Ipso facto: I know the law has changed, but what does it mean for me?

ABOUT THIS SERIES

• This is the second edition of McCullough Robertson’s six part Commercial Law Masterclass series.

ABOUT THIS ARTICLE

• Protecting your interests in the event of a counterparty’s insolvency can be critical.  In this article we discuss what the recent ipso facto reforms mean for you and provide some practical techniques that can be employed to manage your risk.

MASTERCLASS

• We’ll wrap up the series with a Masterclass in Brisbane in early 2019 where you can ask our expert panel any questions.

COMING UP NEXT

• Our next article in this series will focus on duty and taxes and discuss some of the tips and traps to be mindful of during the initial stages of planning an acquisition.

Commercial Masterclass: Second Edition

On 1 July 2018, the ‘ipso facto’ reforms to the Corporations Act 2001 (Cth) (Corporations Act) took effect. These reforms amend the Corporations Act to prevent a party from exercising certain contractual rights, or ‘ipso facto rights’, that are triggered by certain types of corporate insolvency events.

These reforms are intended to protect companies experiencing financial difficulties that are undergoing a genuine restructure. Ipso facto clauses may operate to reduce the chance of a successful restructure, destroy the value of the business and prevent its sale as a going concern. By staying the operation of ipso facto clauses, a genuine restructure is more likely to succeed.

The ipso facto reforms also apply to any right that is enforceable for a reason that, in substance, is contrary to the legislation. This means that these reforms are wide reaching, noting however, that there are a series of contracts and rights that are excluded from the reforms (discussed further below).

In this edition of the Commercial Masterclass, we will consider what these reforms mean to you and will discuss some risk management techniques that can be employed to manage your contracts in light of the ipso facto reforms.

I think my counterparty has solvency issues – does the stay apply?

Threshold questions

If you think your counterparty has solvency issues, there are some threshold issues to consider before thinking about whether you are caught by the stay on exercising your termination rights. These issues are:

1.  Is your contract one of the list of more than 25 excluded types of contracts, agreements or arrangements? Some of the excluded arrangements are:

• contracts, agreements, or arrangements entered into before 1 July 2018;
• contracts entered into or renewed on or after 1 July 2018, but before 1 July 2023 as a result of the assignment or variation of a contract entered into before 1 July 2018;
• a contract for the sale of all or part of a business, including by way of a share sale;
• a contract under which the priority of security interests in particular property is changed or can change;
• flawed asset arrangements (such as where a bank holds funds on deposit as security for a bank guarantee); and
• licences, or permits issued by a federal, state, territory, or local government.

2.  Is the right you are looking to enforce one of the rights that are excluded? Some of the excluded rights are:

• a right to set-off or a right of combination of accounts;
• a right to change the priority in which payments are to be made under a contract;
• a right to assign or novate; and
• step in rights.

If the contract is not an excluded contract and the right you wish to enforce is not an excluded right, then you will need to consider whether the counterparty is otherwise failing to meet its obligations under the contract and what rights you have in those circumstances.

When the stay applies

If your counterparty is subject to one of the three kinds of trigger insolvency events below, the stay applies and the relevant rights will not be enforceable during the stay period.

There is no stay where the counterparty goes straight into liquidation (unless it follows voluntary administration).

What can I do during the stay period?

During the stay period, you will not be entitled to exercise any ‘ipso facto’ rights in your contract, which include termination rights arising due to the insolvency event. If you try to enforce an unenforceable right (e.g. you seek to rely on your termination for insolvency right), you may be liable for damages for wrongly repudiating the contract or for breach for failing to perform the contract.

It is important to note that the ipso facto changes do not necessarily mean that you can never rely on a termination for insolvency clause (for example, for termination which occurs prior to a formal insolvency process being entered into); it simply means that you need to carefully consider all circumstances prior to relying on such a clause. Also, the ipso facto changes do not mean:

•  that you cannot terminate a contract for other reasons (e.g. for failure to pay); or
•  that you have to give new advances of money or credit.

Some tips and strategies

As always, prevention is better than any cure. There are broad anti-avoidance provisions as part of these reforms, which mean that the stay is extended to any right that is ‘in substance’ contrary to the provisions. This means that, in addition to considering whether to amend your contracts, it is important for you to also consider what practical steps to take to manage your contracts.

A lot has been written about how you might want to amend your contracts following the ipso facto reforms, so we do not propose to focus on that here. Instead, set out below are some practical suggestions for you to consider as part of managing your contracts.

1. Consider the default clauses in your contracts

Review the wording of your existing default clauses. Do these clauses allow you to make it clear if you want to terminate for reasons other than insolvency (e.g. separate clauses, to ensure termination for non-payment and any other defaults are not caught by the stay)? Also consider if your standard definition of ‘Insolvency Event’ needs to be updated.

2. Actively monitor performance

It is now more important than ever to actively monitor the performance of your counterparty. This is because once they enter into one of the trigger insolvency events mentioned above, it is too late to exercise a contractual right such as termination by reason of the counterparty entering into the insolvency process or its financial position.

For example, if you are supplying goods or services on credit:

• Is your counterparty making payments in accordance with agreed arrangements?
• Are they requesting payment plans or extensions?
• Does their credit report show they are subject to court action or otherwise indicate poor performance? It may be worthwhile if you provide goods or services on credit to sign up to the free notification service provided by ASIC, which will notify you when winding up action is taken against a company and when various forms are lodged with ASIC on behalf of the company.
• Do you need to think about imposing stricter payment terms or requesting additional security for the company’s performance of its obligations under the contract (e.g. a guarantee from a parent company or a bank guarantee)?

3 Act promptly if you think there is an issue

If you think your counterparty has potential solvency issues, then you should consider your position as soon possible, and not wait until they announce that they are subject to an insolvency event. This is where the regular and ongoing counterparty checks described above will be useful.

4 Carefully document your counterparty’s performance

Any termination based on non-payment or other breaches should be carefully documented (e.g. recording late payments or failures by the counterparty to perform its contractual obligations in accordance with the agreed contract or arrangement), and any communications with the counterparty relating to termination should be drafted so as to ensure that it does not refer to the financial circumstances of the counterparty (if possible).

These are some simple steps that will assist your organisation to better address any risks posed by the new ipso facto provisions.

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.