What are ipso facto clauses?
An ipso facto clause in a contract allows one party to terminate or modify the operation of a contract upon the occurrence of a specific event. Many commercial contracts contain such clauses which operate to allow one party to terminate a contract only due to the commencement of formal insolvency proceedings.
The operation of ipso facto provisions can reduce the scope for a successful restructure of companies by destroying the value of a business or preventing the sale of a business as a going concern. For example, a key supplier related to a profitable part of a company’s business may terminate based only on an insolvency event occurring even if there is no breach otherwise of that contract.
What is stayed under the new law?
The new provisions (which only apply to contracts entered into after 1 July 2018) provide that an express right in a contract, agreement or arrangement is not enforceable against a company only because:
The company enters voluntary administration;
The company has a managing controller appointed over all or substantially all of its assets (in other words, a receiver); or
The company is undertaking a creditor’s scheme of arrangement.
An express contractual right that arises only because of a counter-party’s “financial position” will also not be enforceable if that company is going through one of the three insolvency processes set out above.
Importantly, the stay will not prevent most other rights from being enforced against “insolvent” companies including contractual rights that are triggered where a company has failed to meet its payment or other obligations under the agreement. There are, however, some anti-avoidance provisions which extend the stay to other reasons that are “in substance” contrary to the reforms.
What is the period of the stay?
The period of the stay depends on the type of insolvency process. In the context of a voluntary administration, for example, the stay will begin when the company enters administration and will end when the administration ends or, if the administration ends because the company is being wound up, it will continue until the affairs of the company are fully wound up.
Even when the stay does come to an end, contractual rights will continue to be unenforceable to the extent that the reason for enforcing the rights relates to a company’s financial position before the end of the stay period or is because of the company’s commencement of an administration, appointment of a managing controller or entering into a scheme or compromise.
The Court can extend the period of the stay and also has a general discretion to order that contractual rights can in fact be enforced in the interests of justice.
Conclusion
From 1 July 2018, some contracts cannot be terminated based only on the fact that a certain insolvency event has occurred (even if this is expressly provided for in the contract).
Businesses that contract with companies should review their contracts to ensure they are adequately protected in the case of a default (for example by ensuring contracts allow termination for non-payment). At the same time, directors and administrators can use the stay as a “tool” in the process of restructuring a company to segregate profitable and non-profitable parts of its business, with a view to the profitable parts being continued beyond an administration.
If you would like to discuss how the new law might affect your contracts please contact Peter Leech.