Missed the launch of Sierra Series? Catch up here: Sierra Series: Unfair Contract Terms Under the Microscope.

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Welcome to Part 1 of the Sierra Series: Unfair Contract Terms Under the Microscope - our deep dive into some of the most common contract terms that continue to raise red flags under the Australian Consumer Law’s (ACL) unfair contract terms (UCT) regime.

In this first instalment, we’re examining early termination fee clauses - a familiar feature in contracts that can quickly shift from reasonable protection to unlawful penalty if not carefully drafted.

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1. Early Termination Fee Clauses: What Are They and Why They Matter

These clauses allow one or both parties to exit a contract early, often with a notice requirement and a fee.   When drafted fairly, they offer flexibility and protect legitimate business interests - for example, compensating for lost revenue or unrecoverable costs.

But when they go too far - imposing excessive fees, lacking transparency, or applying unevenly - they risk breaching the UCT regime and attracting significant penalties.

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2. When is an Early Termination Clause “Unfair”?

Under section 24 of the ACL, a term in a standard form consumer or small business contract is “unfair” if it satisfies all three of the following criteria:

• it causes a significant imbalance in the parties’ rights and obligations;
• it is not reasonably necessary to protect the legitimate interests of the advantaged party; and
• it would cause detriment (financial or otherwise) to the other party if enforced.

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According to recent ACCC guidance, early termination fee clauses may be considered unfair if:

• the fee is higher than the cost of the early termination or it doesn’t account for any costs saved by the early termination;
• the customer isn't given reasonable notice of early termination;
• the early termination fees are high following automatic renewal;
• the term allows one party but not the other to end the contract early; and
• the clause penalises one party but not the other for breaching or ending the contract.

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3. Case Spotlight: ACCC v Ashley & Martin Pty Ltd

Note: This case was decided before the 2023 reforms, which now make it illegal to include or rely on unfair terms in standard form contracts.  Today, similar conduct could attract significant penalties.

a. What was the issue?

Ashley & Martin offered hair loss treatment programs under standard form contracts.  These contracts included early termination clauses that required patients to pay 25%, 50% or 100% of the total program cost depending on when they terminated - even if they hadn’t yet received medical advice or were advised not to proceed.

The Federal Court examined 3 versions of the contract used between June 2014 and June 2017, each containing variations of the following termination clause:

“You may terminate your agreement with us at the following times by paying the following sums:

• immediately after accepting the Medical Treatment Program and before the consultation with the medical doctor by paying 25% of the total price payable under the complete Medical Treatment Program;
• within 2 days of accepting the Medical Treatment Program and after the consultation with the medical doctor by paying 50% of the total price payable under the complete Medical Treatment Program, and
• at any time after 2 days after accepting the Medical Treatment Program and after consultation with the medical doctor by paying 100% of the total price payable under the complete Medical Treatment Program.”

b. Why were these clauses found to be unfair?

The Court applied the three-limb test under section 24 of the ACL:

1. Significant imbalance
   • Patients were required to commit to a medical treatment program - and its full cost - before receiving medical advice.  This created a serious imbalance in rights and obligations.
   • The short two-day window to terminate before escalating to 100% payment added pressure and reduced the opportunity for informed decision-making.
2. Not reasonably necessary to protect legitimate interests
   • Ashley & Martin failed to show that the escalating fees were necessary to protect its business interests.  
   • The Federal Court found that:
     
     • The company could have delayed supply until after medical advice was received.
     • There was no clear justification for the steep escalation from 50% to 100% within two days.
     • The termination fees often exceeded the value of goods supplied - in one case, a patient paid over six times the standard price of the products received.
3. Detriment
   • Patients faced both financial and non-financial detriment:
     
     • Financial: Obligations to pay up to 100% of the contract price, even if they couldn’t proceed with treatment.
     • Non-financial: Pressure to make medical decisions quickly, without time to assess risks or seek further advice.

c. Key lessons and takeaways

- Allow time for informed decision-making before financial commitment

The Court found that requiring patients to commit to a medical treatment program - and its cost - before receiving medical advice created a significant imbalance in rights and obligations.  The short two-day window to terminate before escalating to 100% payment pressured patients into premature decisions.

- Ensure termination fees reflect actual loss, not arbitrary percentages

Ashley & Martin failed to justify why termination fees of 25%, 50%, or 100% of the total contract price were reasonably necessary to protect its legitimate interests.  The Court noted that these fees often exceeded the value of goods supplied and lacked proportionality.

- Avoid escalation clauses that penalise delay in termination

The increase from 50% to 100% payment after just two days was unexplained and unjustified.  The Court found no evidence that Ashley & Martin’s interests changed materially in that short timeframe.

- Do not rely on refund clauses to offset unfair termination terms

The refund clause only applied to specific products deemed unsuitable due to adverse medical side effects and did not cover the full program.  It did not mitigate the unfairness of the termination regime.

- Transparency matters - but it’s not a cure-all

Even where later versions of the contract improved clarity, the underlying imbalance and detriment remained.  Transparency alone did not make the terms fair.

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4. Drafting Tips: What “Fair” Looks Like

Let’s take a common example of an unfair clause - similar to what was found in the Ashley & Martin contracts:

✕ Unfair Clause

“If the customer terminates early, they must immediately pay the full contract price to the supplier, including any amounts which are not yet due.”

This clause is problematic because:

• It doesn’t reflect actual loss or costs incurred.
• It applies regardless of whether goods or services were delivered.
• It penalises the customer for terminating, rather than compensating the business.

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✓ Fair clause

Now, let’s look at how this could be amended to comply with the ACL and reflect fair commercial practice:

“If the customer terminates early, the customer must pay the supplier for goods and services already provided, plus a termination fee representing reasonable costs which would otherwise be unrecoverable, and which were or are reasonably likely to be incurred by the supplier in preparation for the performance of (or in the performance of) the contract (e.g., setup costs, third-party commitments).”

This version:

• links the fee to actual loss;
• allows for proportionality and transparency; and
• avoids penalising the customer for exercising a termination right, but instead seeks to compensate the supplier for any reasonable costs it has incurred (or is likely to incur) in relation to the contract, and which the supplier would otherwise not be able to recover as a result of the customer terminating the contract early.

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5. What Should Businesses Do? Practical Steps Forward

Drawing from the Ashley & Martin decision and the key takeaways above, here’s what businesses should do when reviewing or drafting early termination clauses:

• Review your standard form contracts - especially those offered to consumers or small businesses.
• Assess whether your termination fees reflect actual loss - not just a percentage of the total contract price or value.
• Avoid escalation clauses that increase fees based on arbitrary timeframes.
• Ensure your clauses are transparent - clearly explain how fees are calculated and when they apply.
• Consider alternatives - such as deferring supply or including a cooling-off period to allow informed decision-making.
• Document your legitimate interests - if challenged, you’ll need to show why the clause is reasonably necessary to protect them.

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6. Wrapping Up

The Ashley & Martin case is a powerful reminder that early termination clauses must be carefully drafted to avoid unfairness.  Under today’s UCT regime, the consequences of getting it wrong are far more serious - not just voiding the clause, but resulting in significant penalties.

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Next week, we put another usual suspect under the microscope: automatic renewal clauses.  Stay tuned.

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