Early Termination Charge

An early termination charge (ETC) is a charge imposed by supplier on a customer that cancels their contract before the end of the specified term.

The ETC should be representative of the losses that the supplier will suffer because of early termination.  If it is not, the ETC may be unenforceable.

An ETC could be unenforceable because it is an unfair contract term under section 23 of the Australian Consumer Law (ACL) and /or because it is a penalty.

There are steps that can be taken to improve the chance that an ETC is enforceable.

Unfair Contract Terms

Under section 23 of the ACL the Court has the power to declare a contract term void where:-

• It appears in a standard form contract

and

• at least one of the parties to the contract is a small business (employs less than 20 people);  and
• the upfront price payable under the contract does not exceed $300,000; or the contract has a duration of more than 12 months and the upfront price payable under the contract does not exceed $1,000,000; and
• it is for the supply of goods or services or the sale or grant of an interest in land.

and

• the contract term is unfair.

A contract term will be 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
• will cause financial or other detriment to a small business if it is relied on.

The ACCC’s view is that ETCs should reflect the provider’s genuine estimate of its losses if a customer terminates their contract before the term has ended. The ACCC says that ETCs that equate to customers paying out the remainder of their contract are likely to be unfair.

New Rules

From 9 November 2023 the unfair contract provisions will apply where the parties enter into or renew or vary a standard form contract and

• a contracting party employs fewer than 100 persons (increased from 20) or
• has an annual revenue of less than AU$10 million.

The contract value threshold no longer applies.

 Contractual Penalties

ETCs are un-enforceable if they are found to be a penalty.  This is regardless of whether or not the ACL applies.

A penalty can be found if the amount payable is out of all proportion to the loss suffered as a consequence of the early termination.  In other words, if the amount payable is not a genuine pre-estimate of the losses likely to be caused by the early termination.

As the estimation of loss will be done in advance of the contract being entered into, the contracted amount will not be an exact mathematical calculation and may be more or less than the losses actually suffered.  However, that is irrelevant.

If the ETC is found to be a penalty and unenforceable, then the supplier may still be able to sue for damages for at common law.

What is a Genuine Pre-Estimate of Loss?

Determining what is a ‘genuine pre-estimate of loss’ depends on a number of factors.

Factors which should be considered include lost net profit, wasted costs, set up costs, when the customer terminates and business structure.

It is also important to ensure that the supplier takes reasonable steps to mitigate its losses.

To avoid potentially unfair ETC terms, providers should consider the following:

• Is the ETC higher than the supplier’s genuine estimate of the cost from the early cancellation?
• Have set up costs been recovered?
• Have the supplier’s cost savings been taken into account (as it will no longer be required to deliver the service)?
• Is the contract a standard form contract or was it negotiated?

The task is complex and elements of loss not always obvious.

Next Steps

We recommend that all businesses take the time to prepare for the changes to the ACL and review their standard form contracts.  The expanded scope of the unfair contracts regime will now impact many more businesses.

This article is not to be relied upon as a substitute for legal advice.  If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact us.