Most construction contracts provide a right of termination on the occurrence of an insolvency event. An insolvency event is usually defined broadly to include not only actual insolvency, but also those stages leading up to a potential insolvency, including administration and receivership. These clauses are called ‘ipso facto’ (meaning ‘by that very fact or act’) as they provide a fact based trigger for termination rather than one based on default.
The main benefit of these ipso facto clauses is that it gives the terminating party freedom to exit a contract as soon as insolvency becomes a real risk, rather than waiting until it actually happens, by which time it is likely to have suffered actual losses as well as having to deal with a contractual counter-party in distress. Such distress can lead to one or more adverse consequences including:
However from 1 July 2018, reforms to the Corporations Act 2001 (Cth) means that ipso facto clauses will be ineffective in the event that the counterparty becomes insolvent, has a managing controller appointed, or goes into administration. These new laws are part of significant changes to the insolvency laws under the Safe Harbour provisions (some of which are in effect now) that provide protection for the Directors of the insolvent party.
The main policy rationale for these laws is to better enable companies in some financial distress to have a chance of ‘trading out’ of their situation rather than necessarily going into actual insolvency (liquidation).
So what do the new reform measures do?
The reform measures enact a ‘stay’ on the contractual right to enforce a number of contractual measures against the distressed company. The contractual measures affected are the right to:
The regulators have identified that triggering any of the above rights has a serious negative impact on a company’s ability to trade out of its predicament, thus increasing the likelihood that it will continue to remain insolvent or be wound up.
Is there a way to contract out of the new laws?
The new laws cannot be contracted out of. On the second reading of the bill passing the Act, regulatory powers were established to prevent parties from contracting out of the new ispo facto provisions. In the event that the laws do not capture contractual clauses that attempt to circumvent the new provisions, the Government will have regulatory powers to intervene and prevent these clauses from being enforceable. These new laws will apply to new contracts entered into from 1 July 2018, but will not be retrospective. Whether they will apply to extensions or variations of contracts pre-dating these changes (similar to the Small Business Unfair Contract Terms legislation that came into effect in November 2016) remains to be seen.
Does this completely remove the utility of ipso facto clauses from construction contracts?
It is not the case that all ipso facto clauses should be removed from our construction contracts, and they continue to be relevant, as the new laws:
What can you do?
This further intervention in freedom to contract will affect all sectors, but perhaps the construction and infrastructure sector will be affected the most, particularly in light of other legislative contract restrictions including:
Parties to contracts should as soon as possible:
Authors: Scott Alden & Christian Marchant
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this publication is accurate at the date it is received or that it will continue to be accurate in the future. We are not responsible for the information of any source to which a link is provided or reference is made and exclude all liability in connection with use of these sources.
Published by Scott Alden