Be Careful What You Wish For! Evaluating the Ipso Facto Reforms

Successfully restructuring a business in financial distress requires that there be sufficient remaining value to justify saving it. Traditional corporate rescue and restructuring laws were focused on businesses with large fixed-asset bases that were at risk of being subject to litigation and enforcement action against their assets and so protection was needed during the restructuring effort. Ipso facto clauses in contracts strike at the heart of restructuring attempts because they dramatically increase the leverage that the counterparty has against the company attempting to restructure. The exercise of an ipso facto clause can remove significant value out of the business during the restructuring attempt, which can derail negotiations or at least change the dynamics in a manner that reduces the projected sale price. Australia has recently changed its law with regard to ipso facto clauses to assist in the building of a climate of entrepreneurism and to facilitate use of external administration for restructuring and business rescue. The reforms were introduced in late 2017, and commenced on 1 July 2018, and generally only apply to contracts entered into on or after that date.[1] The change was hailed as a major step towards improving Australia’s corporate rescue laws.

In Australia, until this reform, ipso facto clauses were permitted in executory contracts; for example, contracts of sale in the case of liquidation or voluntary administration. The Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017 (Cth) has the stated purpose of ‘enabling businesses to continue to trade in order to recover from an insolvency event instead of these clauses preventing their successful rehabilitation’. The reforms apply to voluntary administration[2] (though not for deeds of company arrangement, that is the Australian version of a rescue plan); receivership (for managing controllers);[3] and creditors’ schemes, where the scheme is proposed to avoid liquidation.[4]

The focus of the reforms is to stay the exercise of rights against a company under a contract, agreement or arrangement where the rights are enforceable because of the company[5] going into a scheme (including where a scheme is announced or where an application to convene a creditors’ meeting to vote on a scheme proposal is made), or entering managing controllership or voluntary administration. The reforms provide an anti-avoidance mechanism by extending the stay in refusing to allow the company’s financial position to be a reason for the exercise of rights where the company is also in a managing controllership, voluntary administration or a scheme.[6] The stay will operate for a period until the end of the particular external administration. The court is given extensive powers in the new laws by being empowered to lift or extend the operation of the stay in a particular case.[7]

However, the protection offered by the stay against ipso facto provisions is undermined by two legislative instruments that provide for more than 60 exclusions and carve-outs from the operation of the ipso facto provisions, some of which are broad exclusions that cover many common commercial transactions. This will mean that whole swathes of commercial arrangements will be removed from these protections. Such a legislative approach can be expected to produce anomalous results that will arise from the decision to ‘pick winners’ by excluding only some types of very specific arrangements, rather than introducing a broad general exception for financial arrangements (as other jurisdictions such as Canada and the US have done). These exceptions provide a grab bag of ad hoc exclusions that will create further uncertainty and will mean that contracts will need to be carefully reviewed to determine not only whether they fit within a class wide contract type exclusion (as covered by the Regulations) but even if they do not, it will need to be determined whether individual clauses in contracts may nonetheless be excluded by the Ministerial Declaration.

Over the next few years there will be scrutiny on whether some creditors will attempt to circumvent the stay and whether there are increased visits to the Court by administrators, who now carry the evidentiary burden of trying to show that a creditor has terminated solely due to an insolvency event and that a stay is to be enforced. 

Sadly, it can be expected that the exclusions to the stay mean that the reforms will not help a large proportion of businesses that seek to restructure. Furthermore, the gallimaufry of exceptions and carve-outs draw artificial and arbitrary distinctions between common forms of commercial transactions, with the result that creditors with similar transactions may have very different contractual rights during a restructuring effort.

In conclusion then, the Australian federal Parliament had an opportunity to make restructuring clearer and easier in Australia through these ipso facto reforms and has unfortunately failed.

The full article can be found here.

Christopher Symes is a Professor of Law at Adelaide Law School

Jason Harris is a Professor of Corporate Law at Sydney Law School

[1] Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017 (Cth) sch 1 item 17.

[2] Corporations Act 2001 (Cth) s 451E.

[3] Ibid s 434J.

[4] Ibid s 415D.

[5] Different terms are used for each form of external administration: a body (for schemes); a corporation (for receivership) and a company (for voluntary administration).

[6] Corporations Act 2001 (Cth) ss 415D(1)(d), 434J(1)(b), 451E(1)(b).

[7] Corporations Act 2001 (Cth) ss 415D(3), 415E, 434J(3), 434K, 451E(3), 451F.