Ipso what - an end to clauses that terminate a contract because of a company’s external administration?

July 2018 is the deadline for contract managers and insolvency practitioners alike to familiarise themselves with the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act¹ (TLA)’s amendments to the Corporations Act² that purport to stay the operation of ipso facto clauses in contracts when an external administrator is appointed to a company.

So-called “ipso facto” clauses are contractual clauses that empower a party who has contracted with a company to terminate or alter the contract’s terms if:

• the company appoints an external administrator, or
• is subject to some other event indicating possible or actual insolvency, including a scheme of arrangement with creditors.

Such clauses have historically been a common feature of commercial contracts that operated to limit one party’s exposure to the actual or possible insolvency of another.

However, the invocation of ipso facto clauses often served as a death-knell for companies that sought to restructure through an external administration - as trade partners, spooked by the possible insolvency of a company, would terminate or alter contracts that were crucial to the company’s survival.  In turn, these terminations could hamstring one of the fundamental purposes of external administration: ensuring a company experiencing financial difficulty can continue to trade.

When can’t an ipso facto clause be enforced under the new legislation?

The TLA provides that if:

• a receiver is appointed over a company;
• an administrator is appointed over a company; or
• a company enters into a scheme of arrangement;

then any “rights” cannot be enforced against the body if those rights arise because of the company’s appointment or scheme of arrangement, “by express provision (however described) of a contract, agreement or arrangement.”

No definition of “rights” is provided in the Act itself - but the explanatory material accompanying the TLA indicates Parliament’s intended operation of the relevant provisions is to specifically counteract ipso facto clauses and thereby increase the viability of schemes of arrangement and external administrations as a means of restructuring and returning companies to profitability.

Whether courts will adopt so narrow a construction, however, remains to be seen.

The stay operates indefinitely from the moment the application or appointment is announced – simply put, the stay prevents the exercise of a contractual “right” where the right is being exercised because a company is or was under external administration, receivership, or subject to a scheme of arrangement.

The stay also operates on contractual rights “to the extent that a reason for seeking to enforce the right is the body’s financial position” which may be reflected in a decision to appoint an external administrator or enter a scheme of arrangement.

How can the stay be overcome?

The amendments provide a court may order a stay on a contractual right be lifted if the party seeking to enforce the contract can prove that either:

• a scheme of arrangement was not “for the purpose of the body avoiding being wound up in insolvency”;
• an administrator consented to the stay being lifted; or
• in the case of a scheme of arrangement, receivership, or administration, “it is appropriate in the interests of justice” for the stay to be lifted.

Little guidance is given in the TLA or supporting material as to what “the interests of justice” may be.  This will likely be an area of uncertainty that the courts will need to consider in due course.

When do the TLA reforms take effect?

Contracts entered into after 1 July 2018 are subject to the new regime.  Contracts currently on foot, however, will not be subject to the stay on ipso facto clauses.  The TLA’s reforms also do not prevent parties from amending or varying terms of contracts entered into before 1 July 2018 to avoid the consequences of the stay.

Importantly, rights arising under contracts entered into after a scheme or arrangement, external administration or receivership has commenced are not subject to the stay (unless those rights are invoked by reason of the company’s financial position during the arrangement or external administration).

Lavan comment

The TLA may obstruct an historically important risk-mitigation mechanism in standard form contracts.  The actual or possible insolvency of a company, as demonstrated by an external administration, receivership, scheme of arrangement or otherwise, can no longer serve as a basis for terminating a contract.

Naturally, whether the TLA increases the appeal of external administration as a means of restructuring a company and returning it to profitability remains to be seen.  Insolvency practitioners should be wary of the potential ambiguities that could arise from the wide-ranging amendments of the TLA, including the grounds for lifting the stay.