Changes to the Corporations Act 2001 (Cth) made last year through the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (Act) introduced safe harbor and ipso facto reforms. The latter of these reforms came into force on 1 July 2018, and recently passed regulations have provided scope for their effects on commercial and construction contractual relationships.
What Are Ipso Facto Clauses?
An ipso facto clause allows a party to exercise a right (usually to end a contract) by reason of an insolvency event occurring in the other party. Insolvency event is usually defined broadly in these contracts to provide the maximum scope of freedom as possible. This right is exercisable regardless of whether the other party has continued, or has capacity to continue, to fulfill their obligations under the contract.
What Have the Reforms Changed?
The stay on ipso facto clauses prevent parties from exercising their right to terminate a contract through such a clause if:
• The contract is entered after 1 July 2018; and
The reason for termination is:
• Because the other party is under voluntary administration, receivership (of the whole or substantially the whole of the corporation’s property), or is subject to a scheme of arrangement; or
• Because of the other party’s financial position, where the other party is under voluntary administration, receivership, or is subject to a scheme of arrangement.
There are some exemptions to the above restrictions, including the following which have particular relevance to the construction industry:
• Exclusion of construction contracts if the total payments for particular work, goods or services is at least $1 billion (note: this exception only applies to contracts entered into between 1 July 2018 and 1 July 2023);
• Exemption for some contracts involving a special purpose vehicle; and
• Exemption relating to critical works for governments.
The new reforms also apply to the exercise of a number of other contractual rights, such as step-in rights or self-executing provisions.
Why Did These Changes Happen?
These exclusions are designed to stop people jumping ship because a company has taken on a little water and allows some breathing room for companies undergoing formal restructures. This is in support of key statutory objectives of the voluntary administration regime, namely aiming to maximize the chances a company in administration can continue operating their business.
If companies were permitted to dissolve contractual relations with companies heading into administration or nearing insolvency, the financial stress already felt by the company would be compounded by the loss of additional business. This effect would likely be exponential, as soon as one group pulls the pin many others are likely to follow suit, resulting in a complete collapse of the business.
How May This Impact You?
These reforms have serious impacts on entities looking to enter into contracts from the 1 July 2018. People seeking to end contracts on the basis of an insolvency event will no longer be able to rely on contractual terms, creating additional factors that need to be considered when entering into a contract. There will be no way to contract around the reforms, and any such clause that falls outside the bounds of the new laws will be dealt with by regulatory powers granted to the Government.
While ipso facto clauses have been very popular in construction and commercial contracts, these changes create greater need for parties to consider due diligence on the financial position of tenderers and other parties. Purporting to terminate a contract in breach of these amendments could be held to be repudiation of a contract and can result in having to pay damages.
Before entering into or terminating a contract, it is important you seek legal advice to determine the financial position of the counterparty, to determine whether an exclusion under the reforms may apply, and to ensure you are not in breach of the stay on ipso facto clauses.