Ipso Facto Termination Provisions Update

Eakin McCaffrey Cox lawyers Gregory Ross, Accredited Specialist in Government and Administrative Law, and Debbie Tran, discuss the impact of new Ipso Facto provisions in the Corporations Act 2001 (Cth), which start on July 1, 2018.

Australian insolvency law reforms were passed in 2017 and the effect of which (and commencement of specific regulations) was implemented over two stages last year (1 March and 1 September 2017).

As part of the reform, safe harbour provisions came into force in September 2017 providing a mechanism for directors to continue to operate an insolvent (or suspected insolvent) company, as long as these directors are taking a course of action reasonably likely to lead to a ‘better outcome’. (We refrain, in this short article, from commenting on the scope/definition/interpretation of the ‘better outcome’ test).

The new ipso facto provisions in the Corporations Act 2001 (Cth) (the “Act”), (as amended by the Treasury Laws Amendment (2017 Enterprise Incentives No.2) Act 2017 (Cth)) which will be effective on and from 1 July 2018, will apply to all contracts, agreements, arrangements etc. entered into on or after that date.

These reforms may be relevant to contracts entered into, whether as supplier or buyer or service deliverer or user and touch upon “ipso facto” termination provisions.

Many of standard form contracts / contract precedents involving individuals and companies may require amendment to reflect the new regulations, once these regulations have been made (as they are currently in draft), and it is suggested that consideration be given to amending existing contracts to bring them into consistency with the reforms.

Briefly (and again without commenting on how effective the new provisions will be in practice), the effect of the ipso facto [formerly ‘drop dead’] provisions will limit the options of a party to enforce a right, and terminate or amend a contract, when a company has entered into a formal insolvency, regardless of the other party’s continued performance of its obligations under the contract (the reforms are to be contained in sections 415D, 434J and 451E of the Act).

However, there are some prescribed kinds of contracts, agreements and arrangements which have been excluded from the stay, as they are recognised as contracts where a stay in the operation of ipso facto clauses would be unnecessary or commercially undesirable.

For example, suggested contracts, agreements or arrangements which are currently not subject to the stay in the new sections 415D, 434J and 451E of the Act, include:

• arrangements required or contemplated by Australia’s laws or where international obligations would be disturbed;
• markets have evolved to depend on established systems and expectations and the ipso facto stay would significantly disrupt those markets;
• sophisticated counterparties traditionally negotiate their own arrangements in relation to complex transactions or complex financial products and the ipso facto stay would undermine those arrangements;
• the ipso facto stay would lead to unintended consequences or would severely disadvantage some contracting parties;
• parties have already entered into arrangements to attempt to alleviate a business’ financial stress and staying ipso factor clauses would undermine or significantly change the terms of those arrangements; or
• the operation of an ipso factor clause is inherent to the operation of a contract and staying it would lead to a perverse outcome.

The carve-outs/exemptions to the application of the stay have not yet been confirmed by the Government and the forum for comments in relation to the draft regulations just closed on 11 May 2018. Accordingly, there may be further changes to the draft currently available https://treasury.gov.au/consultation/c2018-t280567/.

For that reason, it is  suggested  that  readers using standard form contracts consider that, for the time being, current clauses allowing for termination rights on insolvency be left as they are and an additional clause be inserted to make the clause subject to the legislation.

The text of the paper is only a summary and discussion of particular facts and principles. It is not to be taken as legal or commercial advice as to any particular factual circumstances. Gregory and Debbie can be contacted at the email addresses below: