Ipso Facto Reforms and the Need to Review Contractual Terms Dealing with Insolvency
Ipso Facto Reforms and the Need to Review Contractual Terms Dealing with Insolvency
1.  The Ipso Facto reforms
1.1 The reforms

The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) amended the Corporations Act 2001 (Cth) from 1 July 2018 to impose a prohibition on the enforcement of rights against a company including contractual termination rights arising on the occurrence of an insolvency event in relation to that company.

The stay provisions will apply to all contracts, agreements or arrangements entered into on or after 1 July 2018, unless an exclusion applies.   They do not apply to contracts entered into prior to 1 July 2018 (even if amended).

The ipso facto stay will affect the ability of a party to exercise termination rights or other contractual rights under affected contracts once a company enters one of a number of specified insolvency or restructuring procedures.

Specifically, the prohibition prevents the enforcement of contractual rights because the company is in voluntary administration, receivership or subject to a scheme of arrangement. The legislation also captures broader insolvency event clauses by also preventing enforcement of those contractual rights because of “the company’s financial position” at the time that they are under voluntary administration, receivership or subject to a scheme of arrangement.

The reforms emulate to some extent the ‘ipso facto’ moratorium under Chapter 11 of the United States Bankruptcy Code.

The term ‘ipso facto’ means that “by that very fact” that something exists or occurs that something else is true.

In the insolvency context, an ipso facto clause is a contractual provision that allows one party to terminate or modify the operation of the contract (or provides for this to occur automatically) upon the occurrence of a specified insolvency related event.

For example, a clause in a lease that entitles one party to terminate the lease if an administrator is appointed to the other party is an ipso facto clause. Clauses of these sort are very common in commercial contracts.

The stay is not intended to restrict a party from enforcing a right (or from applying self-executing or automatic provisions) for any other reason, such as a breach involving non-payment or non-performance.

In addition, the ipso facto provisions also allow the relevant insolvency administrator to apply for an order expanding the stay to prohibit the exercise of rights (for example, a right to terminate for convenience), even where the right does not expressly operate on the basis of one of the prohibited reasons set out above, if the court is satisfied that a party is likely to exercise those rights for a prohibited reason.

The amendments include anti-avoidance restrictions to prevent parties from contracting out of the operation of the ipso facto stay provisions in the Corporations Act.

1.2  Exclusions

The restrictions on the operation of ‘ipso facto’ clauses are subject to some exclusions (see below). The exclusions apply to:

(a)        certain types of contracts; and

(b)        certain types of rights.

Please refer to our comments below.

2.  Practical steps to manage the risk - Risk management framework

In responding to the ipso facto reforms, we recommend a risk management framework. 

The risk of a contractor becoming insolvent should be managed in a number of ways including the following: 

2.1  Planning for the risk

Categorizing the types of contractors by risk and contracting with them in an appropriate way, for example, stronger controls for ‘mission critical’ services.

2.2  Use of registered securities

For high risk contracts, you may consider entering into security documents registered with the PPSR, such as a General Security Deed which will provide to you some preserved rights, including the right to appoint an administrator and/or have priority rights upon insolvency.

2.3  Due diligence

You should undertake due diligence on the contractor and their solvency when appointing them.

2.4  Non-exclusivity

One of the most useful strategies is to make the appointment of the contractor non-exclusive in the first place and not to guarantee volume.  This may not be appropriate in all cases.

2.5  Keeping in mind contracts excluded from the stay

Some types of contracts are excluded from the stay under the regulations.  These include a Priority Deed in relation to securities.

2.6  Making use of rights excluded by the stay

The rights excluded from the stay are set out in the Corporations (Stay of Enforcing Certain Rights) Declaration 2018 (Cth) (extracted in the attached) and include:

  1. a right to crystallise a security interest: section 5(g) and 5(i) (ii);
  2. a right restricting dealing with property under a security interest: section 5(i)(iv);
  3. a right to perform obligations or engage another person to perform obligations or enforce rights under a contract (ie step in rights to perform): section 5 (j);
  4. a right to appoint a controller: section 6;
  5. a right to terminate for reasons other than administration or insolvency – for example other breaches, such as a failure to perform or pay: refer to wording of section 451E of the Act.

2.7  Termination clause

You can have a termination clause but it must operate at the end of the stay period i.e. on winding up (section 451E)

We recommend that businesses now review their standard terms and conditions, taking into consideration the reforms.

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