The major banks have committed to ensuring all small business loans entered into or renewed from 12 November 2016 will be protected from unfair contract terms after an “unsatisfactory” response to the new rules.
Changes to unfair contract terms legislation were extended to cover standard form small business contracts late last year and SMEs now have the same protections that consumers are afforded.
However, the big four Australian banks have been accused of dragging their feet during the year-long transition period (starting in November 2015) and a March review by the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) and the Australian Securities and Investments Commission (ASIC) resulted in major bank representatives being called to account.
ASBFEO and ASIC have publicly raised concerns that lenders, including the big four banks, needed to lift their game in meeting the unfair contract terms legislation. Following a recent round table hosted the regulators, the big four banks have committed to a series of changes.
- Removing 'entire agreement clauses' from small business contracts. These are concerning terms that absolve the lender from responsibility for conduct, statements or representations they make to borrowers outside of the contract.
- Removing financial indicator covenants from many applicable small business contracts. For example, loan-to-valuation ratio covenants that give lenders the power to call a default when the value of secured property falls, even where a small business customer has met financial repayments, will be removed.
- Removing material adverse event clauses from all small business contracts. These are concerning terms that give lenders the power to call a default for an unspecified negative change in the circumstances of the small business customer.
- Significantly limiting the operation of indemnification clauses. These are concerning terms that aim to broadly protect the lender against losses, costs, liabilities and expenses that arise even outside the control of the small business borrower.
- Significantly limiting the operation of unilateral variation clauses. In addition to providing applicable small business customers with a minimum of 30 days’ notice for any contract changes, banks will clearly limit the circumstances in which unilateral variations can be made.
The banks have also agreed to contact all small business customers who entered into or renewed a loan from 12 November 2016, about the changes to their loans. In many cases, banks have agreed to implement the changes so that they apply to all existing applicable small business customers.
According to ASIC, the banks have further agreed to significantly limit the operation of potentially concerning contract clauses (such as financial indicator covenants) to loan products where such clauses are essential to the operation of the product (such as margin lending contracts).
“Where such clauses continue to exist, banks will re-draft them to ensure that they are clear, transparent and limited to the appropriate circumstances,” noted ASIC, adding that simply including the word 'reasonable' in contracts does not go far enough.
Ombudsman Kate Carnell said that her role was to consider the interests of small business and to ensure that the unfair contract term legislation was working across all industries.
“The banks have been given every opportunity, including a one-year transition period from November 2015, to eliminate unfair contract terms from their loan agreements and their response has been unsatisfactory,” she said.
ASIC Deputy Chairman Peter Kell said the point had been clearly made that lenders must “significantly improve their lending agreements to small business to ensure they meet the new rules”.
“It is important that the banks have committed to improving their small business loan contracts. ASIC will be following up with the big four banks – and other lenders – to ensure that small business contracts do not contain unfair terms,” he said.