Ipso facto clauses lose effectiveness post 1 July 2018

Standard form termination clauses such as “ipso facto clauses” (Ipso Facto Clauses) will need to be drafted with greater care in commercial contracts entered into after 1 July 2018.  The Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017 (Cth) (Amending Act) was passed amending the effectiveness of Ipso Facto Clauses that are “self-executing provisions” (Self-executing Provisions).

This legislation also enacted the “safe harbour provisions” (Safe Harbour Provisions), which generally attempts to provide directors with some protection against liability for insolvent trading in certain situations if they are attempting to restructure the business.

The (Amending Act) contained two (2) broad parts:

• Part 1 – Safe Harbour Provisions for Insolvent Trading (Safe Harbour Provisions); and
• Part 2 – Stay on enforcing rights merely because of arrangements or restructures (Unenforceable Provisions).

In this article we will discuss the new Unenforceable Provisions regime.  The Safe Harbour Provisions will be discussed separately.

So just what is an Ipso Facto Clause?

The Explanatory Memorandum of the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill refers to an Ipso Facto Clause as:

“a provision that allows one party to terminate or modify the operation of a contract upon the occurrence of some specific event, regardless of otherwise continued performance of the counter-party”.

The “occurrence” of the “specific event” that gives rise to termination is referred to as the ‘trigger’ (Trigger).  In commercial contracts, the occurrence of an event relating to financial difficulties (generally defined within the contract) may be drafted as a Trigger, allowing for automatic termination.  What constitutes an event relating to financial difficulty may be broadly defined within the contract, but could (for example) be the appointment of an “Administrator, Liquidator, or Receiver or Controller to a counter party to a contract.  Generally, an Ipso Facto Clause can be drafted in two (2) ways:

• to contain a Trigger that provides the option to terminate the contract at a party’s election of the occurrence of the Trigger event as a contractual right; or
• to contain a Trigger that has the effect of automatically terminating the contract (making the clause a Self-Executing Provision).

What is a Self-executing Provision?

Self-Executing Provisions can be contained in Ipso Facto Clauses to automatically terminate the contract upon a Trigger occurring that is stipulated in the contract.

Section 415FA of the Amending Act has been inserted into the Act to limit the effectiveness of Self Executing Provisions by allowing for a stay on enforcement of these clauses.  Section 415FA(3) defines a Self-executing Provision as:

“a provision of a contract, agreement or arrangement that can start to apply automatically:

(a)  for one or more reasons; and

(b)  without any party to the contract, agreement or arrangement making a decision that the provision should start to apply.“

The Act provides that all Self-Executing Provisions “cannot start to apply against a corporation for certain reasons”.^[1] These reasons are detailed in sections 415D, 434J, 451E of the Act and relate to a company’s financial position, administration of a company or appointing a managing controller.

The Unenforceable Provision amendments

On 1 July 2018, the provisions contained in Part 2 of the Amending Act came into force and amend Chapter 5, Parts 5.1 and 5.2 of the Corporations Act 2001 (Cth) (Act ).  These provisions have the effect of rendering Self-Executing Provisions unenforceable (subject to exclusions) in contracts, agreements or arrangements between bodies^[2] pursuant to sections 415D, 434J, 451E and 415FA of the Act .

Section 415D(1) of the Act  provides a wide range of circumstances in which a stay on enforcing rights under a contract will occur:

1. “A right cannot be enforced against a body for:
   1. the reason that the body, if it is a disclosing entity, has publicly announced that it will be making an application under section 411 for the purpose of avoiding being wound up in insolvency; or
   2. the reason that the body is the subject of an application under section 411; or
   3. the reason that the body is the subject of a compromise or arrangement approved under this Part as a result of an application under section 411; or
   4. the body’s financial position, if the body is the subject of such an announcement, application, compromise or arrangement; or
   5. a reason, prescribed by the regulations for the purposes of this paragraph, that relates to:
      1. the making, or possible making, of such an announcement, application, compromise or arrangement about the body; or
      2. the body’s financial position;

if such an announcement, application, compromise or arrangement is later made about the body;or 

a reason that, in substance, is contrary to this subsection;

if the right arises for that reason by express provision (however described) of a contract, agreement or arrangement.“

What this section provides is that a body’s weakened financial position, whether arising from an application for a “compromise or arrangement” pursuant to section 411 or from other the financial circumstances will not be grounds for immediately terminating a contract if that contract is entered into after 1 July 2018.

Section 434J(1) of the Act provides for a stay on enforcing rights merely because of the appointment of a managing controller of a corporation’s property.  Further, section 451E(1) provides a stay on enforcing rights merely because a company is under administration.

While section 415D(1) of the Act casts a wide net, it is useful for these two (2) provisions to specifically state that entering into administration or appointing a managing controller is not grounds for immediate termination and will be subject to a stay.

How long is the stay?

The enforcement of the terminating party’s contractual right arising from a Self-executing Provision or Ipso Facto Clause will be stayed for the period of time contained in sections 415D(2), 434J(2) and 451E(2) of the Act being generally three (3) months or less.

The period of the stay contained in the Act can be summarised as follows:

• Administration – the stay will start when the administration commences, and will continue until the administration ends. However, if the administration ends with the company going into liquidation, then it will continue until the affairs of the company are fully wound up;^[3]
• Where a managing controller^[4] is appointed over the whole, or the substantial whole of the company’s property, the stay will end when the managing controller’s control of the property ends;^[5]
• For a scheme of arrangement – where the company will make, has announced it will make, or has already made an application to enter into a scheme of company arrangement under section 411 of the Act, the stay will end after 3 months if a section 411 is not later made, when it is made but dismissed, when the scheme of arrangement ends – or if a resolution or order is made to wind up the company, then when the company is finally wound up.^[6]

However, on application to a Court, the stay may be extended beyond a three (3) month period under sections 415D(3), 434J(3) and 451E(3) of the Act.

Are there any exclusions from the Unenforceable Provisions regime?

The type of contacts, agreements or arrangements excluded from the regime are contained in the Corporations Regulations 2001 (Cth) r 5.3A.50[7] and the Corporations Amendment (Stay on Enforcing Certain Rights) Declaration 2018.  An outline of these exclusions as contained in these two (2) legislative instruments will be discussed in detail in a separate article.

Rights not subject to a stay include:

• a right under a contract, agreement or arrangement entered into after the administration;
• a right contained a kind of contract, agreement or arrangement prescribed by regulations or declared in a law of the Commonwealth;
• a stay that is in the “interests of justice” pursuant to section 415E(1)(b) of the Amending Act; or
• any rights arising out of reasons for the administration, the company’s financial position or reasons prescribed the regulations relating thereof.

Three things you need to know

• Contracts entered into before 1 July 2018 are not effected.
• After 1 July 2018, Ipso Facto Clauses in contracts (whether granting the right to terminate by option or if it’s a Self-executing Provision) cannot be enforced until the expiry of the period of the stay where the counterparty’s circumstances include events relating to financial diffulties.
• Consider how other carefully drafted clauses can for example that allow for termination on the basis of convenience or performance for example and also consider including clauses to ensure security for payment.

Links and further references

Legislation

Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017

Corporations Act 2001 (Cth)

Hansard

Explanatory Memorandum, Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (Cth)

Supplementary Explanatory Memorandum, Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (Cth)

Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (Cth)

Further information about commercial contracts

If you need advice on a commercial contract matter, contact us for a confidential and obligation-free discussion:

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

[1] Corporations Act 2001 (Cth), s 415FA(1)(a).

[2] A “body” is defined under section 9 of the Corporations Act  2001 (Cth) as a body corporate or unincorporated bodies including a society or association.

[3] Corporations Act 2001 (Cth), s 451E(2).

[4]Corporations Act 2001 (Cth), s 9 defines a “Managing Controller” as: a) a receiver and manager of the property of a corporation or b) any other controller of that property who has functions or powers in connection with managing the corporation.

[5] Corporations Act 2001 (Cth), s 434J(2).

[6] Ibid., s 415D(2).

[7] Please note that at the time this article was written, the Corporations Regulations 2001 (Cth) have not been updated to reflect the recent amendments.  For the purpose of reviewing the amendments, see the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018.

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