Are you ready for changes to Ipso Facto clauses?
Insight by Kath Naish with Adam Preiner
From 1 July 2018, certain contractual rights will not be immediately enforceable ipso facto or 'by the very fact' of a corporate counterparty entering administration, receivership or a scheme of arrangement.
The Latin term ‘ipso facto’ means ‘by the very fact’ and is used to describe terms in agreements that allow parties to exercise certain rights based solely on the occurrence of a specific event. For example, the right to terminate a supply contract may arise ‘by the very fact’ that a voluntary administrator has been appointed to the customer, even if that customer is up to date with payments and is otherwise continuing to perform all of its obligations under the contract.
Ipso facto clauses triggered by insolvency events benefit parties wishing to extricate themselves from any ongoing contractual obligations to a company facing insolvency. But they can have a detrimental impact on the prospects for a viable company in financial difficulty. This is because, they operate as a practical deterrent to the use of formal insolvency processes designed to facilitate a ‘rescue‘ of the company’s business and enable it to continue to trade. Currently, by appointing a voluntary administrator, directors risk triggering ipso facto clauses which may place the company in a precarious position, exposing it to the unilateral termination of its supply contracts for instance. This will usually have a negative impact on the company’s ability to trade out of its financial difficulties through a scheme of arrangement, voluntary administration or subsequent deed of company arrangement.
For example, company directors operating a financially stressed café may delay or avoid appointing a voluntary administrator, due to a lease term granting the landlord the right to terminate upon the commencement of administration, ipso facto, thereby depriving the company of ongoing trade and location goodwill and perhaps destroying any value as a going concern. If the directors of the company perceive a lack of formal insolvency appointment options (due to the risk of contracts being terminated and rights lost), this may prevent or delay them taking otherwise appropriate action leading to a potential for personal exposure to the debts of the company and winding up.
Ipso facto clauses can also prevent insolvency practitioners from achieving the best results for creditors, by depriving the company of rights contractually forfeited ipso facto their appointment.
Law Reforms
From 1 July 2018 the new ipso facto stay provisions in the Corporations Act 2001 (Cth) will apply to contracts entered into by ‘bodies’ (companies) after that date. The changes will not apply retrospectively to contracts made before that date and remaining on foot after 1 July 2018. The amendments provide for a moratorium on or ’stay’ of ipso facto provisions that are triggered by the following insolvency events:
entering into a scheme of arrangement;
the appointment of a managing controller over the whole or substantially the whole of a company’s property (receivership); or
entering voluntary administration.
The stay is only effective against enforcement of rights based solely on one of the above events, the company’s financial position relating to that event or any other reason prescribed by regulations and relating to those events. The new laws do not prevent enforcement for failure by the company to comply with its obligations under the contract (for example failure to pay for goods on time) which may still give rise to a right to enforce or terminate the contract.
The stay period differs for each insolvency event. In receiverships and voluntary administrations, the period begins when the receiver or administrator is appointed. In schemes of arrangement, it begins when a public announcement or scheme application is made. The moratorium period ends when the company is wound up, when the voluntary administration ends or for a scheme of arrangement, three months after the announcement or when the application is unsuccessful or dismissed.
The reforms are designed to allow the controllers of viable but financially distressed businesses a reasonable opportunity to establish whether or not the business can be saved, restructured or sold as a going concern without losing rights ipso facto one of the specified insolvency events. This may assist in preserving value in the company’s business and increasing the likelihood of a return to creditors.
Exclusions
Certain contracts and certain types of rights set out in the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (Cth) are excluded from the ipso facto stay. These include:
Business and share sale agreements
Underwriting and issuance
Rights of assignment and novation
Margin lending agreements
Factoring arrangements
Derivatives
Government licences and permits
Conclusion
These changes are intended to supplement the financial first aid kit of insolvency practitioners looking to maximise returns for creditors and assist companies to conduct successful business rescues. It is hoped that directors of companies facing financial stress will engage earlier with qualified insolvency practitioners to enable the company to trade-on without the fear of contracts being terminated or rights otherwise lost purely on the basis of the appointment of a voluntary administrator or receiver. In turn, this may optimise the chances of a successful turnaround of the business.
If you deal with businesses which may be facing financial stress, the ipso facto stay could have a significant impact on your contracts entered into after 1 July 2018, including existing standard terms of trade used to engage customers or clients after 1 July 2018. Potential creditors should examine their standard terms of trade or other agreements to ensure that suitable amendments are made to mitigate any costs or losses that may result from the stay.
If you would like more details or to discuss the potential impact on your business, including whether any amendments to your commercial contracts may be needed, please contact us.
This article was co-written by Kath Naish of Beswick Lynch Lawyers and Adam Preiner of O’Brien Palmer.
Contacts: Kath Naish and Tim Lynch