No right to terminate for insolvency – call for comments

WHO SHOULD READ THIS

• Industry participants in the construction sector.

THINGS YOU NEED TO KNOW

• The deadline for comments on the Improving Bankruptcy and Insolvency Laws Proposals Paper is 27 May 2016.

WHAT YOU NEED TO DO

• Be aware of how the proposed measures may affect your existing and future contracts and consider providing feedback to the Government if you have concerns.

The Federal Government has issued proposals to prohibit certain terminations for insolvency clauses in contracts among other proposed changes to insolvency laws. The deadline for feedback is 27 May 2016.

Background

From a projects perspective, the key measure proposed involves constraining the use of clauses which allow contracts to be terminated solely due to an insolvency event by making such clauses unenforceable if a company is undertaking a restructure. This measure is premised on concerns that such clauses deny companies the opportunity to trade through periods of financial difficulty. Such clauses often contribute to a company’s liquidation where its contracts with suppliers or customers are terminated upon it suffering an insolvency event.

Termination for insolvency clauses are common in construction and procurement contracts and appear in industry standard forms. Accordingly, the proposed measures are likely to have a significant impact on contracting. Contractors could be required to continue to work with an increased risk of not being paid and principals could be required to persist with a contractor where there is a greater risk to completion and recourse in the event of construction defects. This may lead to parties dealing only with more substantial counterparties or requiring greater performance security. Parties would need to reconsider what rights they have to suspend work or terminate for default under such a regime.

Key points

Under the proposal:

• any term of a contract or agreement which terminates or amends a contract or agreement (or any term of any contract or agreement) solely due to a relevant insolvency event would be void. Relevant insolvency events include appointment of an administrator or receiver, a company undertaking a scheme of arrangement or a company entering a deed of company arrangement
• a termination clause will be able to be used where the insolvency event is the company going into liquidation
• any provision in an agreement that has the effect of providing for, or permitting, anything that in substance is contrary to the position in paragraph (a) above would be of no force or effect
• affected counterparties could apply to the court to vary contract terms if they can show that they have suffered hardship as a result of being unable to terminate, and
• the Government is considering applying the above measures to contracts retrospectively.

This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.