SUMMARY
- An ipso facto clause is a common clause found within contracts and agreements that allows for one party to terminate (or vary) a contract or agreement when the other party enters insolvency.
- The new reforms will apply only to contracts entered into after 1 July 2018.
- As at 1 July 2018, the new reforms will stay the ipso facto rights under a contract or agreement that arises out of the insolvent party having:
- entered into voluntary administration;
- been placed into receivership (when a managing controller or receiver is appointed); or
- entered into a scheme of arrangement (which attempts to avoid a company being wound up).
- Carveouts and exceptions to these new reforms will apply to certain contractual arrangements and rights, including business purchases.
The new reforms will not affect a party’s ability to enforce another contractual right that is independent from the ipso facto clause. For example, if the insolvent party is unable to perform the contract, then that party may have rights to terminate for non-performance of the contract.
The new ipso facto reforms are set to become very real for all contracts and agreements entered into from 1 July 2018.
As seen with the new Safe Harbour laws, which came into effect in late 2017, the new ipso facto reforms under the Corporations Act 2001 (Cth) are another initiative by the Australian Government aimed at increasing innovation and provide further support for those companies that are financially distressed and entering insolvency.
What is an ipso facto clause?
An ipso facto clause is a common clause found within contracts and agreements. A party would generally rely upon an ipso facto provision to protect themselves, with the ability to terminate the contract, against the insolvency of the other party.
It is a clause which primarily allows for one party to terminate (or vary) a contract or agreement in the event of the other party’s insolvency.
An example of an ipso facto clause can be found within the construction industry. Party A is performing various works for Party B under a contract. Under the contract there is an ipso facto clause providing Party B with rights to terminate, suspend the works or call upon a cash security deposit obtained at the commencement of the contract. Party A appoints an administrator and Party B then relies on the ipso facto clause to terminate the contract, or suspend the works, or call upon the security deposit to mitigate their loss.
What do we need to know?
From 1 July 2018, the new rules surrounding ipso facto clauses will operate to stay a contractual party’s right to terminate or vary a contract that arises out of the other party having:
- entered into voluntary administration;
- been placed into receivership (when a managing controller or receiver is appointed); or
- entered into a scheme of arrangement (which attempts to avoid a company being wound up).*
It is important to highlight that while the ipso facto clauses are unenforceable under the circumstances noted above, the reforms merely provide for such rights to be stayed. This means that the ipso facto clauses will otherwise be enforceable, but not whilst the insolvent company is undergoing its restructure.
Under the new reforms, the periods of the stay of contractual rights are merely during the process of the scenarios referred to above with the exception of a scheme of arrangement, which has the stay ending three months after the public announcement. For example, a company entering administration will likely see the stay of the contractual rights commence when the company enters the administration and the stay will end once the administration ceases, or when the company is wound up (enters liquidation).
Exceptions and carveouts?
There has been a period of public engagement from the Commonwealth Government surrounding the scope of the reforms and the Government’s acceptance of submissions on the draft amendments. So far, the Government has released the Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (The Declaration) and its accompanying Explanatory Statement to the Declaration. It is set that the Declaration will commence on 1 July 2018 and apply from that date.
The main exception is that the stay on the ipso facto clauses is subject to any court order that may be in force.
Otherwise, some of the typical ‘contract and agreements’ being proposed to be excluded from the reforms include (but are not limited to):
- government licences or permits;
- arrangements that relate to:
• the sale of a business, which includes a share sale/purchase;
• securities and financial products;
• operating rules of financial markets;
• subordination arrangements; - arrangements arising as a result of exercising novation, assignment or variation rights in arrangements entered into before 1 July 2018.
A range of rights in The Declaration are proposed to be excluded from reforms include:
- rights under a financing arrangement to charge a higher rate of interest;
- rights to indemnification and uplift;
- termination rights in a standstill or forbearance arrangement;
- rights to change the priority in which amounts are to be paid;
- rights of set-off and subsequent acceleration rights;
- rights of assignment and novation;
- self-executing provisions; and
- certain step in rights.
Winners and losers?
Generally, the ipso facto reforms will have a wide impact on all contracts and agreements from 1 July 2018.
The reforms will provide additional opportunities for insolvency practitioners to attempt to resurrect financially distressed companies by preventing contracting parties (ie. suppliers or head contractors) from terminating current contracts or agreements under an ipso facto clause.
The carveouts are weighed in the favour of financiers. However, the exclusion of business sales and share sale arrangements from the reforms is beneficial to all.
Importantly, the reforms will not affect a party’s ability to enforce another contractual right that is independent from the ipso facto clause. For example, if the insolvent party is unable to perform or make a payment under the contract, then the other party may have rights to terminate for non-performance of the contract.
Due to the general nature of the information that we have provided on carveouts and exclusions, we highly recommend that you review the Declaration or obtain further legal advice as to the application of these reforms to your business operations.
Overall, if you or your business relies on ipso facto clauses, you will need to carefully review your proposed and current contracts to prepare for scenarios where those clauses cannot be enforced against the other party.
If you require advice on this or similar matters please contact our Commercial + Property team.
*Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth)