Ipso facto reforms – what exceptions apply?

From 1 July 2018, new provisions introduced into the Corporations Act 2001 (Cth) (CA 2001) by the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth), impose a stay on the enforcement of ipso facto clauses against a company that becomes subject to certain prescribed insolvency events.

Importantly, the changes only apply to contracts entered into after 1 July 2018.

What are ipso facto clauses?

Ipso facto clauses are contractual provisions that allow a party to automatically terminate or modify a contract on the occurrence of a specified insolvency event. It does not matter whether a party experiencing the insolvency event is continuing to comply with its obligations under the contract/agreement. A simple example is the automatic termination of a supply agreement upon the appointment by the company of a voluntary administrator.

Underlying rationale

The reasoning behind the implementation of the ipso facto reforms is to promote growth, entrepreneurship and assist in fostering and developing an attitude of innovation in Australia. The reforms are designed to encourage corporations to work through difficult times particularly early on in their formative corporate years with the benefit of knowing that the key contracts can be maintained in an insolvency context.

Exceptions to the reforms

The explanatory memoranda of the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) notes correctly that ipso facto clauses can be damaging when corporations encounter financial trouble. However, Parliament also recognised that a one size fits all approach would not work for all ipso facto clauses in contracts entered into following 1 July 2018.

There are two types of carve outs applicable to the new ipso facto reforms. These are:

• specific types of contracts as set out in the Corporations Regulations 2001 (Cth) – Reg 5.3A.50 (Regulations); and

• specific types of rights as set out in the Ministerial Declaration Corporations Amendment (Stay on Enforcing Certain Rights) Declaration 2018 (Declaration) (available here).

The Regulations

The Regulations operate to exempt a wide range of industries from the general stay. By way of example, they cover:

• contracts for the supply of essential services to, or for, a government body; and
• contracts in respect of complex financial products such as bonds, promissory notes or syndicated loans.

The above is a sample of the various types of contracts which the ipso facto stay does not effect and for which their pre-1 July 2018 treatment and operation remains applicable. It is therefore recommended that prior to entering into a new contract to supply services/products, a careful analysis be undertaken as to whether the type of contact being entered into is in fact caught by the Regulations. This will invariably be a difficult question to answer in respect of some contracts in the marketplace for which expert advice will be necessary.

The Declaration

The Declaration operates to prevent the ipso facto clause stay from affecting certain specific rights provided in contracts entered into after 1 July 2018 where it has been deemed undesirable for the stay to apply.

These rights have particular effect on financiers entering into ‘financing arrangements’. ‘Financing Arrangements’ are defined by section 4 of the Declaration to include ‘any form of financial accommodation’.

The rights provided in the Declaration are set out in section 5 and are far fewer in number than the types of contracts set out in the Regulations. Specific rights set out in the Declaration include, but are not limited to, the following:

• the right to charge uplift interest upon a default;

• a termination right under a standstill/forbearance arrangement;

• a right to change the priority, or order, in which amounts are to be paid, distributed or received under a contract or arrangement;

• a right of set off;

• a right of assignment or novation; and

• ‘step in rights’ to complete an obligation under a contract.

The rights provided in the Declaration were drafted following a public consultation process and are designed to prevent the application of the general ipso facto stay in circumstances where there is good reason to do so. The reasons underlying the implementation of each of the rights in the Declaration are helpfully set out here in the Explanatory Statement issued by the Minister for Revenue and Financial Services.

Given the implementation of the ipso facto regime is in its early days, we can expect some teething problems.  For example, certain types of contractual rights may have been incorrectly omitted from the list of rights in the Declaration (and therefore subject to the general ipso facto clause stay). The precise nature of these rights (if any) will become apparent moving forward as counterparties begin to encounter insolvency events in respect of contracts entered into after 30 June 2018.

Key takeaway

Moving forward, it is recommended that parties consult their advisors to determine whether specific rights in new contracts entered into post 30 June 2018 are caught by the new reforms. Rights which have been readily enforced in previous years may be caught by the general ipso facto clause stay which will have significant strategic implications.

Authored by:
Scott Couper, Partner
Jamie O’Regan, Solicitor