Insolvency law reform – stay on enforcement of ipso facto clauses

Key takeaways

On 12 September 2017, some of the most significant reforms of Australia’s corporate insolvency laws in recent years were passed by both Houses of the Australian Federal Parliament. These reforms will introduce:

• a safe harbour for company directors from personal liability for insolvent trading; and
• a stay on the enforcement of ipso facto clauses in certain circumstances.

The reform relating to ipso facto clauses set out in the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (Cth) (Bill) will become the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (new Act) when Royal Assent is received. 

The Act is intended to provide breathing space for companies undertaking a formal restructure, and is a positive step towards improving a company’s negotiating position with its creditors in relation to restructuring of the company. However, the reform does not cover companies that enter into a DOCA, or companies undertaking an informal restructuring (outside of Parts 5.1, 5.2 or 5.3A of the Corporations Act) in reliance on the new safe harbour laws.

Only time will tell whether the reforms will have their intended effect of protecting asset values for the benefit of companies, employees and creditors, and more widely to promote a culture of entrepreneurship.

Back to basics – ipso facto clauses

Ipso facto is a Latin phrase which translates to ‘by the fact itself’.

An ipso facto clause creates a contractual right that allows one party to terminate or modify the operation of a contract upon the occurrence of some specific event, even if the other party is in compliance with all of its obligations under the contract.

In the insolvency context, this means a party to a contract is able to terminate or modify a contract solely due to the other party’s financial position (including insolvency) or due to a formal insolvency appointment, such as the appointment of an administrator.  Currently, enforcement of ipso facto clauses is possible as against companies despite the company continuing to perform its obligations under the contract.  

The operation of ipso facto clauses has attracted criticism for reducing the scope for a successful restructure, preventing the sale of businesses as a going concern and reducing or eliminating returns in liquidation due to the destruction of value held in the company’s contractual arrangements.

This reform is aimed at enabling businesses to continue to trade and maintain their existing contractual arrangements in order to recover from an insolvency event.

What has changed?

The new Act will amend the Corporations Act 2001 (Cth) (Corporations Act) and the Payment Systems and Netting Act 1998 (Cth) to prevent the enforcement of certain rights against a company which is undertaking a formal restructure, when those rights are triggered by the company’s financial position or its entry into a formal restructure. 

A formal restructure for the purpose of the new Act means:

1. when a company is under administration under Part 5.3A of the Corporations Act;
2. a managing controller has been appointed over all or substantially all of a company’s property under Part 5.2 of the Corporations Act; or
3. where a company is undertaking a compromise or arrangement under Part 5.1 of the Corporations Act for the purpose of avoiding insolvent liquidation. The trigger for the stay relating to a compromise or arrangement under Part 5.1 of the Corporations Act includes circumstances where a company:

1. has publicly announced that it will be making an application under section 411 of the Corporations Act for the purpose of avoiding being wound up in insolvency;
2. is the subject of an application under section 411 of the Corporations Act; or
3. is the subject of a compromise or arrangement approved under Part 5.1 as a result of an application under section 411 of the Corporations Act.

Additional amendments proposed by the Senate on 11 September 2017 (to be included in the new Act) provide for:

1. strengthened anti-avoidance mechanisms to ensure that parties cannot contract out of the stay;
2. liquidators who are appointed subsequent to an administration or compromise/arrangement under Part 5.1 of the Corporations Act to be able to consent in writing to the enforcement of a stay; and
3. clarification that the stay will also apply to clauses which automatically terminate or amend existing rights of the restructuring company.

These amendments are primarily intended to allow a quick regulatory response to contractual arrangements which may develop in an attempt to circumvent the stay.

Notwithstanding the stay, parties will still maintain the right to terminate or modify contracts for reasons unrelated to the company’s financial position, such as a breach involving non-payment or non-performance.

What contractual rights will the amendments apply to, and when will the amendments commence?

The amendments will apply to contractual rights in contracts made after the commencement of the relevant sections of the new Act – that is, ipso facto clauses in contracts entered into prior to commencement will remain enforceable. 

There are a number of other specific circumstances set out in the Bill where the stay will not operate. One example is that the stay will not apply in relation to contracts made after the commencement of the formal restructure.

The amendments providing for the stay on enforcement of ipso facto clauses will commence on the later of 1 July 2018 or six months after Royal Assent, but may also commence at an earlier date as proclaimed by the Governor-General.

Period of the stay

Rights that are subject to the stay will not be enforceable against a company:

1. in the context of an external administration, from entry into administration until the administration ends, unless the company is wound up, in which case the stay will apply until the affairs of the company are fully wound up (subject to any Court order). 
2. in the context of the appointment of a managing controller, from appointment of the managing controller until their control of the company ends (subject to any Court order); and
3. in the context of a compromise or arrangement under Part 5.1 of the Corporations Act, from when a disclosing entity publicly announces it will be making an application under section 411 for the purpose of avoiding being wound up in insolvency or when a company makes an application, until either the:

1. application is withdrawn or the Court dismisses the application;
2. end of any compromise or arrangement approved as a result of the application under section 411; or
3. affairs of the body have been fully wound up following a resolution or order for the body to be wound up.

The consequence of point (a) above means that there is no automatic extension of a stay upon the execution of a Deed of Company Arrangement (DOCA), because an administration ends when a DOCA is executed pursuant to section 435C of the Corporations Act. To continue to receive the benefit of the stay, administrators will need to apply to the Court for an extension of the stay while the DOCA remains in place. 

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).