On 1 July 2018, new provisions in the Corporations Act 2001 come into effect that will significantly limit the enforcement of contractual rights that apply on the occurrence of various insolvency related events (new regime). At this stage, the Commonwealth Government has introduced an exposure draft, with the final provisions of the new regime yet to be finalised.
The ispso facto clause and the new regime
In almost all commercial contracts there are clauses that allow a party to terminate or modify a contract on the occurrence of various insolvency related events. For example, a clause in a:
- lease agreement allows the lessee to terminate the lease if an administrator is appointed to the lessor;
- security agreement allows a secured party to take control of the grantor’s assets if the grantor enters into a restructuring arrangement to avoid being wound up in insolvency; or
- building contract allows a contractor to suspend works where the principal has become insolvent.
Terms of this type are known as ipso facto clauses.
Under the new regime, certain ipso facto rights that apply where one party (the debtor party) is undergoing, or proposes to undergo, an insolvency related event will be stayed, subject to limited exceptions. Where a stay applies, rights granted under an ipso facto clause cannot be exercised by reason only of:
- the debtor party restructuring under administration;
- the debtor party restructuring under a compromise or arrangement aimed at avoiding being wound up in insolvency; or
- a managing controller being appointed over all or substantially all of the property of the debtor party.
In simple terms, ipso facto rights cannot be exercised solely on account of an insolvency event described above.
The stay afforded by the new provisions will fall away if, and when, the debtor party goes into receivership or liquidation, or if the stay is lifted on application to the Federal Court.
The new regime is designed to assist businesses to continue to trade and to attempt to recover from an insolvency related event.
Exclusions to the new regime
At present, the new regime only applies to contracts entered into after 1 July 2018. The exposure draft also sets out various types of contracts and contractual rights to which the new regime will not apply (these exclusions may change). For example, contracts:
- for the sale of a business;
- under which a party is or may be liable to subscribe for securities or financial products (e.g. put and call option agreements);
- in which a special purpose vehicle is a party;
- under which the priority of security interests in particular property is changed or can change (e.g. a deed of priority and subordination that is connected to multiple loan agreements);
- for the renewal of existing contracts that were entered into before 1 July 2018 (e.g. a renewal of lease); and
- contracts for the novation or assignment of contracts that were entered into before 1 July 2018.
The new regime does not apply to the exercise of certain contractual rights including:
- the right to enforce a higher rate of interest under a contract;
- the right to set-off amounts owing by the debtor party against amounts owing by a counterparty;
- the right to assign, novate or otherwise transfer rights or obligations under a contract; and
- the right to appoint a controller over a debtor party’s assets where a counterparty has an enforceable security interest over those assets (e.g. rights secured under a security agreement).
While a number of exclusions apply, the Government has broad powers to prescribe new regulations in relation to contracts or arrangements that it deems are drafted with the intention of circumventing the provisions of the new regime.
What you should do
Existing standard form contracts and contracts to be entered into after 1 July 2018 should be reviewed in light of the new regime.
If an insolvency related event occurs with respect to a counterparty to a contract, parties should obtain legal advice before attempting to enforce any ipso facto clauses or otherwise terminating or modifying the contract. Terminating or enforcing other rights under a contract in breach of the new regime may create an unwanted future claim for damages.
Note: This update is a guide only and is not intended to constitute legal advice.