CREDIT INSIGHTS
Ipso facto Insolvency Reforms
The Drive to Promote More Innovation and Entrepreneurship
It’s been well published in recent years that the Australian Government has considered various measures to promote and support the success of business start-ups in Australia. A large percentage of small to medium sized enterprises collapse within the first three years of commencement for various reasons, ranging from the lack of working capital, lack of strategic direction to poor planning, cash flow management and record keeping.
A large percentage of small to medium sized enterprises collapse within the first three years of commencement for various reasons, ranging from the lack of working capital, lack of strategic direction to poor planning, cash flow management and record keeping.
As a result of the Governments initiatives to support and encourage business in Australia, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Enterprise Act) was passed in September 2017 and introduced two key inclusions to the Corporations Act 2001 (Corporations Act):
- Safe Harbour for directors from insolvent trading – This measure has been in effect since 19 September 2017 and aims to provide a legal framework for directors to formulate a course of action which leads to a better outcome for the company and its creditors and at the same time brings the protection/defence of being pursued for personal liability for insolvent trading. See the new section 588GA of the Corporations Act for further details.
- Stay on enforcing rights merely because of arrangements or restructures – The commencement of this measure has been delayed to 1 July 2018 and relates to ipso facto rights in contracts/agreements. See the new sections 415D to 415H of the Corporations Act for further details.
Staying on the topic of Ipso facto reforms, why are these important reforms and what are the mechanical implications for parties to contracts going forward?
A company’s contracts with third parties are often what make an enterprise a valuable going concern and supports its ability to trade into the future, be they contracts to supply key customers, contracts to hold or licence critical intellectual property, contracts to occupy premises and/or lease assets and so on.
Ipso facto clauses are commonly provisions in contracts that allow a counterparty to terminate or modify a contract on the event of insolvency.
Fundamentally the new reforms will make ‘ipso facto’ clauses (especially termination clauses) in contracts unenforceable while a company is attempting to restructure its financial affairs under:
- Voluntary administration;
- A compromise or arrangement aimed at avoiding being wound up in insolvency (a ‘scheme of arrangement’); or
- When a managing controller has been appointed over all or substantially all of the property of the company.
This may breathe new opportunity into the benefits of restructuring a company through an insolvency process such as that noted above and therefore may enhance the prospects of improving the potential return to creditors by the company getting better value from its assets.
The reforms only affect the rights under contracts, agreements, arrangements entered into from 1 July 2018 onwards and not contracts entered into prior to this date or contracts amended post 1 July 2018 but commencing before 1 July 2018.
The stay on enforcement rights applies irrespective of whether termination or other like ipso facto provisions in such contracts are automatic or discretionary, however such a stay ends upon the company entering liquidation and/or when the company fails to perform its contractual obligations under the contract.
Finally, the Court can lift the stay if satisfied that the relevant restructuring arrangement is not for the purpose of avoiding the company being wound up in insolvency, or if it is otherwise appropriate in the interests of justice.
The success of these new provisions will take time to prove their worth in improving the lifespan of new and existing businesses and whether they will inspire companies and their directors to take more measured risk to grow their business is yet to be seen.
