Contract rights excluded from the stay on the exercise of ‘ipso facto’ provisions

A Ministerial declaration has been made providing for a range of contract rights to be excluded from the stay on the exercise of “ipso facto” provisions.

These exclusions are in addition to the contracts and rights excluded from the stay on the exercise of ‘ipso facto’ provisions provided for under Commonwealth regulations made on 21 June 2018 (Regulations).

A number of these further exclusions are important to construction, supply, operations and maintenance contracts and the ability to structure and finance infrastructure projects.

Need to know:

• The ipso facto stay provisions will take effect on 1 July 2018. Unless one of the exclusions apply, these provisions will have wide ranging effect on all contracts, agreement, or arrangements entered into on or after 1 July 2018.
• The Corporations Amendment (Stay on Enforcing Certain Rights) Declaration 2018 (Declaration) specifies types of rights which will be excluded from the ipso facto stay provisions.

Background

From 1 July 2018, amendments to the Corporations Act 2001 (Cth) will come into effect which stay the enforcement of ipso facto clauses in a contract.

What are ipso facto clauses?

The term ‘ipso facto’ is generally used to describe a clause in a contract which allows one party to terminate a contract on the basis of a prescribed insolvency event occurring, such as the company entering into voluntary administration or receivership.

Numerous types of contracts contain clauses of this nature, but construction, supply, operation and maintenance contracts are among the most common examples.

The amendments impose a stay on the exercise of a right to terminate a contract merely as a consequence of:

• the appointment of a voluntary administrator;
• the appointment of a receiver or controller over the whole or substantially the whole of the property of the company; or
• the proposal of a scheme of arrangement.

Other termination rights which may exist are not disrupted and parties will continue to be able to terminate contracts on other grounds, such as default in payment or non-performance. The insolvent counterparty must be able to continue to perform the contract regardless of the insolvency event.

The period covered by the stay will vary depending on the type of insolvency process, but will generally commence on the date the company comes under external administration and end on the date when the administration or receivership ends, in accordance with a court order or when the company is wound up.

What are the exclusions most relevant to infrastructure projects?

As with the exclusions in the Regulations, most of the exclusions are targeted at finance arrangements. However, there are important exclusions which are relevant to infrastructure projects. These include:

• a right of set-off;
• a right to assign, novate or otherwise transfer rights or obligations; and
• ‘step-in’ rights.

Impact for project and construction contracts

The exclusion for set-off rights is important in preserving this key component of the security packages provided for in project and construction contracts.

The exclusions for a right to assign, novate or otherwise transfer rights or obligations are aimed at limiting disruption to the debt trading market according to the Declaration’s explanatory statement. However, the exclusions would appear equally applicable to project and construction contracts. If counterparties can negotiate appropriate rights for themselves, the exclusion could allow counterparties to novate contracts to new contractors if they are prevented from terminating because the original contractor becomes insolvent.

The ‘step-in’ rights exclusion is squarely targeted at construction and long-term services contracts and even contemplates stepping into the place of an insolvent head contractor to enforce rights under one or more of its subcontracts. However, ‘step-in’ rights are always complex remedies to exercise and come with increased risk to the party taking the ‘step-in’ action. Added to this will be the complications of stepping into a contractor who is undertaking a number of different projects for different counterparties. There will be practical difficulties identifying all those aspects of a contractor’s business necessary for the continuation of your project. There may also be competition with other counterparties for control of resources which the contractor may have allocated across several of its projects. Time will tell whether this exclusion is of real commercial value.

What should you do?

When entering into contracts and agreements after 1 July 2018, you should consider whether they are captured by the ipso facto stay provisions or whether particular contract rights fall within an exclusion. This applies to governments, principals and financiers with exposure to the credit risk of contractors and suppliers as much as it does to contractors exposed to the credit risk of subcontractors or principals.

If relying on an exclusion, careful consideration will be needed of the detailed wording of each exclusion to make sure you fall within its ambit. As with the Regulations, the language of the exclusions in the Declaration is open to interpretation and, as they are new, we do not yet have the benefit of any judicial guidance on their meaning - nor should any be expected for some time.