Australia: Special report on the Productivity Commission's review of restructuring practices in Australia: Part Four

This article, the fourth in our series, focuses on the business restructuring recommendations set out in the Productivity Commission's Business Set-up, Transfer and Closure draft report. Our earlier articles may be accessed here.

This week, we consider the proposal that ipso facto clauses that allow termination of contracts solely due to an insolvency event, be unenforceable during any safe harbour period, voluntary administration or receivership.

Draft recommendation 15.4, the enforceability of ipso facto clauses during restructuring efforts

• An ipso facto clause is a clause which stipulates the consequences of an event (ipso facto means by the fact itself). Often, the event will be insolvency and the consequences will be a contractual right to the counter-party to terminate the contract. Other examples of ipso facto clauses include the right of a supplier to suspend the provision of goods or services upon insolvency, or the right of a lender to preclude further drawings, to accelerate payment of debt or charge a higher rate of interest upon insolvency.
• In the US, any clause in a contract which terminates or modifies that contract upon insolvency is unenforceable under the Bankruptcy Code (subject to certain exceptions, including with respect to financing arrangements). This law is intended to protect a debtor from losing valuable contract rights as a result of a bankruptcy filing, it being viewed that ipso facto clauses hamper rehabilitation efforts.
• In Australia, there is broad support for the introduction of an effective moratorium during restructuring efforts, which prevents counter-parties from taking action which is adverse to those efforts and which might result in the destruction of value.
• To that end, both the Financial System Inquiry (in its final report) and the Productivity Commission (in its draft report) recommend consideration of the suspension of ipso facto clauses in a restructuring context.
• The Productivity Commission's draft recommendation has three limbs:

• 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.

  • clauses subject to the moratorium are limited to clauses that permit the termination of a contract solely due to insolvency
  • such clauses are unenforceable if an administrator or a receiver is appointed, or during any safe harbour period
  • where the moratorium could lead to undue hardship, counter-parties can apply to the court for an order entitling them to terminate their contract.
• Generally, submissions support all three limbs of this draft recommendation, although amendments are proposed.
• DibbsBarker and the AICD believe that the recommendation could be improved by further consideration and consultation on the breadth of the moratorium and any exceptions.
• ARITA and the AICD are concerned that the moratorium would operate during a safe harbour period, when the directors remain in control of the company, and that it could be open to abuse. In this context, the AICD suggests that the framework offers inadequate protection, for example to a supplier who is not permitted to terminate their contract and must continue to trade with the company on credit, or make an application to the court which is expensive, time consuming and carries litigation risk.
• PPB Advisory offers the alternate view, that in order for restructuring efforts to be viable during any safe harbour period, the moratorium should apply.
• In the UK, a moratorium is achieved during restructuring efforts outside of formal insolvency regimes pursuant to an effective restructuring protocol known as the London Approach. One of the key tenets of an effective restructuring protocol is that creditors agree to stand still, that is, they agree not to take any adverse action against the company during a standstill period. This tenet coupled with another fundamental tenet, that creditors should remain supportive when they receive bad news, delivers a stable environment in which a company can pursue restructuring efforts.
• The benefit of such a protocol is that counter-parties do not look to work around a limited statutory moratorium, for example by incorporating and relying on contractual rights which are not expressly restricted. Instead, counter-parties work with the company in the spirit of the standstill to avoid value destructive behaviour. We discuss the role that culture plays in delivering more effective turnarounds in our fifth and final alert next week.