Insolvency Reform — Get the Facts on Ipso Facto!

29 June 2018

On 1 July 2018, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (“the Amending Act”) will amend the Corporations Act 2001 (Cth) (“the Act”), to include a “stay” on the enforcement of rights to terminate a contract upon the occurrence of an insolvency related event, except in limited circumstances.

The stay on ipso facto clauses will apply to any new contracts, agreements or arrangements entered into on or after 1 July 2018. It will not apply to contracts entered into prior to 1 July 2018 nor to any novation, assignment or variation of rights arising from contract dated before 1 July 2018.

As ipso facto clauses are common in a range of council commercial contracts (such as lease, supplier and service agreements), it is important for councils to understand how these changes will impact their future commercial dealings.

Ipso Facto Clauses

An ipso facto clause in a contract is a clause that:

• creates a right to terminate or modify the contract upon an insolvency related event; or
• has the effect of automatically terminating the contract when an insolvency event occurs (also known as “self-executing” clauses) –

regardless of whether or not the counterparty is ready, willing and able to perform the contract.  What constitutes an insolvency related event will always depend on the terms of the ipso facto clause but will usually include actual insolvency and events leading up to potential insolvency, such as entering into administration or receivership.

On one hand, ipso facto clauses serve a real commercial purpose for the party not subject to the insolvency event. They are a risk management tool, which gives the solvent party the freedom to exit the contract as soon as insolvency is a real risk, rather than waiting for it to actually happen.

On the other hand, the termination of valuable contracts will, in many cases, prevent the counterparty from being able to turn itself around, often resulting in a less desirable outcome for creditors. The Amending Act addresses these concerns by restricting the right to enforce ipso facto provisions, except in limited circumstances.

What’s Changing?

The Amending Act contains provisions that “stay” (or pause) the enforcement of ipso facto clauses against a party for the reason only that:

• the counterparty has made, or has announced that it will make, an application to enter into a ‘scheme of arrangement’ for the purpose of avoiding administration or insolvent liquidation;
• the counterparty has a receiver or managing controller, who has been appointed over all or substantially all of the company’s assets;
• the counterparty has entered into administration or may enter into administration; or
• the counterparty enters into a deed of company arrangement.

The stay operates while the restructuring process is ongoing and automatically ends when the restructuring ends or, if the counterparty resolves or is ordered to be wound up, when the counterparty’s affairs have been fully wound up.

The Exceptions

On 16 April 2018, the Treasury released an Exposure Draft of the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 and the Corporations (Stay on Enforcing Certain Rights) Declaration 2018.

The draft regulations will amend the Corporations Regulations 2001 and insert provisions that prescribe the kinds of contracts and rights that will be excluded from the stay on ipso facto clauses. The consultation process has now been completed.

Relevant to councils, the following contracts are excluded:

• licences or permits issued by the Commonwealth, a State or a Territory, an authority of the Commonwealth, State or Territory, or a local government, such as a council;
• arrangements for the sale of a business; and
• rights to change the priority in which amounts are to be paid.

Practical Effect

The stay provisions will only apply to contracts that are entered into after 1 July 2018. This means that ipso facto clauses contained in contracts entered into prior to the new provisions will continue to be enforceable. This is the case even where the contract is amended after the stay provisions have come into operation.

Ipso facto clauses contained in contracts entered into after 1 July 2018 will not be unlawful but will be unenforceable – they will not impact the enforceability of the balance of the contract.

Where a party purports to enforce an ipso facto clause in contravention of the Act, the counterparty will be able to apply to the court for a stay. Further, since the terminating party did not have a right to terminate, they may be viewed as repudiating the contract and liable to the counterparty for damages.

Going forward, councils should review precedent contracts to ensure that their legitimate commercial interests will be protected from 1 July 2018. This may mean making appropriate amendments to mitigate risk, such as the inclusion of a termination for convenience clause or a right to terminate for another reason (such as poor performance, failure to meet a payment or obligations) unrelated to the insolvency event.

From 1 July 2018, when renewing existing contracts, councils should consider whether the renewal has the effect of creating a new contract:

• if it does, existing ipso facto clauses will no longer be enforceable, hence, councils should ensure that their commercial interests are protected;
• if it does not, then ipso facto clauses will still be enforceable, but the stay provisions will apply to any variation or amendment.

Going forward, councils should always consider the financial strengths of prospective contracting parties and legal advice should always be obtained before exercising contractual rights (especially to terminate) on the basis of an insolvency event.

For further information contact Cimon Burke on 8113 7105 or cburke@kelledyjones.com.au.