The ipso facto stay: what is in, what is out

By Jennifer Ball

Since 1 July 2018, for new contracts, there are wide-ranging restrictions on parties seeking to exercise contractual rights under ipso facto provisions. What provisions are covered? Can I rely on the ipso facto provision that is in my company's favour?

While much attention earlier this year was paid to the introduction of the safe harbour for directors, the second element in Australia's major reforms to insolvency laws ‒ the moratorium on the enforcement of ipso facto clauses (including self-executing clauses) ‒ is now in effect.

The ability to enforce ipso facto clauses (including termination provisions) against a debtor upon or during its insolvency can reduce the scope for a successful restructure or prevent a sale of business as a going concern. The aim of the reforms is to provide the debtor with some breathing space to continue to trade during a formal restructure, preserving value for the benefit of the debtor company, its employees and its creditors.

While initially the stay was welcomed by Australian insolvency industry professionals and practitioners, the lengthy list of contracts and contractual rights that have been excluded from the operation of the stay by reason of the recently released Regulations and Declaration cast doubt on how effective it will be. The Explanatory Statements which accompanied the Regulations and Declaration provide some insight into the Government's policy behind the exemptions. In particular, there is a recognition by the Government that it is necessary in some cases for enforcement of ipso facto clauses to continue, for example, where there is an established market mechanism already in place, or where it would be a commercial nonsense for an ipso facto right to be rendered unenforceable.

The reforms affect a broad range of contracts entered into on or after 1 July 2018. You should therefore now be considering how these reforms and the exclusions to the ipso facto stay may affect your operations and how you might manage risks under contracts entered into after that date.

How the ipso facto reforms will work

Putting aside those contracts and rights that are excluded from the stay, the particular contracts and/or rights that are stayed will largely depend on the terms of the contract in question.

The reforms broadly provide that a moratorium will be imposed on the enforcement of any rights (including self-executing clauses) in a contract, agreement or arrangement that are enlivened by one of the following "Trigger Events":

  • the company entering into voluntary administration;
  • the appointment of a managing controller (eg. a receiver and manager) to the whole or substantially the whole of the company's property; and
  • the company announcing (if it is a disclosing entity) that it will make an application under section 411 of the Corporations Act for the purpose of avoiding being wound up in insolvency or being subject to a compromise or arrangement pursuant to section 411 of the Corporations Act (scheme of arrangement).

The grandfathering of contracts entered into prior to 1 July 2018 may mean that some counterparties are entitled to enforce their rights under ipso facto clauses against the insolvent company, whilst other counterparties will not be in a position to exercise such rights contained in their post-1 July 2018 contracts. This may already have led to contracting parties amending their pre-1 July 2018 contracts, rather than entering into new ones post-1 July 2018, so as to preserve the grandfathered status of their contractual rights.

What types of contracts are excluded from the new ipso facto stay?

The Regulations list the prescribed kinds of contracts, agreements or arrangements exempted from the operation of the ipso facto stay provisions. We have set out the exemptions by reference to the industry to which they have the clearest connection. They may, however, have application to more than one industry.

Government

Types of contracts or rights exempted from the stay by operation of the Regulations:

  • Government licences, permits or approvals
  • National security, border protection or defence capabilities
  • Supply of goods and services to, or by or on behalf of a public hospital or public health service relating to public hospitals and health services
  • Supply of essential or critical information technology or communications technology, products or services to the Commonwealth, a State or Territory
  • Arrangements involving a special purpose vehicle (SPV) for the provision of a public-private partnership (PPP)
  • The provision of any kinds of works, goods or services such as building works under certain construction contracts entered into between 1 July 2018 and 1 July 2023, where total payments under all contracts for the project is at least $1 billion

Comments:

The exemptions do not address all Government contracts, so certain contracts will remain subject to the regime, including:

  • Leases (which remain subject to the voluntary administration moratorium regime)
  • Contracts for the delivery of infrastructure by methods other than PPP, unless the total project cost is at least $1 billion
  • Other Government projects with a cost of less than $1 billion
  • Supply of goods and services to, or by or on behalf of Government enterprises outside public health

Aircraft Financing

Types of contracts or rights exempted from the stay by operation of the Regulations:

Arrangements relating to certain laws and international obligations, within the meaning of the Cape Town Convention on International Interests in Mobile Equipment relating to certain security agreements, title reservation agreements and leasing agreements (involving movable property)

Loan markets, financial products and the securitisation industry

Types of contracts or rights exempted from the stay by operation of the Regulations:

  • The issue of covered bonds, securities, financial products, promissory notes, or syndicated loans and related underwriting arrangements
  • Management of financial investments
  • Derivatives or transactions which are directly connected with derivatives
  • Securities financing transactions or transactions which are directly connected with securities financing transactions
  • Transactions involving the provision of securitisation or certain project finance arrangements involving a SPV
  • Project financing
  • Margin lending
  • Arrangements relating to payment systems, financial markets, and clearing and settlement facilities including related netting and security arrangements
  • Certain approved Real Time Gross Settlement (RTGS) systems
  • Subordination and priority arrangements (including flip clauses)
  • Factoring arrangements
  • Flawed asset arrangements
  • The operating rules (other than listing rules) of a financial market and certain arrangements in relation to clearing and settlement facilities including where the party is the Reserve Bank of Australia

Comments:

These exemptions do not extend to all finance contracts. Examples that remain subject to the regime include:

  • Unsecured bilateral loans
  • Financing under arrangements that are not loans, for example, bill discount facilities

Construction industry

Types of contracts or rights exempted from the stay by operation of the Regulations:

  • Netting arrangements
  • The provision of any kinds of works, goods or services such as building works in certain construction contracts (as described) entered into between 1 July 2018 and 1 July 2023, where total payments under all contracts for the project are at least $1 billion

Comments:

The figure of $1 billion and the timeframe of 5 years appear to be arbitrary.

General

Types of contracts or rights exempted from the stay by operation of the Regulations:

  • Arrangements for the sale of a business or share sale
  • Arrangements which novate, assign or vary rights under a pre-1 July 2018 arrangement, provided the novation, assignment or variation occurs pre-1 July 2023
  • Contracts relating to escrow source code for computer software
  • Commercial charters of ships
  • Uplift clauses and indemnification clauses

Comments:

Sales of land (and leases of land, which remain subject to the voluntary administration moratorium) are not exempted.

…and what rights are excluded from the stay?

The types of contractual rights listed in the Declaration as being exempt from the operation of the ipso facto stay provisions primarily relate to finance contracts. Briefly, those types of rights are:

  • the right to charge a higher rate of interest in financing arrangements (defined to include any form of financial accommodation or a contract, agreement or arrangement such as a finance lease, an operating lease, a bill facility, performance bond, guarantee, bank guarantee, letter of credit or hire purchase agreement);
  • the right to be paid by way of indemnity (whether or not the indemnity is limited in any way) for charges and expenses incurred in preserving or enforcing rights;
  • termination rights under a standstill or forbearance arrangement;
  • the right to change the priority or order in which amounts are to be paid, distributed or received;
  • a right to take action to enforce rights of set off or combination of accounts, rights to net balances, or a right to appoint a controller in certain circumstances;
  • acceleration rights or a right to crystallise a security interest for the purpose of setting off, netting or combination of accounts or a right to appoint a controller in specified circumstances;
  • rights of assignment and novation;
  • self-executing provisions in relation to the treatment of circulating assets in insolvency so there is no conflict with the Personal Property Securities Act 2009;
  • step-in rights and the right to engage a third party to perform obligations or enforce rights (eg. in construction contracts and long-term services contracts) upon the occurrence of insolvency;
  • the right to enforce a possessory security interest held by authorised deposit-taking institutions and operators of clearing and settlement facilities such as cash, negotiable instruments, securities and derivatives;
  • the right of a secured creditor to appoint a controller under a security interest to an asset where another controller has been appointed by another creditor or a right to appoint a controller has been enforced; and
  • the right of an all asset secured creditor to appoint a controller over the property the subject of the security where a scheme of arrangement has been announced.

Anti-avoidance measures

The legislators have intentionally made it difficult for counterparties to circumvent the stay, by including strong anti-avoidance mechanisms, including a provision that a right cannot be enforced against a company following any Trigger Event for a reason that:

  • relates to the company's "financial position"; or
  • is in substance contrary to the Corporations Act.

The phrase "financial position" is not defined in the Corporations Act, and so it could be interpreted quite broadly and there is little guidance given in the Explanatory Memorandum.

A party will remain entitled to exercise a contractual right if it can prove that it was triggered by a reason other than the relevant Trigger Event or the financial position of the company, such as non-payment or non-performance of the contract by the debtor company. The Court has a wide-ranging discretion to extend the period of the stay, lift the stay or even extend the application of the stay to the enforcement of other rights that are not expressly caught by the wording of the legislation (eg. right to terminate the contract for convenience) if it appears that those other rights will be exercised merely because of an insolvency event. In exercising its discretion, the Court is required to have regard to the interests of justice.

How the Regulations and Declaration will affect attempts by counterparties to limit exposure

The ipso facto reforms will have a significant impact on the rights and leverage of counterparties to contracts with insolvent companies.

Some exclusions from the stay, such as payment and clearing systems, derivative contracts and netting arrangements, had been expected by the market, and are sensible because a stay would cause great uncertainty for, and undermine the operation of, the financial markets. Similarly, the construction and mining sectors will welcome the exclusion of step-in rights. These permit a party on the occurrence of an insolvency event in relation to its counterparty, to step in to the shoes of that party and enforce certain rights or perform obligations of that party so as to take works out of the insolvent party's hands. The reasoning behind the exclusion of these rights from the stay is that they were the parties' agreed solution designed to keep the contract on foot, despite the insolvency of one of them.

Despite these positives, it is of some concern that the lists of contracts (exempt under the Regulations) and rights (exempt under the Declaration) may lead to an asymmetrical enforcement of parties' rights, which could result in materially different outcomes for stakeholders. In addition, the grandfathering of contracts entered into prior to 1 July 2018 may result in situations where some counterparties are entitled to enforce their rights under ipso facto clauses in pre-1 July 2018 contracts against the insolvent company, while other counterparties will not be in a position to exercise such rights contained in their post-1 July 2018 contracts.

We encourage our readers to familiarise themselves with the new ipso facto regime, review all existing contracts and consider how the reforms might affect their businesses. In particular, you should ask whether any contracts to be entered into after 1 July 2018 might require re-drafting to mitigate the risks presented by the ipso facto reforms or to take advantage of the exclusions prescribed by the Regulations and the Declaration.

The exemptions specified in the Regulations and Declaration will be critical to limiting the scope and effect of the ipso facto stay regime on counterparties.

 

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