In brief: Recent amendments to the Corporations Act 2001 (Cth) (Corporations Act) have introduced a prohibition on the enforcement of ipso facto clauses in certain circumstances.
The Federal Government has for some time considered amendments to the insolvency regime in the Corporations Act to streamline the recovery of businesses in financial distress.
What are ipso facto clauses and how do they work?
Ipso facto clauses are designed to typically allow for the termination of a contract if the other party to the contract enters into an insolvency. Such clauses are standard in many commercial and financial contracts (including construction contracts), and considered essential to protect the interests of the contracting parties as it allows them to control the contractual relationship in those circumstances.
The policy behind the prohibition is to maximise the chance of businesses in financial distress to either trade their way out of trouble, or find a purchaser, without having to worry about essential contracts being terminated or having onerous terms imposed.
If a right arises by express provision of a contract, agreement or arrangement, that right cannot be enforced against a corporation for the reason that:
- it enters into voluntary administration;
- a managing controller (which includes a receiver and manager) is appointed over the whole or substantially the whole of the corporation's property; or
- it publicly announces that it will be making an application to enter into a scheme of arrangement for the purpose of avoiding being wound up in insolvency.
While the amendments are clearly aimed at staying enforcement of rights to terminate or onerously amend contracts on the insolvency of a counterparty, the terms of the new provisions are not restricted to those specific types of rights. Instead, the reason for the triggering of the right is used as the qualification for the stay. That is, if one of the trigger events occurs, any contractual rights arising as a result cannot be enforced.
Construction industry participants should be aware of the implications
As a practical example, many construction contracts will typically contain a right for the principal to terminate the contract or to take works out of the hands of the builder upon the insolvency of the builder. Similar provisions typically exist in subcontracts too. Under such contracts entered into after the commencement of these amendments, a party may not be able to rely upon such rights in the event of the occurrence of one of the events referred to above, such as the appointment of a voluntary administrator to the downstream party. Although it is yet to be seen, the prohibition may in fact go further and apply in circumstances of general insolvency which are factually consequent upon the occurrence of one of these events. This is a fundamental shift from the current position and one that will require the careful attention of drafters of contracts.
Amendments to stay enforcement of ipso facto clauses
There is a recognition that the stay should not apply to certain types of agreements, usually for reasons of commercial efficacy, such as complex financial arrangements, netting agreements, aircraft leases and rights of set off. The exceptions will be contained in Regulations, allowing types of agreements to be excepted without the need for legislation. Interestingly, removal of trustee provisions in trust deeds are expected to be excepted. As this is a common cause of unnecessary complication in administrations of corporate trustees, it is disappointing that these provisions are to be excepted.
Additionally, clauses that exempt financiers from a requirement to provide further funding following an insolvency event will not be caught by the prohibition.
The stay on enforcement will be limited in time or to the duration of the external administration, and is subject to Court order.
The amendments to stay enforcement of ipso facto clauses are designed to reduce the incidence of otherwise viable businesses failing, and can be considered complementary to the introduction of a safe harbour regime for directors of companies facing insolvency.
How to prepare for the amendments to the Corporations Act 2011
The amendments come into force on 1 July 2018, unless the act is proclaimed earlier. The provisions will apply to contracts entered into after this date. Such contracts will need to be carefully reviewed in light of the legislative changes to seek to protect parties' legitimate interests without falling foul of the ipso facto stay provisions.
This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2020.