In our previous bulletin we discussed the ‘safe harbour’ model in the Government’s suggested reforms to the current insolvency laws.
This bulletin considers another of the focus questions in the Proposal Paper: the voiding of ipso facto clauses relating to insolvency events.
Ipso facto clauses are common place in commercial contracts. They allow a party to automatically terminate a contract where a specified insolvency event has occurred, such as where a liquidator, receiver or administrator is appointed or a deed of company arrangement is entered into.
There is a sentiment in some quarters that ipso facto clauses are a major impediment to distressed companies being able to turn their situation around.
The opposing view is that the other contracting party should be able to protect their commercial interests.
Model for constraining the operation of ipso facto clauses
The Government proposes that any term that allows a contract or agreement to be terminated or amended solely because an insolvency event has occurred would be unenforceable.
As an anti-avoidance measure, it is also proposed that any term in an agreement that has the effect of providing for, or permitting, anything that in substance is contrary to the above provision would also be unenforceable.
The proposed reform would not extend to other events of default not falling within the ipso facto net – for example, a breach involving non-payment or non-performance of a contractual term.
However, it remains to be seen what will be caught by the ipso facto net. Will events of default that are indicators of insolvency (such as an unpaid judgment) be caught? Will a creditor be prevented from accelerating repayment or from requiring additional security upon default?
Nothing in the proposal paper would require a creditor to provide a further advance of money or additional credit to an insolvent entity.
It seems likely that the outlawing of ipso facto clauses will result in contracts being drafted in an attempt to avoid the ipso facto net by including further key performance requirements and expanded lists of events of default. Whether such attempts are successful will depend upon the type of contract and the specifics of any legislation.
If you are in the process of updating your precedent contract, the ipso facto reform should at least be considered. In any event, it is always prudent to consider whether your contract terms could be bolstered to better protect your position.