Ipso facto reforms at a glance

The Commonwealth Government has introduced reforms to the insolvency regime which will change the way in which ipso facto clauses in contracts operate on the occurrence of an insolvency event.

These reforms come into effect on 1 July 2018.

What are ipso facto clauses?

Ipso facto clauses are provisions in contracts that allow a party to terminate or modify a contract on the occurrence of an insolvency event, such as the appointment of an administrator.

The enforcement of ipso facto clauses (particularly termination clauses) by counterparties during the administration, receivership or formal restructure of a company often:

• erodes or destroys the going-concern value of the company; and
• undermines the potential for the company to be successfully restructured.

Many see this as being especially harsh in circumstances where a company otherwise continues to perform its obligations under a contract.

For these reasons, the Commonwealth Government has introduced reforms which limit the enforceability of ipso facto clauses in certain insolvency scenarios.

What is changing?

From 1 July 2018, counterparties will not be able to enforce ipso facto clauses against companies in circumstances where the right is enforced because a company:

• has had an administrator appointed to it;
• has had a receiver appointed over all its assets; or
• is subject to a creditors’ scheme of arrangement (or is the subject of an application for a creditors’ scheme of arrangement, or it has announced that it will make such an application).

Which contracts are affected by the changes?

The reforms only affect rights arising under contracts entered into after 1 July 2018.

This means that the changes do not affect:

• rights arising under contracts that were entered into before 1 July 2018; or
• rights arising under amendments to contracts, where the original contract was entered into before 1 July 2018.

What types of contractual rights are affected?

The reforms place a stay on “the enforcement of a right” under a contract.

Until such time as the courts give greater clarity to the scope of this phrase, we expect that rights that are likely to be affected include:

• termination rights;
• acceleration rights (the right to demand payment of the whole of a debt); and
• step-in rights (such as the right of a financier to step in and complete a building project if the developer becomes insolvent).

The stay on enforcement captures ipso facto clauses regardless of whether they are self-executing (automatic) or exercised at the discretion of the counterparty.

What events trigger the stay on enforcement of ipso facto clauses?

The stay on enforcement of an ipso facto clause will be triggered if the counterparty seeks to rely on:

• the appointment of an administrator to a company;
• the appointment of a managing controller to a company (i.e. the appointment of a receiver and manager over all of a company’s assets); or
• a company being subject to a creditors’ scheme of arrangement to avoid it being wound up in insolvency (including making an application for a scheme or announcing an intention to do implement one).

In addition, a counterparty will not be able to rely upon the “financial position” of a company experiencing one of the above events to enforce an ipso facto clause.

A counterparty may still exercise its contractual rights (including termination) on the basis of another default (i.e. any reason other than those listed above). For example, a counterparty may still terminate a contract on the basis of non-payment or non-performance.

Are there any exceptions?

Yes. The stay on enforcement of ipso facto clauses will not apply to:

• ipso facto clauses contained in contracts entered into before 1 July 2018 (even if the contract was amended after that date);
• swaps, arrangements for managing financial risk, and certain other arrangements governed by the Payment Systems and Netting Act 1998 (Cth) and the International Interests in Mobile Equipment (Cape Town Convention) Act 2013 (Cth) where the provisions of these Acts are inconsistent with the ipso facto reforms;
• other types of contracts to be specified in regulations by the Commonwealth Government in due course (these are yet to be declared by the Minister);
• the right of a counterparty to terminate or amend a contract for another reason; and
• the right of a secured creditor holding security over all (or substantially all) of the assets of a company to enforce that security before or during the decision period (13 business days) following the appointment of an administrator.

Despite the stay on enforcement of an ipso facto clause, it will be possible to enforce such a clause if the counterparty obtains:

• the written consent of the administrator, receiver or scheme administrator; or
• an order of the court permitting enforcement of the right.

Authored by:
James Roland, Partner
Clementine Woodhouse, Associate