The Australian Federal Government's controversial ipso facto stay regime took effect on 1 July 2018.
The regime affects the ability of a contractual party to exercise rights, such as termination rights, that are triggered by the counterparty becoming insolvent. The ipso facto stay applies to all new contracts that are not carved out under the regime.
As a part of this regime, regulations and a declaration were recently enacted to provide exceptions to the ipso facto stay. These include significant changes from the previous Exposure Drafts, which serve to narrow the scope of some exceptions.
This article provides an overview of:
- what the ipso facto stay regime is;
- the exceptions contained in the new regulations and declaration, including those which differ from the Exposure Draft; and
- strategies for dealing with agreements under the new regime.
The ipso facto stay regime
The ipso facto stay regime was enacted in September 2017 by the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Amendment Act), which inserted the relevant provisions into the Corporations Act 2001. The regime is intended to encourage entrepreneurism and innovation by making the insolvency process more forgiving and facilitating the restructuring of insolvent companies.
Ipso facto clauses
An ipso facto clause is a contractual provision which either grants a party a right, or provides that something happens automatically, upon the occurrence of an insolvency event. For example, an ipso facto clause may provide that the licensor can elect to terminate the licence if the licensee appoints an administrator, or that the licence terminates immediately in this event.
For the stay to apply, the clause must be triggered by:
- the company announcing that it will enter a scheme of arrangement;
- the company entering into receivership;
- the company being placed under administration;
- the financial position of the company in the above circumstances; or
- a reason that it is "in substance contrary" to the regime.
The stay of enforcement
Under the Amendment Act, any clause which is triggered by one of these events is unenforceable for a period of time after being triggered. The stay lasts until:
- three months after the announcement;
- when the application is finalised;
- when the company is wound up; or
- when control of the receiver ends.
The right also remains unenforceable indefinitely if the reason for seeking to enforce the right is "the body's financial position before the end of the stay period". The Court is given powers to make various orders relating to the stay, including orders:
- that the three month duration be extended;
- that a clause is enforceable despite the stay applying; and
- that a clause is unenforceable despite the stay not strictly applying, if the Court is satisfied that the party seeking to exercise the clause is doing so by reason of one of the insolvency events specified in the legislation.
Exceptions to the regime
The exceptions to the regime are contained in the:
- Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (enacted on 21 June 2018) (Regulations), which provide for certain types of contracts to be excluded; and
- Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (enacted on 20 June 2018) (Declaration), which provides for certain types of clauses to be excluded.
The contracts excluded by the Regulations fall into several categories of exceptions related to certain contracts:
- for public services, such as the supply of products to the Commonwealth;
- for securities and financial products, such as a contract for the sale of all or part of a business;
- between sophisticated parties, such as contracts that involve a special purpose vehicle and either provide for securitisation, a public-private partnership, or a project finance arrangement;
- relating to debt and creditors, such as a contract under which the priority of security interests is changed;
- relating to financial markets;
- relating to real time gross settlement systems and netting arrangements; and
- entered into before 1 July 2023 as a result of the novation, assignment, or variation of a contract entered into before 1 July 2018.
The full exclusions are contained in section 5.3A.50 of the Regulations, which are available here.
Special purpose vehicle exception
The special purpose vehicle exception has been significantly narrowed in the Regulations from the prior Exposure Draft. Under the Exposure Draft, any contract to which a special purpose vehicle was a party was excluded from the stay regime. Under the Regulations however, the excluded contract must also provide for:
- securitisation or a public-private partnership; or
- a project finance arrangement under which a financial accommodation is to be rapid or otherwise discharged primarily from the project's cash flow and all or substantially all of the project's assets, rights and interests are to be held as security for the financial accommodation.
This seemingly thwarts an earlier assumption, based on the Exposure Draft, that the regime could be circumvented by channelling agreements through special purpose vehicles.
The Regulations also narrow another notable exception, in that under the Exposure Draft the regime did not apply to contracts that were entered into prior to 1 July 2018 and then novated or assigned after that date.
This exception still exists under the Regulations; however it is limited to contracts which are assigned or novated prior to 1 July 2023. After this time, the novation or assignment exception will effectively cease to apply.
The Declaration also excludes certain types of clauses from the ipso facto stay, regardless of the type of contract in which these clauses are contained. These excluded clauses include rights to:
- change the basis on which an amount is calculated under a financing arrangement;
- indemnities arising from the preservation or enforcement of rights;
- terminate under a standstill or forbearance arrangement;
- change the priority in which amounts are to be paid;
- set-off or net balances; and
- assign, novate or otherwise transfer rights or obligations.
The full exclusions are contained in section 5(4) of the Declaration, which is available here.
Strategies for businesses
Ipso facto clauses are routinely included in IP agreements such as licences or distribution agreements, and businesses will need to carefully consider how they wish to approach the potential stay period for these clauses in new contracts.
Impact on drafting agreements
Ipso facto clauses should still be included in contracts, on the basis that they will operate to the full extent permitted under the law. This is because a party seeking to rely on an ipso facto clause may seek a court order to lift the stay, and because the clause may be enforceable after the stay period has expired.
Companies should be aware, however, that generally they will not be able to rely on an ipso facto clause to terminate an agreement during the stay period. This becomes a relevant factor when weighing up the risks involved in entering into the contract.
Until 1 July 2023, it is also possible to avoid the stay regime entirely by novating or assigning an agreement which was entered into prior to 1 July 2018, and this may be a preferable option for contracting parties in some circumstances.
Terminating for non-performance
Despite some ambiguity in the legislation, the Explanatory Memorandum to the Amendment Act provides that "notwithstanding the operation of the stay, a counterparty maintains the right to terminate or amend an agreement with the debtor company for any other reason, such as a breach involving non-payment or non-performance".
Therefore, if a counterparty becomes insolvent and then fails to perform its obligations under the agreement, the non-defaulting party will be entitled to terminate the contract under a general termination provision, despite the counterparty's insolvency.
This reinforces the importance of a contract explicitly articulating the circumstances in which it can be terminated for non-performance, as the parties will be able to rely on these clauses despite the ipso facto stay regime.
Potential for repudiation
A party should seek legal advice before relying on an ipso facto clause to terminate a contract which was entered into after 1 July 2018. Terminating under such a clause when the stay regime applies may constitute a repudiation of the contract, thus exposing the party seeking to terminate to an award of damages.
Insolvent trading safe harbour reforms
Businesses should be aware that the Amendment Act also included reforms to Australia's insolvent trading provisions, which commenced on 11 September 2017. Under the new provisions, directors are protected from personal liability for certain insolvent trading if the director, after realising the company is insolvent, takes "a course of action reasonably likely to lead to a better outcome for the company". This carve out only applies to debts incurred "directly or indirectly in connection with any such course of action". As with the ipso facto stay regime, this is intended to encourage the restructuring of financially distressed businesses.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.