The Australian corporate insolvency regime is undergoing significant reform. A suite of new amendments have been implemented or proposed, and the new “ipso facto” amendments that have been implemented as part of the second wave of reforms will apply to most contracts entered into after July 1, 2018.
The primary purpose of these ipso facto reforms is to prevent a counterparty terminating a contract when a company is implementing a formal restructure or is the subject of certain insolvency processes. However, the reforms are not limited to termination. The ipso facto amendments will restrict the enforcement of all contractual rights where a counterparty enters voluntary administration, receivership or a scheme of arrangement unless the rights have been specifically excluded by declaration or regulation.1
The ipso facto amendments are set out in the Treasury Law Amendment (2017 Enterprise Incentives No.2) Act 2017 (the Amendment Act) which adds additional provisions to Chapter 5 of the Corporations Act. Chapter 5 governs the external administration of companies in Australia.
The term ipso facto is a Latin phrase that translates to “by the very fact of.” An ipso facto clause allows one party to terminate, modify or exercise other contractual rights upon the occurrence of a specified event (ie, an insolvency event). For example, a contractual right to terminate a franchise agreement if receivers and managers were appointed to all the assets and undertakings of a franchisee would be an ipso facto termination right.
Purpose of amendments
The aim of the amendments is to allow breathing space for a company to continue trading during a formal restructure. Currently, a party may be entitled to terminate or modify a contract due to the financial position of a company (including insolvency) or due to the commencement of formal insolvency proceedings, such as the appointment of administrators. Termination rights are generally triggered whether or not the company is performing its obligations under the contract.
Ipso facto termination rights are problematic for the sale of the distressed company or for the facilitation of a formal restructure. The agreements in place with the company are generally fundamental to the underlying value of the business, and accordingly, ipso facto clauses have been criticised for reducing the scope for a successful restructure, destroying the enterprise value of a business entering formal administration and preventing the sale of a business as a going concern.
When the stay will apply
The ipso facto amendments will apply where a counterparty is the subject of one of the following insolvency processes:
- A managing controller (including a receiver and manager) is appointed to the whole or substantially the whole of a company's property
- A body pursues a scheme of arrangement for the purpose of avoiding being wound up in insolvency, or
- A publicly listed company announces that it will pursue a scheme of arrangement for the purpose of being wound up in insolvency
Together, these are called the “processes”. If a counterparty is subject to one of the processes, then a party to a contract will not be able to rely on any contractual rights that arise by reason only:
- That the counterparty has entered one of the processes
- Of the counterparty's financial position while it is in one of the processes
- Of a reason prescribed by regulations, or
- Of a reason that, in substance, is contrary to the above
Notwithstanding the operation of the stay, a counterparty maintains the right to terminate or amend an agreement with the debtor company for any other reason, such as a breach involving non-payment or non-performance.
To afford protection to creditors, where the operation of an ipso facto clause is stayed, the ability of the debtor company to enforce a right under a contract for a "new advance of money or credit" is also stayed. As the term "new advance of money or credit" is not defined, the scope of the stay is ambiguous. For example, it is unclear whether a debtor company would be precluded from drawing down on a facility within the limits of the overdraft.
Certain contracts, set out in regulations, have been excluded from the operation of the ipso facto amendments.2 All contractual rights (including termination rights) under those excluded contracts will remain be enforceable. Without being exhaustive, key contracts that have been excluded include:
- Certain agreements relating to securities, financial products, bonds, promissory notes or syndicated loans
- Arrangements for the sale of a business
- Arrangements involving a special purpose vehicle for the provision of securitisation, a public-private partnership or project finance
- Construction contracts worth over $1 billion entered into before 1 July 2023
- Government licences, permits or approvals
- Derivatives, securities financing transactions, flawed asset arrangements, margin lending facilities and covered bond arrangements
- Arrangements where securities are, or may be, offered under a rights issue, and
- The management of financial investments
Where the agreement is not excluded under the regulations in its entirety certain contractual rights may be excluded from the operation of the stay as set out in the declarations.3 Where contractual rights are excluded, those specific contractual rights will remain enforceable under the contract. The balance of the ipso facto contractual rights however will be subject to the stay. Key examples of contractual rights that have been excluded from the stay include:
- Termination rights in a standstill or forbearance arrangement
- Certain step-in rights
- The right of a secured creditor to appoint a receiver or other controller to an asset, where another receiver or controller has been appointed
- Rights to change the basis on which an amount is calculated, including the charging of default interest, under a financing arrangement or guarantee, indemnity or security related to a financing arrangement
- Rights to change the priority in which amounts are paid
- Rights of assignment and novation, and
- Certain set-off rights
A franchisor operating in multiple jurisdictions enters into a franchise agreement with a franchisee in Australia. The franchisee becomes insolvent and enters into administration. An external administrator takes control of the Australian franchisee and continues to run the business.
As a result of the administration, unsecured creditors cannot take any enforcement action against the franchisee without leave of the court and the administrator has no obligation to pay existing suppliers or to pay outstanding wages to employees.
As a result of the new ipso facto amendments, the franchisor cannot rely on any termination rights that arise under the franchise agreement by reason only that the administrator was appointed or because of the financial position of the franchisee.
The franchisor would be left in a position where it cannot terminate the contract and also faces significant reputational risks to its brand due to employees and suppliers not being paid. The franchisor may also be liable in respect of outstanding wages and supplier invoices (depending on the structure of the franchise).
There are workarounds that can be implemented and options available to mitigate the risks, including reputational risks. We recommend that franchise agreements (and other agreements) are reviewed in this context to include appropriate contractual rights and protections should the above scenario occur.
Application outside of Australia and recommendations
Prudent companies entering into any contract with an Australia company from July 1, 2018 may seek to obtain advice as to the implication of the new ipso facto amendments and whether they will apply. The new ipso facto amendments may apply to your contract even if the contract is governed by another jurisdiction by way of a choice of law clause.