Insolvency Law Reform Part Two: ipso facto provisions

In Part One of this article (Insolvency Law Reform Safe Harbour Provisions), we reviewed the amendments to the Corporations Act 2001 (Cth) introducing a safe harbour to the civil insolvency provisions.  In this Part Two, we look at the amendments which prevent suppliers and third parties from exercising termination rights using “ipso facto” clauses triggered by insolvency events.  These amendments are set to commence on 1 July 2018.

An “ipso facto” clause is one which allows one party to terminate (or to vary the terms of) a contract upon the occurrence of certain events.  Such clauses are often triggered by ‘insolvency events’, which are usually defined in the contract to include the appointment of voluntary administrators, entry into a scheme or arrangement, entry into receivership, and even the appearance that a company is unable to pay its financial obligations.  Such clauses are often triggered without regard to whether a company can continue to perform its obligations under the contract.

From the point of view of the company who may be experiencing an insolvency event, this poses a serious impediment to a successful restructure, as it reduces the range of available restructuring options and it can be highly destructive to the value of the company’s business and the potential return to its creditors (due to destruction of goodwill).  A company will not be able to engage in legitimate business rescue strategies if its creditors are able to terminate the contract with the company when it attempts to restructure.

From the point of view of the counterparty terminating the contract, it makes good business sense to cease supplying goods or services to a company who may not be able to pay its invoices.

The ipso facto reforms introduce an automatic stay to ipso facto rights triggered by administration, schemes of arrangement, and receivership, as well as an automatic stay to ipso facto rights triggered by a company’s financial position (this second provision restricts counterparties from relying on collateral defaults to circumvent the stay provisions).

Further, the provisions introduce stay orders in respect of a potentially broader range of rights (for example, termination for convenience rights) where the court is convinced that such rights are or might be exercised, or there is a threat they might be exercised, solely because a company has entered into administration, a scheme of arrangement, or receivership.

The provisions are extended beyond the immediate event which might otherwise trigger the right.  Rights are unenforceable indefinitely after the stay has been lifted if the reason for enforcing the rights relates to the company’s financial position before the end of the stay period, or the company’s commencement of administration, a scheme of arrangement, or receivership.

Stays are only available to entities entering into a scheme of arrangement, voluntary administration, or receivership.  The provisions do not apply to:

  • rights in contracts entered into after the date of administration, scheme of arrangement, or receivership;
  • rights in contracts specified in regulations or prescribed by ministerial determination;
  • rights which manage financial risk associated with a financial product and which are commercially necessary for provision of that type of product;
  • secured creditor’s right to take enforcement action under its securities during the ‘decision period’ in administration; or
  • contracts entered into before the commencement of the regime (1 July 2018).

Importantly from the point of view of the counterparty, where a stay applies, the counterparty is not obliged to provide further credit during the period its rights are stayed.  A counterparty is also still able to terminate a contract with a company who is not performing its obligations (such as not paying its invoices).

These amendments will affect any business who operates as a creditor or supplier and who has standard terms and conditions or template contracts which contain an ipso facto clause.  We strongly recommend that such businesses contact us to have their contracts reviewed and amended and to obtain advice on the best way forward once the ipso facto provisions commence.

Please contact Steven Morris or Jennifer Ingrey of our office if you need any advice in relation to anything set out in this article.

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