Power Imbalance in Contracts Involving Small Businesses

ADJOURNMENT MOTION

The Leader of the House (Ms Grace Fu Hai Yien): Mr Deputy Speaker, Sir, I beg to move, "That Parliament do now adjourn."

Question proposed.

Power Imbalance in Contracts Involving Small Businesses

6.44 pm

Mr Murali Pillai (Bukit Batok): Mr Deputy Speaker, I would like to declare my interest as a disputes lawyer in private practice. In last year’s Budget, small and medium enterprises (SMEs) were described in some materials published by the Ministry of Finance as being at the heart of the Singapore economy. They make up 99% of our enterprises, employ two-thirds of our workforce and account for half of Singapore’s gross domestic product. This is a positive sign which demonstrates the entrepreneurial spirit of Singapore.

The 2017 Annual Business Survey conducted by the Singapore Chinese Chamber of Commerce and Industry found that business sentiment among Singapore SMEs has risen. However, SMEs continue to face a number of challenges. The same business survey also revealed that SMEs continue to face rising business costs, with 72.3% of respondents saying that they face higher business costs, compared with 62.3% the year before. Rising business cost is also cited as the biggest challenge by 68.4% of those polled, ranking ahead of competition in the Singapore market and manpower shortage.

The Government continues to help SMEs through various means, for example, through the SME working capital, and we just heard today's debate on the Enterprise Singapore Board Bill to support enterprise development, yet another example of helping SMEs. SMEs themselves would have to continually evolve ways to deliver more productivity gains, for example, by leveraging technology.

One area that we could look closer at and where small businesses are particularly disadvantaged, is in respect of contractual dealings with large suppliers who dominate the market. These dominant players’ usage of market power to drive the use of one-sided and unfair terms has the effect of increasing business risks and costs on the part of small businesses. I respectfully suggest that the time has come for regulatory and legislative solutions to be offered to protect the interests of small businesses from such domineering practices.

Mr Deputy Speaker, Sir, to provide Members of this House a better sense of the clauses I am referring to, I seek leave to distribute to Members a handout containing some standard clauses that are incorporated in the areas of provision of utilities, telecommunication services and leases.

Mr Deputy Speaker: Leave is granted. [A handout was distributed to hon Members.]

Mr Murali Pillai: I am grateful, Sir. I will be referring to these clauses in the body of my speech.

In the Budget debate last year, I raised the issue of large players taking advantage of their size in commercial dealings with small businesses. This persists in the rental markets which involved, on the one hand, landlords with muscle, such as real estate investment trusts and, on the other hand, tenants which are small businesses. This imbalance in power has allowed tenancy agreements to contain onerous clauses for tenants. For example, a “demolition clause” allows the landlord to recover the premises for redevelopment purposes initiated by the landlord itself without any compensation to the tenant, who may have spent a significant sum to retrofit the premises and who may not have had the benefit of most of the terms of the tenancy. An example of such a clause may be found in the handout.

I dealt with such a case some years back. I acted for my aunt who ran a beauty parlour at a shopping mall for an initial period of three years. The mall owner extended her lease for another three years. My aunt decided to spend money to renovate her premises. About 10 months later, she was served with a Notice to yield premises on the basis that the owner decided to renovate the floor in which her beauty parlour was located. My aunt was in tears as she had ploughed most of her savings into renovating the premises. She was facing certain financial ruin. Not only that, she was upset that her staff who have been loyal and been with her for years would have to be let go, too. Thankfully for my aunt, the High Court, in a reported decision, ruled that the owners exercised the demolition clause in bad faith. This is rare. For the vast majority of tenants in my aunt’s shoes, they have to yield their premises without any compensation.

Additionally, commercial lease contracts include provisions stating that the tenant is responsible for any additional property tax that is payable on the leased premises above the base property tax payable by the landlord. However, if the shoe was on the other foot and the landlord subsequently receives tax savings through tax rebates, reliefs or exemptions, there is no contractual provision requiring the landlord to pass these tax savings to the tenant.

It is also common for commercial leases to contain what I term as "illusory options". What do I mean by this? There are leases that provide that options to renew are granted on the basis of rent to be decided by the landlord at the time of the renewal. Another variation is the provision in the leases that the revised rent is to be determined by the landlord, whose determination is final and conclusive. In both cases, the contractual provision giving the tenant the right of an option to renew is effectively illusory and non-enforceable as the essential terms for the renewed lease have not been agreed on and the tenant can potentially be provided with the Hobson's choice by the landlord at the point of renewal.

It is unfortunate that despite the Singapore Business Federation’s (SBF's) laudable attempt to address this situation by issuing the Fair Tenancy Framework that was put together by its Rental Practices Working Group chaired by Ms Cynthia Phua, a former Parliamentarian, in 2015, the usage of these onerous clauses still subsists.

Besides tenancy contracts, other examples of contracts which may contain unfair clauses include contracts for the provision of utilities or telecommunication services. I have provided an illustration of such clauses in the same handout that I distributed earlier in the House. For such contracts, small businesses are often in no better position than individual consumers in that they have little bargaining power to negotiate contract on the supplier’s standard terms.

Presently, in Singapore, small businesses are given some protections when entering into standard form contracts under the Unfair Contract Terms Act (UCTA). However, UCTA protections focus mainly on certain types of clauses, such as exclusion of liability clauses and indemnity clauses, which must be reasonable in order to be enforceable. Even then, certain types of contracts are excluded from UCTA, such as contracts that involve property interests.

In a report for the Federation of Small Businesses (FSB) written by the Centre for Competition Policy in the United Kingdom (UK) in 2014, the report recognised two key arguments in favour of providing greater protections for small businesses. The first is that small businesses, which may not be as sophisticated and have the same level of resources as large companies, need protection to make effective purchasing decisions relative to larger businesses. Second, as a matter of policy coherence, if small businesses behave more like individual consumers than they behave like large businesses, then it would be coherent to treat them the same under the law.

In Hong Kong, small businesses may rely on the Control of Exemption Clauses Ordinance, which is the equivalent of our UCTA. However, unlike Singapore, for consumers, which by definition excludes small businesses, there is also recourse to the Hong Kong Unconscionable Contracts Ordinance (UCO). The UCO provides that with respect to a contract for the sale of goods or supply of services in which one party deals as a consumer, where the court finds any part of the contract to have been unconscionable in the circumstances when the contract was made, the court may refuse to enforce that part of the contract, or limit the application of the unconscionable part.

The Hong Kong UCO vis-à-vis consumers is, therefore, wider in its application compared to Singapore's UCTA in that it applies to all contractual clauses and not merely exclusion or indemnity clauses. The Hong Kong UCO was modelled after the Australian Trading Practices Act of 1974 which applied to both small businesses and consumers.

The United States (US) and Germany have also legal provisions that render one-sided contracts with small businesses unenforceable. Article 138 of the German Civil Code, known as BGB, renders a legal transaction, where a person exploiting the counterparty's weakness grants to himself a pecuniary advantage which exceeds the value of performance to such an extent that under the circumstances, the pecuniary advantage is an obvious disproportion to the performance, void. Section 2-302(1) of the Uniform Commercial Code of the US provides that if a court, as a matter of law, finds a sale contract or any clause of a sale contract to have been unconscionable at the time it was made, the court may refuse to enforce the contract, amongst other options. This provision has been judicially interpreted to apply outside the arena of sale contracts to lease of chattels, insurance contracts and other areas. Perhaps, Singapore could consider similar legislation.

The current UK position is similar to Singapore’s in that only legislative protection afforded to small business is through the UK UCTA. The main tranches of consumer law, such as the Consumer Rights Act 2015, which offers the most significant protections, only cover individual consumers. However, there is some sectoral protection of small business customers in the UK by the regulators.

For example, under the 2003 Communications Act, a distinction is drawn between "domestic and small business customers" and other customers. Consistent with this, the UK telecommunications regulator, Ofcom, provides such small businesses with the same protection as domestic customers throughout its general conditions. For example, both types of customers are covered by Ofcom rules relating to information to be provided at the point of sale, the ban on automatic rollover contracts and restrictions on misleading or aggressive selling. Each supplier is required to develop and publish a Code of Practice for both individual and small business consumers that should, at a minimum, specify where such customers can avail themselves of necessary information. Access to the Alternative Dispute Resolution scheme is also available for both domestic and small business customers.

Australia has taken a robust approach to protecting small businesses through the Competition and Consumer Act 2010, and the Australian Consumer Law (ACL). ACL provides for a national unfair contract terms law covering standard form consumer and small business contracts. ACL provides that a term is unfair when it causes a significant imbalance in the parties’ rights and obligations arising under the contract, and it is not reasonably necessary to protect the legitimate interests of the supplier, and it would cause financial or non-financial detriment to a party. Terms that are determined by a court to be unfair are void.

Additionally, the Competition and Consumer Act and the ACL are administered by the Australian Competition and Consumer Commission, which may investigate alleged breaches of the Act and take enforcement or compliance action.

Apart from this, certain Australian states have also enacted additional laws for more sectoral-based regulations. For example, in Western Australia, most retail shop leases are regulated by the Commercial Tenancy (Retail Shops) Agreement Act 1985, which does not apply to leases to publicly-listed companies and which regulates commercial tenancy agreements. For example, the Act prohibits the landlord from engaging in conduct that is unconscionable in connection with the lease. The relevant factors to be taken into consideration to determine whether the landlord has contravened this section include the relative strengths of the bargaining positions of the landlord and tenant; whether the tenant was required to comply with conditions that were not reasonably necessary for the protection of the legitimate interests of the landlord; and whether any unfair tactics were used against the tenant.

Having regard to the approach taken by other countries, I personally prefer that we examine whether there is a need for a general protection approach, such as that provided by the Australian ACL, instead of a sectoral approach.

This would be consistent with instilling principles of fair dealing in corporate cultures, where customers are able to have the confidence that they deal with companies where fair dealing is central to the corporate culture. Such fair dealing guidelines have already been implemented in 2013 by the Monetary Authority of Singapore (MAS) in the financial industry in Singapore in respect of financial institutions and their customers. It is open for other regulators in Singapore, such as the Infocomm Media Development Authority or the Energy Market Authority, to adopt MAS’ practice and require the big players to provide fair dealing outcomes to their customers.

Providing legislative and regulatory protection for small businesses would go a long way to equalising the bargaining positions between small and large businesses and lower the business risks and costs assumed by these small businesses. It will make them more competitive and, hopefully, allow them to make an even bigger contribution to the vibrancy of Singapore's economy.

Mr Deputy Speaker: Senior Minister of State Indranee Rajah.

6.59 pm

The Senior Minister of State for Law (Ms Indranee Rajah): Mr Deputy Speaker, the hon Member has spoken about the imbalance in the bargaining positions of SMEs vis-à-vis bigger players. He has suggested a general protection approach through legislation.

The Government is empathetic to challenges faced by SMEs. The question is how should we approach this issue and what should be the underlying philosophy that underpins our policy and approach?

In Singapore, our underlying philosophy is that, in general, free-market principles should apply and the Government should intervene only when necessary, for example, to address systemic market failures. Even when we do intervene, we try as far as possible to have the right regulatory touch and avoid heavy-handed interventions that could lead to distortion or unintended consequences. This philosophy has ensured that our businesses, big and small, can respond quickly to market signals and adjust their business strategies accordingly. It has led to growth and good outcomes for all. In a competitive business environment, consumers benefit.

In any economy, it is inevitable that there will be competing demands and different interests. The question is how to strike the right balance. Take, for example, the sample clause on the option to renew, which the Member had handed out. From the landlord's perspective, what he wants is certainty. He does not want to be put in a position where the tenant can automatically renew the lease without knowing what the rent is, as that would be unfair to the landlord. The landlord would argue that his clause is fair because his revisions must be pegged to market rate, and the tenant has the choice not to renew and rent elsewhere. So, as Members can see, there are conflicting viewpoints.

Of course, one can legislate to the effect that landlord must have a clause that option to renew will be on the basis of market rate, full-stop. But that may not solve the problem as the tenant and the landlord may disagree on what the market rate is. If they cannot agree, the tenancy will either not be renewed, in which case the tenant will still have to find new premises, which is the same position that the tenant would have been in if he had rejected the landlord's revision under the sample clause; or the tenant can continue with the lease, while both parties litigate the market rate, which will sour the relationship, and likely rule out a further lease beyond the option term, which may not be in the tenant's interest.

Of course, you can then have a clause that says that the option to renew will be on the basis of market rate to be determined by a third-party valuer. Then you will have the question of who should pay for the valuer's fees.

I highlight this not to suggest whether the standard clause produced by Mr Murali Pillai is a good clause or a bad clause, but simply to point out that, in every situation, there will be different views on what is fair, and the answer is not always clearcut. Ideally, the contract should reflect a mutually agreed negotiated position, taking into account the parties' commercial considerations.

Introducing legislation is not without difficulties. Just as in the property market today, there exists a wide spectrum of landlords and tenants with varying bargaining powers, and in differing circumstances. This makes it difficult to determine whether a particular clause is unfair or simply the result of a valid, albeit hard commercial bargain.

In making these judgement calls, the Court may run the risk of substantively altering the bargain struck between two commercial parties, causing uncertainty in the process. In fact, this has been one of the common criticisms of the application of “statutory unconscionability” in Australia.

Enacting such legislation in Singapore can cause market distortion and, eventually, market inefficiency, to the detriment of all. Unintended consequences can arise as well. For example, should the landlords, which this legislation targets, respond by increasing the rental rate to address the added business cost, this might end up hurting SMEs even more in the long run.

However, not having general protection legislation does not mean that there are no safeguards under our laws to protect against injustice. General contractual principles, such as the doctrines of duress, undue influence and unconscionability, apply to all contracts. These doctrines have been applied by the Singapore Courts to prevent a contracting party from being unfairly exploited by the other, when entering into a contract.

In relation to the demolition clause highlighted by the Member, the High Court has held, in the case which the Member referred to, that such a onerous clause will be “usually interpreted very strictly” in favour of the tenant, as the Courts recognise that “premature termination of the lease generally imposes inconvenience, if not hardship, on the tenant”. The outcome of Mr Murali Pillai's aunt's case does, in fact, illustrate how the law, as it currently stands, allows the Court to protect against unscrupulous behaviour.

Fundamentally, the issue, as the Member pointed out, is that of bargaining power. As such, the way forward for SMEs should be to strengthen their bargaining power through growing their businesses, bolstering their negotiating positions with the assistance of business and trade associations, such as SBF, ensuring that they have other options and alternatives while, at the same time, seeking out ways to raise productivity, reduce cost and maximise profits.

The Government has many schemes and programmes which SMEs can leverage to achieve these outcomes. For one, Government landlords like the Housing and Development Board and JTC have sought to ensure that their respective tenancy agreements do not contain onerously one-sided clauses. These are alternative premises for SMEs to consider renting.

SMEs should also consider leveraging Government schemes to build business capabilities, innovate and improve productivity. For example, SMEs can tap on schemes, such as SPRING Singapore's Capability Development Grant, to defray up to 70% of qualifying cost when they embark on projects to develop their capabilities in 10 key areas. In addition, the Government provides near-term support for SMEs to manage their business costs, such as the corporate income tax rebate and Wage Credit Scheme.

These support schemes all work together to assist SMEs in transforming their businesses by uplifting their productivity in developing new capabilities. Therefore, SMEs which do not get the benefit of the savings from property tax in the specific clause mentioned by the Member can, nevertheless, access various schemes which will help their businesses as a whole.

SMEs can also explore whether rental costs can be reduced through new business models. SME retailers, for example, might consider expanding through e-channels beyond the traditional “brick-and-mortar” retail shops. This will reduce the need for physical space and, hence, rental costs and, at the same time, expand their businesses. To strengthen their bargaining position, SMEs can also consider working with their respective trade associations to spearhead discussions with landlords, and leverage the Fair Tenancy Framework to level the playing field for themselves.

We have also launched the Industry Transformation Maps (ITMs), a collaborative effort between the Government, Trade Associations and Chambers, and industry, to help our businesses transform and grow. SMEs are encouraged to participate in the ITMs so that they can achieve their full potential for growth and profit.

In conclusion, we should be slow to constrain market players unduly through legislation. The best way forward is to promote entrepreneurship and help our SMEs grow bigger and stronger which would improve their relative bargaining positions, individually and collectively.

Question put, and agreed to.

Resolved, "That Parliament do now adjourn."

Adjourned accordingly at 7.08 pm