IPSO FACTO TO COME INTO EFFECT SOON!

On 28 March 2017, the Australian Federal Government released draft legislation in relation to two major reforms intended to encourage turnaround, restructuring and business rescue. The main focus in this article will be on the operation of ipso facto clauses.

These clauses allow one party to a contract to terminate the agreement upon the occurrence of a specific event, often linked to insolvency and more particularly a formal insolvency appointment. The type of termination can occur regardless of the counterparty’s continued performance of its obligations under the contract, which can have a devastating impact on the business .These types of clauses are regularly found in leases, supply agreements, licences etc.

It is clear that clauses such as this can make it near to impossible for the appointed insolvency practitioner to achieve a successful restructuring of the troubled business.

The draft legislation introduces two new provisions (sections 415D and 451E) that relate to ipso facto clauses triggered by schemes of arrangement and administration, respectively. The Ipso Facto provisions are set to commence on 1 July 2018 (or earlier by proclamation).

After a campaign that ARITA first launched around a dozen years ago, safe harbour and ‘ipso facto’ reforms passed the Senate on 11 September 2017.

The proposed reforms will see a moratorium on ‘ipso facto’ provisions triggered by the company’s financial position and extends to:

  • Schemes for the purposes of avoiding being wound up in insolvency
  • Managing controllers appointed to the whole or substantially the whole of the company’s property (‘managing controller’), and
  • Voluntary administrations.

These provisions would override “insolvency related terms”, that is, term where the customer’s administration or voluntary arrangement automatically terminates the supply or contract; a term where the customer’s insolvency triggers the right to terminate the supply.

Some of the key points to be aware of in relation to the draft legislation are:

  • The new law will only apply to contracts, agreements or arrangements entered into after the commencement of the new law.
  • The ‘ipso facto’ right will remain unenforceable against a company after the end of the stay:
    • For events that occurred before the end of the stay period, or
    • Due to the company having been subject to a scheme, voluntary administration or having had a managing controller appointed.
  • The right to terminate or amend an agreement remains if the breach occurs for any other reason, such as non-payment or non-performance.
  • The stay can be waived in writing by the appointed insolvency practitioner.
  • A lender to the company cannot be forced to advance new money or credit under an existing agreement during the period of the stay.
  • The court can order that the stay not apply in relation to a particular contract.
  • The court can grant extensions of the period of the stay.
  • The stay will not extend to contracts entered into after the company enters into the scheme, voluntary administration or has a managing controller appointed.
  • The stay will apply to schemes for disclosing entities from the time that the company announces that it will be making an application under s 411. The company will then have three months or longer, if provided by the court, to actually make the application.
  • If a replacement managing controller is appointed over the whole, or substantially the whole, of the company’s property there is continuity in the period of protection.
  • A stay on a right during a voluntary administration will extend into a subsequent winding up, but a liquidation commenced without a preceding voluntary administration will not have the benefit of ‘ipso facto’ protection.
  • A secured creditor with security over the whole or the substantially the whole of the company’s property maintains its right to appoint a controller under s 436C where a voluntary administrator has been appointed, via amendments to s 441A.

Implementing the ‘Ipso Facto’ provisions may benefit the business in distress. This will result in termination of the contract between the supplier and the provider of services. Any eventual sale of the business being for a lesser value may result in a lesser return to the creditors in the administration.