As a business owner, one of the biggest wins for your business is when somebody commits to your product or service. If you offer a membership or fixed-term offering, the promise of a long-term relationship is exciting. You have a safety net for a set period and a cash-flow forecast that is looking very positive. However, as in business and the real world, not all relationships are meant to last. Your customer might wish to terminate their membership before the fixed period. In these circumstances, you want the find the balance between ending things amicably and compensating your business for the time, effort and expense you put into the relationship. This article explains when your business can charge early termination fees.
What is an Unfair Contract Term?
Under the Australian Consumer Law (ACL) (ACL), you cannot draft unfair contract terms into your business agreements. The rule applies to standard form contracts entered into or renewed on or after November 2016, where:
- at least one of the parties to the contract is a small business (employs less than 100 people or has less than a $10 million annual turnover); and
- it is for the supply of goods or services or the sale or grant of an interest in land.
A contract term is unfair if it:
- causes a significant imbalance in the parties’ rights and obligations;
- is not reasonably necessary to protect the legitimate interests of the party taking advantage of the term; and
- causes financial or other detriment to a small business if it were relied on.
When deciding whether a term is unfair, the court considers many factors, including:
- how transparent the term is;
- other terms in the contract; and
- the overall rights and obligations of each party under the contract.
A court is more likely to rule a term unfair if only one party:
- has the right to terminate the contract;
- gets penalised for breaching or terminating the contract; or
- has the right to vary the terms of the contract.
What Happens if My Early Termination Fee is Unfair?
If a court decides that a certain contract term is unfair, the term becomes ‘void’ and, therefore, unenforceable. The Australian Competition and Consumer Commission (ACCC) can also impose large fines on your business for non-compliance with the unfair contract terms regime.
The ACCC can also bring action against businesses using unfair contracts with small businesses. For example, in a recent Federal Court case against FujiFilm, the Federal Court deemed 38 contract terms in 11 small business contracts unfair and void. One such term was a clause requiring customers to pay extensive exit fees in the event of termination. Therefore, when drafting, you should think carefully about each clause you include in your contract.
Continue reading this article below the formEarly Termination Fees
An early termination fee may be a set amount you charge in the event of cancellation or a pro-rata sum which varies depending on the remaining contract length. The validity of early termination fees will depend mainly on whether it is a ‘genuine pre-estimate of loss’ for your business.
How Do I Determine a Pre-Estimate of Loss?
Determining what a ‘genuine pre-estimate of loss’ is in a particular scenario depends on a few factors, including your lost net profit, wasted costs, and when the customer terminates.
A lost net profit is the unpaid amount of the contract, minus:
- any costs you would have incurred in performing the remainder of the contract;
- any discounts you offered on the remainder of the contract price; and
- the cost of any reasonable steps you took to mitigate the loss.
It is important to ensure you take reasonable steps to mitigate your losses.
A wasted cost is the fees and up-front costs you incurred for setting up the contract and your costs of performing the services up until the date of termination, minus the amount you have recouped already. This does not include any costs you would have incurred regardless of the early termination.
Does It Matter When the Termination Occurs?
If you have high set-up and low ongoing costs, termination near the start of a contract may be extremely detrimental to your business. Likewise, you may be able to recoup your initial costs through a termination fee. However, if the customer terminates towards the end of the contract, you may have already recouped most of your initial costs.
Alternatively, if you have low set-up but high ongoing costs, you may find it difficult to prove your loss during an early termination. However, if maintaining your service is expensive and a customer terminates towards the end, your termination fee could reflect the costs you have incurred in providing those services.
Know which key terms to negotiate when buying a business to protect your interests and gain a favourable outcome.
Key Takeaways
Determining whether or not your early termination fee is an unfair contract term is not straightforward. However, it is worth ensuring the termination fee is appropriate, or you risk the entire clause being deemed unenforceable.
For help drafting fair early termination fees or general assistance with your commercial contracts, 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
An early termination fee is a set amount you charge in the event of cancellation or a pro-rata sum which varies depending on the remaining contract length.
If a court decides that a certain contract term is unfair, the term becomes ‘void’ and, therefore, unenforceable. The Australian Competition and Consumer Commission (ACCC) can also impose large fines on your business for non-compliance with the unfair contract terms regime.
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