New laws affecting ipso facto clauses in contracts came into effect on 1 July 2018. These laws provide a temporary stay on the enforcement of contracts being terminated where a contracting party enters into voluntary administration, receivership or a scheme of arrangement with creditors.

What is an ipso facto clause?

Ipso facto clauses – also known as termination provisions – are found in a wide range of commercial contracts. They create a contractual right that allows one party to elect to terminate or modify the operation of a contract, or for the contract to terminate automatically, upon the occurrence of a specific trigger event.

In the insolvency context, an ipso facto clause is triggered on the occurrence of an ‘insolvency event’, which generally occurs in circumstances where an administrator, liquidator, receiver or controller is appointed. An ipso facto clause will ordinarily be triggered irrespective of whether the party that has suffered the insolvency event is otherwise performing its obligations under the contract.

Ipso facto clauses have long been the subject of debate in Australia. On the one hand, these clauses are said to be beneficial as they provide contracting parties with a right to terminate a contract if another party is at risk of becoming insolvent. On the other hand, ipso facto clauses are also often criticised for reducing the prospects of a successful turnaround of an insolvent (or potentially insolvent) party, and otherwise of negatively impacting the enterprise value of a business that may be entering formal administration.

What are the new laws?

The Amending Act seeks to stay the enforcement of ipso facto clauses by mandating an automatic ‘stay’ on a party's right to enforce a provision to terminate or amend a contract (such as through the operation of acceleration clauses) because the counterparty enters into voluntary administration or a scheme of arrangement.

More specifically, the Amending Act operates to stay a contractual right to suspend or terminate the contract arising because:

  • a company enters into a scheme or arrangement (or announcing it will enter into a scheme or arrangement) to avoid being wound up in insolvency (s415D)
  • a managing controller or receiver is appointed to a company (s464J) or
  • a company goes into voluntary administration (s451E).

However, this stay will not prevent parties from terminating in other circumstances, such as a breach of contract arising from non-payment or non-performance.

The Corporations Act has also been amended to allow courts to override the stay if it is satisfied that it is appropriate to do so in the interests of justice.

Importantly, these provisions only apply to contracts entered after 1 July 2018.

How long is the stay effective?

The length of the stay will depend on the type of insolvency event that occurs. The following table sets out the various timelines.

Exclusions from the stay on ipso facto clauses

There are certain agreements and arrangements that are excluded from the stay on ipso facto clauses. These are outlined in the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (Cth) (the Regulations), and include:

  • business and share sale agreements
  • contracts resulting from a novation, assignment or variation on or after 1 July 2018 of a contract entered into prior to that time
  • subscription agreements for securities or financial products
  • arrangements for underwriting the issuance or sale of securities or financial products
  • government licences or permits
  • arrangements for the keeping of source code in escrow and
  • financial market operating rules and certain arrangements relating to clearing and settlement facilities.

In addition to the Regulations, the Government is currently finalising the Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (Cth) (the Declaration), which includes further exclusions. The date on which the Declaration comes into effect is yet to be determined.

What this means for you

Now that the Amending Act has come into effect, business owners and contract managers should familiarise themselves with this new regime. Significantly, businesses must understand that the new laws apply only to contracts executed after 1 July 2018. Accordingly, ipso facto provisions that are in contracts already in force, remain effective.

In addition, business owners and contract managers should ensure they conduct a comprehensive review of all contracts they enter after 1 July 2018. Particularly, they should consider whether it is appropriate to include a clause that provides an express right to terminate a contract following non-performance or non-payment, as the new laws do not prevent termination in these circumstances.