Insolvency reform: stay of “Ipso Facto” provisions will provide breathing space for companies facing insolvency

The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (the Act) received royal assent on 18 September 2017. 

It introduces new safe harbour provisions and restrictions on the operation of so called "ipso facto" suspension and termination provisions in contracts, which is the focus of this article. While the safe harbour provisions under the Act commenced upon assent, the ipso facto amendments will commence from 1 July 2018 (or earlier by proclamation).

OVERVIEW

New restrictions on the operation of so called ipso facto provisions will prevent a party from enforcing a contractual right to suspend or terminate that has arisen by virtue of its counterparty experiencing an insolvency event.

Often, an ipso facto clause will entitle a party to suspend or terminate the contract despite the counterparty continuing to perform their contractual obligations. This right to terminate can have a significant impact on the underlying viability of the counterparty’s business and the counterparty’s cash flow, limiting their opportunity to improve their financial position and/or undertake a restructure.

The new regime seeks to assist struggling companies to maintain their value when engaging in a formal administration process or, alternatively, so that they may be sold as a going concern.

THE REFORMS

Ipso facto provisions

The new regime will apply to contracts entered into after 1 July 2018, and will operate so as to effectively "stay" a contractual right to suspend or terminate that arises as a result of:

1. (a) a company entering administration, receivership or where a scheme of arrangement is proposed;

2. (b) a company’s financial position if in administration, receivership or subject to a scheme of arrangement;

3. (c) a reason prescribed by regulation that relates to (a) or (b); or

4. (d) a reason contrary in substance to (a) or (b).

The stay (or suspension) of contractual rights also applies to so called "self-executing provisions". These are defined under the Act as contractual provisions that apply automatically, for example, a provision that would activate upon a company entering into administration, receivership or a scheme of arrangement.

How long is the stay effective?

The length of the operation of the “stay” will turn on whether the company is undergoing an administration, appointment of managing controller or receiver, or scheme of arrangement, and will be subject to any court orders that may be in force.

• For a voluntary administration – the stay will begin when the company enters administration and end when the administration ends or when the company is wound up.

• For a receivership – the stay will begin when the managing controller or receiver is appointed and end when the managing controller or receiver’s control ends.

• For a scheme of arrangement – the stay will begin when a public announcement or scheme application is made, and end three months after the announcement, when the application is unsuccessful or dismissed, or when the company is wound up.

Scope of the anti-avoidance provisions

The anti-avoidance provisions extend the scope of the regime to capture contractual clauses that attempt to circumvent the new legislation. This is achieved by suspending a contractual right to terminate that arises for a reason that is contrary to the regime “in substance”.

The new laws will not prevent parties from enforcing their independent contractual rights to terminate the contract for unrelated reasons (such as for non-performance or, if included, for convenience).

The Senate’s introduction of a power to expand (through regulation) the application of the stay on ipso facto clauses creates some uncertainty as to the extent of its scope in operation.

Although courts will have the power to override a stay, we may need to wait for the breadth of these new provisions to be considered by the courts, and judicial guidance to be provided, before the precise scope of the anti-avoidance provisions can be more fully understood.

Impact for construction contracts

There are a number of typical provisions in construction contracts that may be caught by the anti-avoidance provisions.

For example, a right to take the work out of the hands of an insolvent counterparty, to call on a bank guarantee or to make a set-off claim if triggered by the occurrence of an insolvency event or the financial position of the building construction, may be contrary to the regime in substance, and therefore be subject to the stay.

What should you do?

Companies should review their contracts and consider whether amendments are required to ensure that any rights currently activated by an insolvency event or the financial position of the counterparty remain available in a default situation.