It is common to have ‘ipso facto’ clauses included in commercial contracts, so that a contracting party becomes automatically entitled to enforce its rights against the counterparty upon the occurrence of one or more events specified in the contract. This article discusses the effect of legal reforms on the enforcement of such clauses due to the occurrence of an insolvency related event.
Why did the Government introduce the reforms?
The reforms introduced by the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (the Act) will prevent a party from enforcing a contractual right to suspend or terminate a contract due to a counterparty experiencing an insolvency related event. The reforms will come into effect on 1 July 2018.
By making ipso facto clauses unenforceable, the Government is seeking to assist viable but financially distressed companies to continue to operate whilst they restructure their businesses. It recognises that enforcement of ipso facto rights may contribute to destruction in the enterprise value of businesses and make their rehabilitation more difficult.
What are the reforms?
Broadly speaking, the new laws provide that an “ipso facto” right to terminate or amend a contract will not be enforceable for a certain period if that right is triggered by:
- the company proposing to enter into a scheme of arrangement;
- the company entering into receivership;
- the company placed under administration; or
- the financial position of the company if it finds itself in any of the above scenarios.
There is also an anti-avoidance provision, which provides that an ipso facto clause will not be enforceable if it in substance is contrary to the above regime.
Ipso facto clauses are described as self‑executing provisions in the new laws.
How long does the stay last?
The stay period commences upon the occurrence of the insolvency event, and ends depending on the nature of the insolvency event as follows:
- scheme of arrangement: ends three months after announcement, or if an application is made in respect of the scheme, when the application is finalised or otherwise when the company is wound up;
- voluntary administration: ends when the voluntary administration ends, or the company is would up; and
- receivership: ends when the control of the receiver or managing controller ends.
The Court has discretion to extend the stay period if it is satisfied that the extension is appropriate having regard to the interests of justice.
What are the consequences of the stay?
The party against whom the ipso facto clause cannot be enforced will be able to conduct its affairs without being at risk of termination or suspension of the contract.
However, it will not be able to enforce a right that it has against the counterparty for a new advance of money or credit so long as the operation of an ipso facto clause is stayed.
Will a party be able to enforce an ipso facto clause after the expiry of the stay period?
Once the stay period has ended, a party will not be able to enforce a right against the other party due to circumstances that were in existence during the stay period.
Do the new laws apply to contracts, agreements or arrangements entered into before the commencement of the new provisions?
The new laws only apply to ipso facto clauses in contracts, agreements or arrangements entered into on and from 1 July 2018.
Are there any exceptions to the new laws?
The stay provisions do not apply in a number of situations, such as the following as stipulated in the Act:
- if the right is contained in contracts, agreements or arrangements entered into after the insolvency related event occurs; and
- if the managing controller, administrator or liquidator (appointed after the administration ends) has consented in writing to the enforcement of the right.
Further situations may be excluded from the stay provisions under the regulations or declarations. Relevantly, the draft Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (Regulations) and the Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (Declaration) were released for consultation in April 2018.
The Regulations provide that the stay provisions will not apply to a contract, agreement or arrangement:
- under which a body corporate issues, or may issue, securities or financial products;
- for the sale of all or part of a business, including by way of the sale of securities or financial products; and
- entered into or renewed on or after 1 July 2018 as a result of a variation, novation of, or assignment of one or more rights in existence prior to 1 July 2018.
Similarly, the Declaration provides that the stay will not apply in respect of:
- a right to change the basis on which an amount is calculated, including due to a different rate applying, in respect of a financing arrangement or a guarantee, an indemnity or a security related to a financing arrangement;
- termination right under a standstill or forbearance arrangement;
- a right to change the priority in which amounts are to be paid;
- a right of set-off or a right of combination of accounts; and
- a right to net balances or other amounts.
The above exceptions implicitly acknowledge that it is necessary or appropriate for ipso facto clauses to continue to operate due to a number of reasons, for example, there being an established market mechanism in place, or where it would otherwise be uneconomical.
The enforcement of certain ipso facto clauses will be stayed from 1 July 2018.
The stay applies in relation to terminating or amending a contract entered into on or after 1 July 2018, due to a party for example entering into receivership, voluntary administration or scheme of arrangement. There are, however, a range of exceptions to this.
It is important that companies familiarise themselves with these important changes in law, including the exceptions, so that they are not caught by surprise post 1 July 2018. Companies should also obtain advice to ensure that their legal position is adequately protected in the event of a default by the counterparty. The stay, for example, will not affect the right to terminate or amend an agreement for other reasons, such as a breach involving non-payment or non-performance.