So you think that you have the right to terminate a contract if the other side is insolvent? Maybe not as of 1 July 2018.
New laws have recently come into effect preventing parties from enforcing contract termination rights triggered by certain insolvency events for a period of time.
The new restrictions aim to assist businesses in financial distress to maximise their survival chances.
This article outlines what you need to know about the changes.
Ipso facto clauses are commonplace in Australian contracts. An ipso facto clause is a contractual provision that allows a party to terminate or modify the operation of a contract upon the occurrence of an insolvency event. For example, a contract clause that entitles a party to terminate the contract if a voluntary administrator is appointed to the other party is an ipso facto clause.
Previously there was no general restriction on the enforcement of ipso facto clauses against companies undertaking a restructuring or rehabilitation in Australia. This meant, for example, that trade creditors may refuse to continue to provide goods and services following the occurrence of an insolvency event in reliance on an ipso facto provision, even if the company is otherwise continuing to perform under the contract.
The ability for another party to a contract (called a “counterparty”) to terminate key contracts following the occurrence of an insolvency event is generally recognised as one of the most significant impediments to successfully implementing a formal corporate rescue or sale (as a going concern) in Australia, particularly for contract based businesses where value is primarily concentrated in the company’s contracts and not in its physical assets.
The new laws amend the Corporations Act 2001 (Cth) and apply to prevent or ‘stay’ certain termination and other ipso facto rights from being enforced against a counterparty which, as part of a genuine restructure, appoints an administrator or receiver to all, or substantially all, of its property or proposes a scheme of arrangement.
The rights that will be subject to the stay are those rights that arise by reason of the counterparty’s entry into the insolvency process or its financial position. The stay will also apply to self-executing type provisions (i.e. automatic termination type clauses).
The period of the stay depends on the type of insolvency process. For example, in the event of a voluntary administration, the stay will begin when the company enters administration and will end when the administration ends or, if the administration ends because the company is wound up, it will continue until the affairs of the company are fully wound up.
Even when the stay does come to an end, any right that is subject to the stay will remain unenforceable to the extent the reason for seeking to enforce that right relates to circumstances that arose prior to the commencement of the stay. For example, where a party has a contractual right of termination which relies on a counterparty’s financial position and which arose prior to that counterparty’s entry into administration, the party cannot exercise that termination right if the counterparty successfully trades out of the administration.
As you would expect, because of the wide-ranging impact of the new laws, the Government has excluded certain types of contracts and certain types of rights from the operation of the stay by regulation and declaration. These include (among others):
The new laws came into effect on 1 July 2018 and only apply to contracts made after that date.
Now is the time to start thinking about how these new laws might affect your business. Particularly, what you can do to seek to maintain flexibility and be protected in a range of scenarios and circumstances related to the financial distress of your company or that of your contract counterparties.
We have developed a number of strategies aimed at assisting companies to deal with the potential implications of the new laws. Please contact us for further information.
This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Should you wish to discuss any matter raised in this report, or what it means for you, your business or your clients' businesses, please feel free to contact us.