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PKF Australia

Accountants and Business Advisers

IPSO FACTO Law Reforms

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Tom Lesnikowski

Principal

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IPSO FACTO Law Reforms

Background

The introduction of the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 accompanied in the “Safe Harbour” provisions, protecting Directors from liability resulting from insolvent trading by Directors and restricting creditors from enforcing Ipso Facto Clauses in contracts.

Ipso Facto is the Latin phrase which translates as “by the fact itself”.

These Ipso Facto reforms apply where a company appoints a Voluntary Administrator, or a Receiver and Manager is appointed when a company is undertaking a Scheme of Arrangement. Of these, Voluntary Administration is the most common scenario and the focus of this article.

Many contracts and commercial agreements contain Ipso Facto clauses that provide the parties to the contract with the opportunity to terminate or vary contracts based on the insolvency of another party.

In a practical sense, these clauses can make the restructuring of insolvent entities that have an underlying business capable of being salvaged particularly difficult, especially where the business is reliant on contractual rights for day to day operations.

For example, if I was running a business that was facing financial difficulties and I appointed a Voluntary Administrator, if the business was heavily reliant on a contract with a particular supplier that had Ipso Facto clauses, that supplier would be entitled to immediately terminate the supply agreement. Such a termination would make any restructuring of the business near impossible and trigger personal guarantees, job losses, other company failures, and the loss of invested capital.

The Corporations Act 2001 – Section 435A states the following:

The object of this Part, …is to provide for the business, property and affairs of an insolvent company to be administered in a way that:

(a)  Maximises the chances of the company, or as much as possible of its business, continuing in existence; or

(b)  If it is not possible for the company or its business to continue in existence – results in a better return for the company's creditors and members than would result from an immediate winding up of the company.

Clearly, the Ipso Facto clauses allowing the right to terminate solely due to an insolvency event fly in the face of these objectives.

The Reforms

In the 2017 Summer edition of Pulse, we wrote about the safe harbour provisions that were brought in to protect Directors who are genuinely seeking to restructure struggling companies. 

The Ipso Facto reforms which became law effective on 1 July 2018 are an additional piece of those reforms aimed at overhauling the Australian Insolvency landscape.

For all contracts entered into AFTER 1 July 2018 there is a prohibition on the enforcement of Ipso Facto clauses. This prohibition is designed to allow Voluntary Administrators to continue to trade the business, explore restructuring opportunities and seek to achieve better returns for all stakeholders.

Existing contracts dated prior to 1 July 2018 will not enjoy the new protections and these contracts can still be terminated purely on the grounds of insolvency. The following table provides an overview of who is affected by the reforms.

Party

Effect

Supplier subject to Supply Agreement

Will no longer be able to rely on the grounds of insolvency to terminate a supply agreement.

Insolvent Company operating
a business

Can now appoint an Administrator in the knowledge that the Administrator cannot be shut out from service or supply and can explore restructuring options.

Secured Creditor

Will still be able to appoint a Receiver and Manager over the assets of a Company as long as its security is over all or substantially all of the company’s assets.

 

As with any legislative reform, there are numerous exceptions and carve-outs particularly with government contracts, securities and sophisticated financial arrangements, exchange markets and the agreed ranking of certain debts or other obligations to name a few.

Where to for Business?

The introduction of the new law is a timely reminder to all business operators to regularly review supply agreements and the contracts that govern your business arrangements with customers and suppliers alike.

These reviews should not just be limited to contracts but also credit management procedures, both the granting of credit and the management of credit, particularly for new contracts entered into after 1 July 2018. 

We recommend that when considering amendments to existing contracts or creating new contracts that you seek advice that takes into account this new regime.


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