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WILL THE “IPSO FACTO” STAY REALLY HELP SMES TRADE OUT OF DIFFICULTIES?

Newsletter

by Paul Gidley31.07.18

Contractual “ipso facto” clauses historically allowed a party to a contract to unilaterally terminate or modify the contract in response to an insolvency event affecting the counterparty. The “ipso facto” clauses were able to be enforced irrespective of the counterparty’s viability or performance in fulfilling their contractual obligations.

As of 1st July 2018, amendments to the Corporations Act 2001 (Cth), Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (the Amending Act) have stayed the right to “ipso facto” enforcement where a company:

  • Appoints a voluntary administrator

  • Appoints a receiver or controller over the whole or substantially the whole of the property of the company

  • Enters a scheme of arrangement

The intent of the amendments is to prevent acceleration of companies’ financial difficulties. For example, “ipso facto” cancellation of contracts for supplies renders them unable to trade out of difficulties or prevents sale of the business as a going concern.

Will the ipso facto stay perform as intended?

“Ipso facto” clauses have disproportionately disadvantaged small to medium enterprise (SMEs). Larger enterprises’ asset base sustains counterparty (particularly creditor) confidence whereas “ipso facto” clauses have triggered at lower thresholds for small businesses.

In the past, Shaw Gidley have argued for a carte blanche stay on “ipso facto” clauses with case-by-case exemptions sought from the Court rather than prescribed exemptions.

We can already see how trying to fine-tune and target exemptions may reduce the instrument’s effectiveness.

The Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (the Regulations) were tabled in the Senate on June 26th and repealed on July 2nd.

Draft Regulations have exempted financing arrangements and preserved certain rights such as uplift clauses and indemnification against lender’s expenses arising from borrower’s insolvency, the right to terminate a standstill or forbearance arrangements, the right to change the priority or order of amounts to be paid, distributed or received, rights of novation and assignment and rights of set-off. It is argued that this will avoid discouraging financing, and, lead to earlier insolvency.

This seems counterproductive for small and medium enterprise (SMEs). Enforcement of “ipso facto” clauses in financing contracts have proven a significant barrier to rescue of these businesses. It is likely that broad exemptions from the stay for financing arrangements will continue the acceleration of viable SMEs into premature liquidation, rather than encouraging financing to extend solvency.

Another exemption proposed in the Draft Regulations is licences, permits or approvals issued by the Commonwealth, a State or a Territory, an authority of the Commonwealth, a State or a Territory, or a local government. The intention is to protect vital services. However, not all government licensing arrangements are for vital services. For example, training providers may be SMEs that license a substantial part of their offering from a level of government. This exemption to the stay necessarily deprives such a company (experiencing an insolvency event) of supply just as it would if the supply was goods. We consider this to be a perverse outcome contrary to the intent of the Amendments Act and demonstrates the difficulty of achieving effective reform when broad carve outs or exemptions are attempted.

The ipso facto stay will only apply to contracts entered after 1st July. Some commentators suggested that this will encourage multiple revisions of current contracts rather than new contracts.  As a result, a business experiencing an insolvency event will remain at risk from ipso facto clauses in existing contracts, and that risk may extend to counterparties to post-July 1 contracts with the same business if the result is liquidation.

Termination for convenience clauses, step-in rights, contract revisions and Special Purpose Vehicles have already been touted as potential workarounds to the new regime in some arenas. At Shaw Gidley we will continue our focus on business rescue. We hope that the instrument will support this goal as intended and wait with fingers crossed for the final Regulations.