Ipso Facto Clauses and Creditors Rights Under Contracts New Laws Commence 1 July 2018

Background

It is common for commercial contracts to contain “ipso facto” clauses (“IFCs”).

IFCs are clauses in a contract which allow for certain rights (e.g. termination) on the occurrence of a specified event (“Event”).

The Commonwealth Government has recently introduced reforms under The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (“Amending Act”) which will limit the rights of parties to contracts to enforce IFCs in certain insolvency scenarios.

These reforms will come into effect on 1 July 2018.

The reforms build on existing rights under the Corporations Act 2001 (Cth) (“CA”); see s 440B of the CA.

What are the Amendments?

The Amending Act will make amendments to the CA such that IFCs in contracts entered into after 1 July 2018 will potentially be unenforceable in the following insolvency scenarios:

  • A compromise or arrangement for the purpose of avoiding being wound up in insolvency (including public announcements that the company will be making such an application; and being subject to an application);

    • The company has come or is under administration;

   • The appointment or existence of a managing controller appointment over the whole or substantially the whole of the company’s property;

If an Event occurs, a counterparty cannot rely on an IFC, if the IFC is premised upon:

   • The occurrence of an Event;

   • The financial position of the company which experiences the Event;

   • A reason prescribed by the regulations;

   • A reason which is, in substance (even if not in form), one of the above.

The IFC cannot be enforced during the stay period.

The stay period is defined differently according to the relevant Event. For instance, in respect of a company under administration, this starts when the company comes under administration and ends at the latest of the following:

   • when the administration ends;

   • if one or more orders are made for the extension of the period, that extended period;

  • if the administration ends because of a resolution or order for the company to be wound up – when the company’s affairs have been fully wound up;

As set out above, the Court may order an extension of the stay period if satisfied that it is in the interests of justice (e.g. the company returns to the control of the directors following an administration). 

The IFC remains unenforceable against the company indefinitely after the end of the stay period, to the extent that a reason for seeking to enforce the IFC is:

   • The company’s financial position before the end of the stay period;

   • The company having come into or been under the Event before the end of the stay period;

   • A reason, prescribed by the regulations;

   • A reason which is, in substance (even if not in form), one of the above.

For instance, in relation to a company that was under administration, a counterparty cannot simply wait under a Deed of Company Arrangement is in place to exercise their IFC rights that were previously stayed during the administration.

Certain types of contracts, agreements or arrangements and rights are likely to be excluded either wholly or in specified circumstances. For instance, the following have been set out in the Draft Regulations and a Draft Declaration:

Contracts

   • Business sale agreements and share sale agreements;

Rights

   • A right to change the basis on which an amount is calculated, including the charging of default interest:

The relevant insolvency practitioner can consent to the use of the IFC;

During the period of the stay, a counterparty is not obliged to provide any new advance of credit, if that right existed before the period of the stay;

An insolvency practitioner can apply for enforcement of the stay (e.g. where a counterparty is using a right to terminate for convenience and where it appears that the reason for the exercise of the right is an Event). Again, the interests of justice are the determining factor;

A party can apply to have the stay lifted under certain circumstances;

The operation of the Amending Act does not preclude a counterparty from terminating if the  company is in default under another clause of its contract (for instance, a right to terminate for non-payment);

The operation of IFCs will not apply in relation to rights under a contract, agreement or  arrangement entered into after the Event.

Analysis

The Explanatory Memorandum set out at paragraph 2.3 - 2.5:

An ipso facto clause creates a contractual right that allows one party to terminate or modify the operation of a contract upon the occurrence of some specific event. In the currently insolvency context, such rights may allow one party to terminate or modify the contract solely due to the financial position of the company (including insolvency) or due to the commencement of formal insolvency proceedings, such as on the appointment of an administrator. This type of termination can occur regardless of the counterparty’s continued performance of its obligations under the contract.

The operation of ipso facto provisions can thus reduce the scope for a successful restructure, destroy the enterprise value of a business entering formal administration or prevent the sale of the business as a going concern.

These outcomes can also reduce or eliminate returns in liquidation because they disrupt the businesses’ contractual arrangements and destroy goodwill, potentially prejudicing other creditors and defeating the purpose of a voluntary administration.

Whilst the purpose of the Amending Act is sound, it is questionable as to how effective the amendments will be if the provision regarding suspension of any obligation to provide further credit extends to further goods or services on credit. This provision is not defined and therefore the scope of this is unclear at this point in time.

Clarification is also required in respect of the voting rights of a counterparty where a particular Event occurs. For instance, the typical IFC under a loan agreement would previously allow termination and the calling up of the full amount as immediately due and payable. This had a significant impact on voting rights at meetings. Now there may in fact be no amount due and owing to the particular lender if the account is up to date.

Also, it is expected that there will be relatively long “transitionary” period where pre Amending Act counterparties are free to exercise their IFCs whereas post Amending Act counterparties are not. This may create unanticipated results in voting and restructuring proposals. However, it is acknowledged that an implementation date is required to provide the business world an opportunity to adjust and implement appropriate safeguards.

Insolvency: We are in a changed landscape; but we are here to help you navigate it. Should you require assistance, please obtain specialist advice from the insolvency experts at Gavin Parsons & Associates.


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Date posted: 2018-05-24