On 1 July 2018, the “ipso facto reforms” under the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act (“the Act”) came into effect.
These reforms seek to provide companies in financial difficulty with “breathing space” by enabling them to see out a formal administration process, and to potentially restructure or be sold as a going concern, without the looming threat of counterparties terminating contracts or enforcing rights to the company’s detriment.
Importantly, the ipso facto reforms will apply to all contracts entered into after 1 July 2018.
What is an ipso facto clause?
Prior to the reforms, ipso facto clauses commonly entitled counterparties to terminate, suspend performance, or enforce other rights upon a certain event related to the company’s financial position or solvency.
For instance, clauses often allow counterparties to exercise rights where the company’s debt-to-equity ratio falls below a certain threshold; there is a material adverse change in the company’s financial performance; or a receiver or administrator is appointed.
These ipso facto rights may be exercised even though the company is otherwise performing its obligations under the contract.
It goes without saying that when a contract vital to the company’s survival (such contracts with key suppliers or financiers) is terminated or suspended in such circumstances, the struggling company has virtually no hope of restructuring or recovering.
How do the reforms affect your rights?
Under the new regime, a clause which allows a counterparty to exercise rights for one or more of the following reasons is automatically “stayed” and cannot be enforced:-
- Because the company enters voluntary administration, receivership or undertakes (or proposes to undertake) a scheme of arrangement with its creditors for the purposes of avoiding being wound up;
- Because of the company’s financial position related to any of the above “insolvency events”;
- A reason prescribed by the Regulations; and
- Any other reason that, in substance, is contrary to the regime.
Generally speaking, the length of the “stay” will be for the duration of the insolvency event (e.g. the period of the administration or receivership), although this can be extended by the Court.
Creditors be aware…
There are several important exceptions which creditors (and other counterparties) should be aware of when seeking to exercise their rights against an insolvent company:-
- A creditor can still exercise contractual rights based on reasons other than the occurrence of an insolvency event. For instance, a creditor may still terminate a contract if the insolvent company has not paid outstanding invoices;
- It is still possible for the creditor or contracting party to apply to the Court for leave to enforce a right the subject of a stay if the “interests of justice” require it; and
- The relevant administrator or receiver can consent to the ipso facto right being exercised.
What should you do?
It’s important for businesses, creditors, suppliers and advisers to be aware of the changes implemented by the ipso facto reforms. Importantly:-
- For legal advisers, the ipso facto reforms should be front of mind when drafting, and advising clients, on contracts after 1 July 2018. It is important that security, insolvency and breach terms in any standard form contracts are reviewed to ensure that they still adequately protect your client’s rights.
- For creditors, suppliers and other contracting parties, where there is a concern about a counterparty’s solvency you may need to act swiftly to enforce rights so as to avoid any potential stay, and protect your position. Critically, if the “interests of justice” require it, an application should be made to enforce any rights the subject of a stay.