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The Facts on Ipso Facto - when 'by that very fact or act' is not enough
13/9/2018

Australia's new ipso facto regime came into effect as of 1 July 2018. The regime enacted in September 2017 through the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 amends the Corporations Act 2001 (Cth) providing for the operation of the ipso facto stay for certain corporate restructuring and insolvency procedures.

The reform is designed to improve the likelihood of recovery for companies experiencing trading difficulties by limiting circumstances where a counterparty can modify or terminate an existing contract based solely on the 'fact or act' of an insolvency event or trading difficulties. The new regime applies to contracts entered after 1 July 2018. Parties need to ensure that contracts entered after this date protect parties' rights in situations of default and comply with the new regime. Anti-avoidance provisions capture contract terms that attempt to circumvent the Act and limited exemptions are apply.

How the Courts will interpret the new regime is yet to be seen. In the meantime, the potential implications for clients in the construction and property sector needs closer review.

The Facts on Ipso Facto - when 'by that very fact or act' is not enough.

 What are Ipso Facto clauses?

 Ipso Facto means 'by that very fact or act' - an ipso facto clause is a contractual provision allowing one party to terminate or modify the operation of a contract upon the occurrence of a specified insolvency event.

The New Regime

Australia's new ipso facto regime came into effect as of 1 July 2018. The regime stays the enforcement of contractual rights when a corporate Counterparty enters restructuring or insolvency procedures.

The Purpose of the New Regime

The reform is designed to improve the likelihood of an insolvent company trading and recovering from an insolvency event. A party modifying or terminating an agreement with a Counterparty may seriously affect the Counterparty's:

a)         cash flow and consequently inhibit their return to financial stability;

b)         ability to conduct business; and

c)         reduce or eliminate returns in liquidation.

 

How the Regime Operates

The regime operates by limiting a Counterparty's ability to terminate a contract based on the company entering an insolvency event or the financial position of the party. The following provisions stay a party's right to enforce an insolvency clause:

a) when a company enters administration (subsection 451E(1))

b) where a managing controller has been appointed over the company's property (subsection 434J(1)); or

c) where the company is undertaking a compromise or arrangement for the purpose of avoiding being wound up in insolvency (section 415D).

The period of stay exists until the administration, receivership or the scheme of arrangement ends, unless the company is wound up, or the company applies to the Court to extend the period of unenforceability. 

The Statutory Amendment and Benefit

The regime was enacted in September 2017 through the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017. Part 2 of the Act amends the Corporations Act 2001 (Cth) as of 1 July 2018 by inserting sections that provide for the operation of the ipso facto stay for certain corporate restructuring and insolvency procedures.

Anti-avoidance provisions are included in the Act which intend on capturing contract terms that attempt to circumvent the Act. They prohibit the enforcement of rights for reasons that are 'contrary in substance' to the new provisions. Terms that allow a party to terminate for reasons relating to a company's financial position would be also be captured. However, the explanatory memorandum expressly states that companies are free to terminate contracts for other reasons, such as non-performance of contractual obligations.

An instance where there may be ambiguity is whether a party can draw down on bank guarantees in the event of the Counterparty entering administration, this may be contrary to the provisions under 451E(1)(d). The regime benefits contractual Counterparties' by ensuring they are not penalised due to financial distress, providing they continue to meet their contractual obligations.

Exemptions

The Act provided for the following exemptions:

a) if the administrator consents to the enforcement of the term;

b) if the company enters into liquidation;

c) various types of contracts are exempt – See Corporations Amendment (Stay of Enforcing Certain Rights) Regulations 2018 (including licences issued by the government or contracts for the sale of a business, contracts for building work in which the total payments exceed $1 billion); and

d) the Court may order that rights are enforceable against a body with leave of the Court and in accordance with such terms as the Court imposes. For example, the order could be sought for a right to terminate for convenience (Section 451F).

How the Regime Might Affect You

These provisions are applicable to contracts entered from 1 July 2018. Contracts will need to be drafted to ensure that parties' rights are protected in situations of default. In particular, the contract should clearly identify the material terms and conduct that constitute a material breach of the contract that give rise to the right to terminate. Parties retain the option to apply to the Court for an order to enforce their rights in the contract.

How the Courts will interpret the new regime is yet to be seen.

For advice on the operation of the new ipso facto provisions and any contractual matters call the Integra Team.

DISCLAIMER: This article was prepared by Integra Legal and we have taken great care to ensure the accuracy of the contents. However, the article is written in general terms and you are strongly recommended to seek specific professional advice before taking any action based on the information it contains.