A recent Federal Government regime commencing on 1 July 2018 may affect the operation of insolvency clauses in contracts entered into on and from 1 July 2018. The types of clauses that may be impacted are clauses allowing a party to terminate or change the operation of a contract if another party to that contract becomes insolvent.
This Federal Government regime was introduced primarily under the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth), and is commonly described as the ipso facto regime (Regime).
What is an ipso facto clause?
An ipso facto clause is effectively a bankruptcy or insolvency clause whereby a party is permitted to exercise its rights to terminate a contract due to the bankruptcy or insolvency of the other party.
How are insolvency clauses affected?
The ipso facto regime changes the functionality of insolvency clauses in contracts by placing a stay on a party’s right to terminate or change the operation of the contract, unless excepted. That means that any action that can be taken by a party against another party (ie such as the right of one party to terminate the contract in the event of the insolvency of the other party) would be put on hold, unless an exception applies.
Notably, under the Regime, while a stay is in place on an ipso facto clause, the company the subject of an insolvency event may not exercise any right it may have under the contract to request an advance of money or to request credit from the other party.
What types of insolvency events are affected?
The following are examples of the types of insolvency events we have seen in contracts to which the Regime applies:
- Company Arrangement – an arrangement between a company and the creditors of that company (for the purpose of avoiding being wound up) that is put in place to determine how the company’s affairs will be dealt with;
- Receivership – in the event a controller or manager is appointed in respect of all or part of a company’s assets; and
- Administration – in the event a company is taken under the management of an appointed administrator.
How long does a stay on an ipso facto clause last?
The stay period commences when:
- Company Arrangement – an application for a company arrangement is made (or, for a company, being the disclosing entity, an announcement relating to a company arrangement is made);
- Receivership – a controller or manager is appointed in relation to a receivership; or
- Administration – when a company is placed into administration.
The end of the stay period varies and is not clear. Subject to extensions, the stay on an ipso facto clause may end:
- Company Arrangement – when the application for company arrangement is withdrawn (or when it is dismissed by a Court), when the company arrangement comes to an end (unless there is a resolution to wind up the company, in which case the stay period ends when the company is wound up) or, if a company (that is a disclosing entity) has announced that it will make application for company arrangement and does not make that application within three months of the announcement, then three months after the announcement is made;
- Receivership – the control or the appointment of a controller and manager of the company’s assets ends; or
- Administration – when the administration of the company ends.
The stay period may be extended by order of a Court and may therefore continue indefinitely where, for example:
- a stay has been lifted before the end of the stay period because the reason for enforcing the right relates to the company’s financial position; or
- before the company’s commencement of company arrangement, administration or receivership.
What are the Exceptions?
The ipso facto regime excludes a wide range of contracts. The following list of contracts, (amongst others) are excluded from the ipso facto stay provisions:
- Arrangements relating to the sale of a business
- Arrangements in relation to the management of financial investments
- Arrangements relating to escrow accounts containing code and/or passwords for the operation of software (for access by the licensee in the event the licensor is subject to an insolvency event)
- Agreements, approvals and permits issued by the Commonwealth, a State or Territory, or a local government
- Agreements for the supply of goods or services to a public hospital or health service
- Agreements directly connected with a securities financing transaction
- Agreements or arrangements entered into on or after 1 July 2018 but before 1 July 2023 that is a novation or assignment of some or all rights under an agreement, or a variation of an agreement.
Court may Order a Lift of the Stay
A Court may make an order that a stay does not apply to any specific part of an ipso facto clause or, alternatively, to the whole of ipso facto clause. The Court may also order the lifting of the stay for a company arrangement if the Court is satisfied that the application was not made for the purpose of avoiding the winding up of the company.
For each company arrangement, receivership and administration, the Court may order that the stay does not apply if the Court is satisfied that it is appropriate in the interests of justice. How the Court determines what is not in the interests of justice in respect of a company arrangement, receivership or administration is not entirely clear.
What Should You Do?
You should review your existing contracts and agreements to see whether they are captured by the ipso facto stay provisions or whether they are exempt. If you intend to rely on an exception, please be aware that the wording of the exception is open to interpretation and there has not been any real guidance or decisions from the court at this stage. Given the uncertainty in this area, we recommend you seek advice before taking any action.