The federal government has recently introduced reforms to Australia’s insolvency and restructuring laws to provide companies under financial stress an opportunity to trade out of their difficulty. A key part of the reform package is the introduction of a new “ipso facto” regime, which restricts the ability of a party to terminate a contract and exercise other contractual rights in certain cases of insolvency or restructuring of the other party.
What are ipso facto clauses?
Commercial contracts typically contain clauses, known as ipso facto clauses, which permit one party to terminate the contract or otherwise modify its operation when the other party suffers an insolvency event. Insolvency events are often defined broadly to include actual insolvency together with entry into formal restructuring or insolvency procedures, including administration and receivership. The exercise of termination or other rights under an ipso facto clause may destroy any prospect of the counterparty recovering its financial position.
The ipso facto reforms
Australia’s ipso facto reforms came into effect on 1 July 2018 through amendments to the Corporations Act. The new regime imposes a stay on the enforcement of contractual rights against a corporate counterparty where those rights arise only because:
- the company is undertaking a scheme of arrangement to avoid being wound up in insolvency;
- a managing controller (including a receiver) has been appointed over all or substantially all of a company’s property; or
- the company enters administration; or
- because of the company’s financial position at the time it enters or becomes subject to any of the three processes named above.
The regime does not typically apply to liquidations (unless they immediately follow an administration or scheme of arrangement), and parties are prohibited from contracting out of the new regime, with anti-avoidance measures being included in the legislation.
Parties are prohibited from contracting out of the new regime, with anti-avoidance measures included in the legislation.
What kinds of rights are affected?
The rights subject to the stay under the new regime are not limited to termination rights triggered by an insolvency event. Rather, subject to certain exceptions, the regime extends to any rights that arise by express provision of a contract, agreement or arrangement because of the other party’s financial position or its entry into one of the three insolvency or restructuring procedures referred to above.
How long does the stay last?
The duration of the stay depends on the procedure in question and how the relevant events unfold. In summary (and subject to any court orders affecting the operation or period of the stay), the stay will last:
- For schemes of arrangement: from the time when the when the company announces or applies to undertake a compromise or arrangement with its members or creditors to avoid being wound up, until
- 3 months after the public announcement (if the application is not made in that time);
- when the application is withdrawn or dismissed by the Court;
- at the end of any compromise or arrangement approved as a result of the application; or
- the company is fully wound up.
- Where a managing controller has been appointed: from the start of the managing controller’s appointment until their control of the company’s property ends.
- Where the company is under administration: from the time the company comes under administration until the administration ends or the company is fully wound up.
This means the contracting parties are essentially “locked in” and obliged to continue performing their obligations to one another.
Importantly though, the ipso facto regime does not prevent a party from terminating a contract during the period of the stay for reasons that are unrelated to the other party’s financial position or entry into one of the procedures named above, for example, termination for breach by the other party.
Are there any exceptions to the regime?
Generally speaking, the ipso facto regime will apply to all contracts, agreements or arrangements entered into after 1 July 2018. However, certain prescribed rights, and certain categories of contracts, have been excluded from the scope of the regime by operation of the Corporations (Stay on Enforcing Certain Rights) Declaration 2018 and the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (which amend the Corporations Regulations 2001), respectively.
The legislation also permits a party holding rights under an ipso facto clause to make an application to the Court that the stay on enforcement be lifted on the basis that it is in the interests of justice to do so.
In addition, the stay will not apply to a particular right where the scheme administrator, managing controller, or administrator (or subsequently appointed liquidator) consents in writing to the enforcement of that right.
What should you do now?
In light of the new ipso facto regime, it will be important to:
- consider the ipso facto provisions in detail at the start of a transaction, including whether you are able to take advantage of any exclusions or exceptions;
- conduct careful pre-contractual due diligence so the financial position of a potential counterparty is fully understood before a contract is signed;
- consider bolstering service levels or other performance-related provisions to ensure your rights to terminate for breach are available even if you cannot rely on rights arising under an ipso facto clause; and
- review and update your processes for monitoring contractual counterparties so you can maximise opportunities to detect financial distress and consider your options before the counterparty enters into external administration.