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Ipso Facto Clauses During Formal Insolvency

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By Georgie Cape, Law Clerk, MST Lawyers and Alicia Hill, Principal, MST Lawyers

Amendments to the Corporations Act 2001 (Cth) will have the effect of making ipso facto clauses in contracts unenforceable during formal insolvency processes. This article will explain what an ipso facto clause is, set out the position before this amendment, what will change and the effects of these changes.

What is an ipso facto clause?

An ipso facto clause is a clause in a contract that enables one party to modify or terminate a contract upon the occurrence of an insolvency event, such as the appointment of an administrator. Modification or termination can occur despite the company’s compliance with all other terms of the contract including payment and performance.

Previous Situation

Previously, the Act did not make any reference to ipso facto clauses. This meant that these common contractual clauses were enforceable by suppliers, customers, landlords and other stakeholders of a company upon the happening of an insolvency event permitting them to modify or terminate the contract.

Changes

The Treasury Laws Amendment (2017 Enterprise Incentives No.2) Bill 2017 (the Amendment) amends the Act to make ipso facto clauses unenforceable during formal insolvency processes (e.g. administration, liquidation etc).

The contractual rights of ipso facto clauses will be stayed (temporarily unenforceable) during a company restructure that is occurring under:

  1. administration;
  2. a negotiation or compromise intended to evade the company being wound up in insolvency; or
  3. an appointment of a managing controller over all, or substantially all, of the company’s property.

The period of the stay will begin at the time:

  1. the company enters into external administration;
  2. the company makes an application for compromise, or
  3. a managing controller is appointed.

The period of stay will end when:

  1. the administration ends (unless it ends because the company is being wound up in which case it will only end when it is fully wound up);
  2. the application of compromise is withdrawn or dismissed (or if the company becomes fully wound up); or
  3. the managing controller’s control ends.

All of these durations may be extended by a Court Order. Alternatively, the Court may also make an Order to lift the stay if it is in the interest of justice.

These modifications will come into effect the later of 1 July 2018 or six months after Royal Assent. The Governor-General may proclaim to effectuate these changes earlier.

It is important to note that ipso facto clauses will not alter a party’s right to terminate or modify the contract where there is a breach of the terms or obligations of the contract, including non-payment or non-performance.

Exceptions

The Amendment will not apply to contracts with ipso facto clauses entered into before the commencement date, or to contracts that were entered into before the commencement date but later altered.

Agreements made after the initiation of a restructure will not be able to stay the enforcement of ipso facto clauses.

The stay will also not apply to contracts specified in the Regulations or types of agreements specified by the Minister.

Effects of the Changes

The termination of contracts or agreements has adverse effects on a company, often leading to a decrease in the company’s worth. Consequently, a company in financial difficulty will be placed in an even more compromising situation. The prevention of the enforcement of ipso facto clauses gives companies the ability to continue operation while restructuring and provides an increased likelihood of success in improving its financial condition.

By allowing customers, suppliers and creditors the option to terminate their contract with the company may have the effect of deterring attempts to rescue the company.

If you would like to discuss any aspect of this article further, please do not hesitate to contact Alicia Hill by email or call +61 3 8540 0200.