Do your contracts include a right to terminate or act where the other party commits an insolvency event? New legislation commencing on 1 July 2018 may restrict your ability to rely on these clauses which are known as 'ipso facto' clauses. Partner Langton Clarke explains the new exemptions and what the changes mean.

What is an ipso facto clause?

Ipso facto clauses are found in a large range of commercial contracts and allow a party to terminate a contract or exercise some other right upon the occurrence of an 'insolvency event'. This includes many events short of actual liquidation, such as a company entering into voluntary administration or having a receiver appointed. In each case, it is simply the insolvency event that triggers the rights, not any other breach of the contract terms.

Background

In September 2017 the Commonwealth Government introduced legislation to protect company directors from insolvent trading claims if the company is undertaking a restructure or other course of action which is reasonably likely to lead to a better outcome for the company than the appointment of an external administrator (safe harbour provision). Also, the new law limits the enforceability of ipso facto clauses during an external administration. This assists and encourages directors to implement restructuring initiatives to resolve the company's future direction and recovery from financial distress.

The legislation stays the enforcement of a party's rights under an ipso facto clause where a company enters a scheme of arrangement, appoints a managing controller or has come under voluntary administration, unless a regulated exemption to the stay applies.

Exemptions

While the ipso facto provisions commence on 1 July 2018, the regulations which seek to limit the operation of the stay of ipso facto clauses in specific situations are yet to be finalised.

In April, the Federal Government released draft exposure regulations proposing exemptions to the statutory stay on ipso facto clauses, by:

• excluding some contracts from the operation of the new law
• identifying some contractual rights and clauses which parties will be able to enforce even though, on their face, they are ipso facto clauses.

Contracts proposed to be excluded from the stay include:

• licences issued by government
• some contracts relating to financial products
• margin lending facilities
• contracts where a special purpose vehicle is a party
• business sale agreements, including by the sale of financial products
• contracts where the priority of security interests in particular property is changed or can change.

Further, where a contract is not excluded from the stay regime, enforcement of the ipso facto clause in question may still be excluded if the clause gives rise to certain rights, including:

• the right to change the basis on which an amount is calculated under a financing agreement or arrangement (including applying a higher interest rate)
• the right to be indemnified for liabilities arising from the preservation or enforcement of rights
• a clause which alters the priority in which amounts are paid under a contract where an insolvency event arises
• the right to assign, transfer or novate rights or obligations on the happening of an insolvency event.

What do these changes mean?

Although the stay on exercising rights under ipso facto clauses will likely impact on a wide range of contracts across all industry sectors, the restriction on the party seeking to rely upon the clause may in practice not be that significant.

The stay will not prevent parties to a contract exercising other rights which are not connected with an insolvency based event. In particular, where a party is in breach of its obligations under a contract (other than an obligation not to commit an insolvency event) the stay alone will not prevent the non-defaulting party exercising any rights that may arise as a consequence of that breach, the right to terminate a contract being the most common.

The stay is only intended to restrict the exercise of rights which are triggered just because an insolvency event has occurred.

Also, the new law includes protection for parties who are impacted by the stay. If they are prevented from exercising rights arising as a consequence of an insolvency event, then the party subject to the insolvency event is also restricted from exercising any right it may have to require a new advance of money or credit from the party subject to the stay.

Our Litigation team can assist with any queries about how this new legislation may affect your business. We will provide further updates once the Regulations are finalised and officially released.