‘Excessive’ security? - Risks in using an all assets charging clause in standard form contracts
General charging clauses are often included by suppliers in their standard terms and conditions to protect against non-payment.
But in a recent decision by the Federal Court, a security granted under a standard form supply contract was found to be unfair, and therefore void and unenforceable under the Australian Consumer Law (ACL).
Many suppliers may be alarmed to learn that having made a decision to supply goods or services on credit, it may be in the hands of the Courts to say whether they had ‘excessive’ security.
In this article, we consider the impact that this recent Federal Court decision will have on general charging clauses in standard terms and conditions and we outline some steps that suppliers should take to ensure their standard terms and conditions are fit for purpose.
Lobux v Willshaun
In the Federal Court case of Lobux Pty Ltd v Willshaun Pty Ltd [2022] FCA 204, Lobux (as the supplier and secured party) entered a contract with Willshaun (as the purchaser) for the supply of a ‘Hooklift Backdoor Vacuum Tank’. Before Lobux had completed the manufacture of the tank and before the purchase price had been paid in full, Willshaun took possession of the tank. Willshaun then started using the tank in its business, but never paid the balance of the purchase price to Lobux.
Lobux took action against Willshaun for payment of the balance of the purchase price and sought to rely on a general charging clause (in its standard contract) over ‘all of [Willshaun’s] rights, title and interest…in any land, realty or other assets capable of being charged…either now or in the future, to secure the performance by [Willshaun] of its obligations under these terms and conditions (including, but not limited to, the payment of money).’.
Under the ACL, a term of a standard form contract will be unfair if:
(a) it would cause a significant imbalance in the parties’ rights and obligations arising under the contract; and
(b) it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
(c) it would appear to cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.
The judge held that the general charging clause in the Lobux standard contract would cause a significant imbalance in the parties’ rights and obligations and that it would cause detriment to Willshaun. The judge noted that:
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the contract had other clauses (such as a retention of title (ROT) clauses) which served to sufficiently protect Lobux’s legitimate interests; and
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Lobux had not rebutted the presumption that the general charging clause was not reasonably necessary to protect its legitimate interests.
As a result, it was held that the general charging clause was unfair.
Impact on supply contracts
While the general charging clause was found to be unfair in the Lobux case, this will not always be the case. Whether or not a general charging clause in a supplier’s standard form contract (like your typical supplier T&Cs) will be held unfair will largely depend on whether the supplier can demonstrate that the clause is necessary to protect its legitimate interests.
In the Lobux case, the judge took the view that the ROT clause was sufficient to protect the supplier’s legitimate interest and the general charging clause was unnecessary. However, ROT clauses will not always be sufficient. For example, if the goods supplied are perishable, or if the goods supplied are bespoke or made to the specifications of the customer, then repossession of those goods may not adequately compensate the supplier for non-payment by the customer. In those circumstances, it would be commercially sensible for a supplier to have additional protection against non-payment – such as a general charging clause.
In our view, the case shows that the Courts are likely to regard an unfocussed and ‘across the board’ use of charging clauses as unacceptable. The supplier will need to justify the use of a clause in each case. There are several steps a supplier should take to determine whether a general charging clause in a supplier’s standard terms and conditions will be enforceable and to inform the decision whether to use one. These include:
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Step |
Comment |
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Consider what protections against non-payment are available |
The protections available to a supplier for non-payment will depend on the goods supplied and the market the supplier operates in. Protections (aside from a general charging clause) against non-payment typically include: · upfront payment or stricter credit limits · ROT clauses · personal guarantee from a director Any one or more of these may be all that is reasonably necessary to protect the supplier. Of course some of these may not be commercially viable or practical for several reasons including: · a supplier’s main competitors may offer better payment terms to a customer · a supplier may need to undertake additional due diligence steps to ascertain if a director has assets to support a personal guarantee, as there is no point in getting a personal guarantee from an individual who has no assets · there may be additional administrative burden and cost If no other protections against non-payment are available or commercially viable, then a general charging clause may be reasonably necessary to help protect the supplier. Such a clause is not a ‘silver bullet’ in terms of getting paid (because of priority and other reasons) but it can be a powerful tool in some cases. |
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Evaluate the real value of the ROT clause |
As many suppliers will know all too well there are often circumstances in which an ROT clause will not allow the supplier to be adequately compensated if the customer does not pay. Can the supplier recover the goods? Can the customer’s stock level and dealing in them be monitored? Is there a market for the recovered goods? Can the recovered goods be sold at a price to adequately compensate the supplier for non-payment? If a ROT clause is sufficient to adequately compensate the supplier, then a general charging clause will more than likely be considered to be unfair. If a ROT will not be sufficient, a supplier should consider what other protections or security it could obtain from the customer. |
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Better credit assessment |
Where the customer poses a high credit risk then a general charging clause is more likely to be necessary to protect the supplier’s legitimate interests. Where the customer’s credit risk is low then a simple ROT clause may be enough. |
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Consider if a general charging clause should be conditional |
Given the purpose of the general charging clause is to protect against non-payment, and non-payment is usually more likely to occur when a customer becomes insolvent, consider if the general charging clause should only operate if the customer becomes insolvent. This approach makes its use easier to justify. |
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Ensure the general charging clause is transparent |
If a general charging clause is included in the standard form contract, then consider if it is sufficiently transparent. In some jurisdictions, like NSW, it is necessary to take ‘reasonable steps’ to ensure that, before supplying goods or services, consumers are aware of any terms and conditions which may ‘substantially prejudice’ their interests. |
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Document the credit and security decision |
Suppliers should document the reasons or rationale for the protections and clauses used in their standard terms and conditions, as this will be helpful if a customer claims any of their terms and conditions are unfair. |
Conclusion
The Lobux case highlights the need for suppliers to review their standard terms and conditions and to assess the clauses they have in place to protect against non-payment. The above steps serve as a general guide for suppliers to consider when determining what protections are reasonably necessary.
Care needs to be taken to ensure that each clause is reasonably necessary to protect the supplier’s legitimate interests and does not onerously affect the customer to be deemed unfair, void and enforceable.
It may be wise to have the general charging clause in a module which can be either included in or left out of a set of terms depending on the factors discussed above.
Recent case law in addition to the Lobux case shows that the scope of the unfair contracts law is expanding. With the current Government pushing ahead with earlier proposals to impose penalties on the use of unfair terms, with the introduction of the Treasury Laws Amendment (More Competition, Better Prices) Bill 2022, the risk of severe pecuniary penalties for unfair contract terms looks to be just around the corner. Businesses who have not already carefully considered the way that the rules apply would be well advised to do so now.
Authors: Maja Samardzic, Michael Cossetto & Oliver Shtein