The Australian Government is proposing to constrain certain "ipso facto" clauses ‒ a move which could make flip clauses void. The closing date for submissions is Friday 27 May 2016.
How would changes to ipso facto clauses affect securitisation?
An "ipso facto" clause is a contractual provision that allows a party to terminate/vary the contract in specific circumstances. The Government is taking aim at ipso facto clauses that allow a party to terminate or amend any contract by reason only of an "insolvency event". The measures aim to facilitate an orderly restructure of a failing company and the concern is that those types of ipso facto provisions pull the rug out from under the troubled company.
In a securitisation context, this has implications for the validity of flip clauses, where a defaulting swap provider is subordinated to other creditors in securitisation cashflows by virtue of that default, which typically includes an insolvency event. These clauses would be void under the new proposals.
Flip clauses are included in most rated securitisation transactions and in some unrated transactions. The enforceability of such flip clauses has previously been the subject of litigation in connection with the Lehman Brothers insolvency. They have been held to be valid under English law. In the US, in a similar case that was ultimately settled, the US bankruptcy court held that the flip clause was an ipso facto clause which are void under US law. If the proposal is enacted as is, then the Australian position would be similar to that in the United States.
However, securitisation swaps themselves should be unaffected (including any termination rights) as the proposals do not extend to close-out netting contracts protected under the Payments Systems and Netting Act.
Key questions for the securitisation industry
It is not clear how the proposals (to be enacted in the Corporations Act) interrelate with the restructure regime in the Banking Act that applies to domestic swap counterparties.
Another area of concern is how far the proposals extend. Would, for instance, a provision in a security agreement that grants the secured party control over the secured property on the occurrence of an insolvency event be void?
Making a submission
The Government has invited submissions on whether these provisions should:
- apply to all ipso facto clauses;
- have retrospective operation (this would have implications for existing securitisations); and
- apply to all contracts and, if not, the classes of contracts that should be excluded.
The closing date for submissions is Friday 27 May 2016.
Given the potential impact of the proposed changes, and the areas of uncertainty, we urge you to consider making a submission.
We will be contributing to the Australian Securitisation Forum's submission and would be happy to discuss in further detail the proposals and any submission you may wish to make.