of performing the remainder of the contract, less the discount applied, less the value of the supplier’s obligation to take reasonable steps to mitigate its loss). If you need assistance with exiting a contract early or drafting an early termination clause, our contract lawyers can assist.
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