IPSO FACTO CLAUSES: WHAT YOU NEED TO KNOW

By Nicole Flory, Lawyer, MST Lawyers, Nasiya Goldberg, Lawyer, MST Lawyers and Alicia Hill, Partner, MST Lawyers

Introduction

On 1 July 2018, new Ipso Facto provisions introduced into the Corporations Act 2001(Cth)(The Act) by the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017 (Cth) commenced as part of the Federal Government’s insolvency innovation reform packages. The new provisions have altered the contractual rights of parties against insolvent counterparties by imposing a stay on the enforcement of Ipso Facto clauses, preventing the termination of a contract upon the occurrence of certain insolvency events. The new provisions apply to nearly all contracts, agreements and arrangements entered into on or after 1 July 2018. However, some contracts and contractual rights are excluded from the operation of the provisions pursuant to statutory instruments.

Given the infancy of the new regime, many companies are yet to fully grasp the changes or the implications for their businesses and what may be required to protect their commercial interests appropriately. The nature of the changes may alter the way you do business with your customers or contract with your clients, so it is important that you understand both the changes and the measures required to mitigate the potential risks to you and your business.

The New Ipso Facto Regime

What Is An Ipso Facto Clause?

An Ipso Facto clause is a contractual provision enabling a party to terminate or modify a contract upon the occurrence of a certain insolvency event, such as the appointment of an administrator. These clauses appear in most commercial contracts across nearly all industries. Often the contract itself will broadly define what constitutes an insolvency event, and in most instances, it is the appointment of an administrator, a liquidator, or a receiver or controller.

For example, a clause in a Franchise Agreement which entitles one party to terminate the agreement upon the appointment of an administrator to the other party is an Ipso Facto clause. Similarly, an event of default under a loan agreement caused by the appointment of a receiver to all of a borrower’s loaned assets is also classed as an Ipso Facto clause.

Reason For The Ipso Facto Changes?

The purpose of the changes to the Ipso Facto clause is to limit an insolvent counterparty’s ability to terminate contracts or to exercise its contractual rights solely on the basis of an insolvency event. In turn, insolvent companies should be able to continue to trade as they attempt to recover from or work through, the particular insolvency event.

What are the Key Changes?

Under the new provisions, the stay on the enforcement of rights, regardless of whether such rights arise automatically (self-executing clauses) or at the discretion of a party to the contract, will arise on the occurrence of the following insolvency events:

• An administrator is appointed;
• The appointment of a managing controller over the whole or most of a company’s assets; or
• Steps are taken to propose a scheme of arrangement to avoid winding up (for listed companies this will also include announcing such a scheme).

The reforms only affect rights arising under contracts entered into on or after 1 July 2018. This means the changes do not apply to or affect rights arising under contracts entered into before this date or to amendments to contracts, where the original contract was entered into before 1 July 2018.

Despite this, a party can still exercise its contractual rights (including termination) ensuing another default (i.e. termination of a contract resulting from the non-payment or non-performance by a contractor even where the underlying reason is insolvency).

A party will also be entitled to enforce its Ipso Facto rights if written consent is obtained by either:

• an administrator;
• a controller;
• a scheme administrator; or by
• an order of the Court;

permitting the enforcement of such right.

The amendments will not apply if a company enters liquidation given the purpose of the moratorium. However, the amendments will apply if a company enters into voluntary administration and then proceeds to liquidation.

For companies that are parties to international contracts and agreements, it is also worth noting the changes are not only restricted to contracts governed by Australian law.  Foreign contracts will be subject to the changes but may be limited by principles of international and private law.  

The Stay On Ipso Facto Clauses

Under the new regime, a right in a contract, agreement or arrangement will be stayed, and self-executing provisions will not apply, only by reason of:

• the company entering into an insolvency event;
• the company’s financial position;
• any other prescribed reason; or
• a reason that is in substance contrary to the above.

Where a counterparty is restricted from enforcing contractual rights against a company because of the stay, the ability of the company to enforce its rights under a contract for a new advance of money or credit is also stayed. The “new advance of money or credit” is not defined in the amended legislation and therefore the scope of the associated stay in this instance is not entirely clear. For example, would an obligation to supply goods or services on credit be considered a ‘new advance of money or credit’?             

How Long Does A Stay Last?

Broadly speaking, a stay will last for the duration of the relevant insolvency event that triggered the stay and may remain in place indefinitely after that period ends.

Specifically:

• In the case of administrations, the stay will start upon the commencement of the administration and will continue until the administration is at an end. If the administration ends with the company going into liquidation, then the stay will continue until after the affairs of the company are fully wound up by the Court.
• Where a manager or controller is appointed over the whole, or a substantial amount of the company’s property and assets, the stay commences upon the appointment and will end when the managing controller’s control of the company’s assets ends.
• Where the company announces (or intends to announce) that it will enter into a scheme of company arrangement, the stay will end:
  • after three months if another arrangement is not made;
  • when the scheme is dismissed;
  • when the scheme of arrangement ends;
  • a resolution or order is made to wind up the company; or
  • when the company is finally wound up.

Applications “In The Interests Of Justice”

Parties to a contract affected by an insolvency event may apply for Court orders “in the interests of justice”, seeking:

1. an extension of any period of the stay on an Ipso Facto clause, for example beyond the time a company exits administration; or
2. the setting aside of a stay on an Ipso Facto clause, enabling a contracting party to enforce an existing Ipso Facto clause in a contract.

However, it is important to note that in these early days of the new regime, an application for orders “in the interests of justice” would be fraught with uncertainty. At this time the regime does not specify the elements to making a successful application, and at this stage, there is no relevant case law to assist with interpretation. 

An application “in the interests of justice” would likely involve balancing the competing interests of:

1. the company which has entered an insolvency event in having the opportunity to continue to operate while the company is restructured to the benefit of the company’s employees and creditors; as against
2. the counterparty’s entitlement to exercise termination rights under an Ipso Facto clause in an existing contract. The effects for such parties across a range of contracts and agreements are discussed in further detail below.

Types of Clauses Affected By The New Regime

The changes apply to all contracts, agreements and arrangements entered into on and after 1 July 2018, unless they fall within an excluded category.

Contracts Categories Excluded Under The New Regime

There are over 30 categories of contracts and contractual rights that are excluded under the new changes, some of which include:

• a licence, permit or approval issued by a government authority (e. gaming licences, liquor licences, development permits);
• agreements relating to national security, border protection and defence;
• the supply of goods and services to public hospitals and health services;
• the supply of essential IT and communication technology products or services;
• agreements involving bonds, promissory notes, syndicated loans;
• arrangements for the management of financial investments;
• agreements which are outsourcing arrangements under the Prudential Standards;
• agreements involving a special purpose vehicle and that provide for securitisation, a public-private partnership or a project finance arrangement; 
• rights of set off;

• rights of termination under a standstill or forbearance arrangement;
• sale of business agreements;
• rights to appoint a controller of property in specified circumstances; and
• contracts entered into on or after 1 July 2018, but before 1 July 2023, that relate to certain building projects with a value of at least $1 billion.

Our Recommendations

If you have not yet considered how these changes have or will affect you or your franchise then you should do so.  We recommend you contact MST Lawyers regarding:

• Review your contractual documentation.
• Consider whether the Ipso Facto regime could interfere with your contractual rights where a counterparty enters into a formal restructuring or insolvency event.
• Consider amending your existing agreements and contractual documentation, processes and policies to mitigate the risks and take advantage of any available exclusions.
• Consider assigning or novating contracts rather than entering new agreements if you wish to preserve the Ipso Facto clauses.
• Update existing contracts and manage any renewal of terms.
• Terminating an existing contract(s), if required.
• Start monitoring your counterparty closer to determine whether you may have other contractual rights of termination, and keep records of dates and times to ensure you can verify abandonment of premises or business, previous failures to pay invoices, failure to complete works on time, failure to rectify defects and, failure to obtain permits.

Effects of the new changes on the Relevant Industries

The new Ipso Facto regime will bring a host of new challenges and uncertainties in contracting, many of which may not be realised for some time.  The new regime will have broad-ranging effects on many types of contracts and agreements across most industries including:

• Franchise agreements;
• Commercial and retail leasing contracts;
• Financial contracts and loan agreements;
• Supply contracts; and
• Construction contracts.

Franchising

For franchises, the changes will impact upon various aspects of the franchise relationship and in particular upon the various rights contained in the Competition and Consumer (Industry Codes— Franchising) Regulation 2014 – The Franchising Code of Conduct (the Code).

Therefore, any contracts/franchise agreements entered into after 1 July 2018, where an Ipso Facto clause is triggered on account of an insolvency event or express contractual provision will be subject to a stay on the enforcement of those rights.

Clause 29 of the Code allows a franchisor to terminate a franchise agreement immediately upon the occurrence of an insolvency event. As this is not a statutory right, in order to rely on this procedure to terminate an agreement, there needs to be a contractual right to terminate included in the relevant franchise agreement.

As most franchise agreements provide the franchisor with an express contractual right to terminate the agreement because of a franchisee’s insolvency, the new regime effectively removes the ability of franchisors to do so. Franchisors can no longer rely on the right to terminate and will instead be forced to liaise with and co-operate with insolvency practitioners for the duration of the stay. 

The new regime will also affect franchisors’ rights to vary supply terms under supply agreements.  Franchisors will be required to supply franchisees with goods and services for the duration of the stay or until otherwise ordered; even in instances where the franchisee cannot pay for the supply of those goods. In these instances, an application to the Court to lift the stay in the interests of justice may be an available option.

A further matter that will be affected under the new regime is the step in rights of franchisors, which effectively allow a franchisor to step into the shoes of an insolvent franchisee to secure premises and rights to manage and operate the franchise, will also be affected. Franchisors will now need to consider arranging and entering into additional agreements at the time of signing franchise agreements which provide these contractual rights. In the event of a franchisee’s insolvency, these agreements will require approval or agreement from an appointed administrator or manager prior to acting on them. However, at the very least, these agreements will provide a basis for negotiating with the administrator if this option has already been contemplated for.

Other types of agreements that may be affected:

• Franchise Agreement/third party agreement;
• Supply contract or agreement;
• Security agreement/contract;
• Financial guarantee;
• Loan/mortgage for financial services;
• Hire/purchase agreement.

Property

Property law will be affected by the new provisions specifically in relation to the contractual rights of landlords under commercial/retail leases.

Commercial/retail leases will often include an Ipso Facto clause which states that a landlord is entitled to terminate the lease (by re-entry or notice of termination) if a corporate tenant enters into an insolvency event.  Landlords should take note that their rights under such a clause will be stayed under the new regime.

For landlords, this means:

• Landlords will no longer be able to terminate the lease solely on the basis of the appointment of administrators/receivers to the tenant. This may mean that landlords will not be able to re-enter (and therefore re-let) the premises, even though the current tenant is insolvent and is not in a financial position to comply with its obligations under the lease to pay its rent, outgoings and ongoing maintenance costs.
• Landlords will need to rely on other contractual rights to terminate the lease, such as the right to terminate for a tenant’s non-payment or non-performance under the lease. This requires landlords to exercise prudence in actively tracking the tenants’ compliance under commercial/retail leases.  Landlords are encouraged to seek advice from MST Lawyers upon a tenant’s non-payment or non-performance under the lease, as this will preserve your contractual rights to terminate for a tenant’s non-payment or non-performance under the lease.
• It may be commercially preferable for a landlord to terminate a commercial/retail lease with a corporate tenant for cause well before an insolvency event occurs, for example when the tenant has breached the lease by way of:

1. Persistent non-payment of rent despite receipt of a notice of default; and/or
2. Abandonment of the leased premises.

• It is important to note that the new regime does not affect a landlord’s entitlement to exercise its right to terminate a commercial/retail lease on the basis that a corporate client enters liquidation (unless the company first enters into voluntary administration and then proceeds to liquidation).

It is also important to note that amendments, renewals, novations and assignments of commercial/retail leases entered into prior to 1 July 2018 will not be affected by the new Ipso Facto regime.  Landlords should seek advice from MST Lawyers as to whether they stand to benefit from amending, renewing, novating or assigning an existing commercial/retail lease

• Cleaning companies;
• IT services and professionals; and
• Building and construction contractor and subcontractor agreements.

The new provisions may also force scenarios whereby:

• subcontractors are forced to keep working for contractors who can’t pay;
• businesses are unable to terminate independent contractors who are financially unable to complete the job; and
• contractors will be forced to keep working for developers who can’t pay.

Corporate/Commercial Law

Corporate contracts and rights will be affected by the new stay provisions, though some will have the benefit of the statutory exclusions.  The types of contracts affected by the new provisions include:

• IP agreements
• Product licence agreement
• Distribution agreements
• Shareholder agreements
• Share agreements
• Asset agreements
• Partnership agreements

As such, your business may need to carefully consider how to approach the stay if an issue arises in regards to these types of contracts and rights.

For more information, please do not hesitate to email Alicia Hill or call +61 3 8540 0200.