To stay or not to stay? Proposed exclusions from the ‘ipso facto’ reform

The Australian Government Treasury (Treasury) has released the long awaited exposure drafts and explanatory statements in respect of the types of arrangements that are to be excluded from the moratorium (or ‘stay’) on reliance by solvent counterparties on ‘ipso facto’ clauses (ipso facto reform). Public consultation in respect of the proposed exclusions is open until 11 May 2018.

This is an opportunity for businesses to consider how the new stay on ipso facto clauses might affect their business operations and to engage in consultation with Treasury before the ipso facto reform takes effect.

Background - ipso facto clauses

In 2017, as part of its National Innovation and Science Agenda, the Australian Federal Government amended the Corporations Act 2001 (Cth) by inserting provisions to stay the enforcement of certain ipso facto clauses. The ipso facto reform will take effect on 1 July 2018 in relation to contracts entered into after that date.

Ipso facto clauses are very common in commercial contracts and entitle a solvent party to a contract, agreement or arrangement (arrangement) to enforce its rights if the other counterparty suffers an insolvency related event. This applies irrespective of whether the counterparty is otherwise performing its obligations. The rationale of the ipso facto reform is that it will assist businesses to continue to trade in order to recover from an insolvency event instead of preventing their successful rehabilitation.

Proposed exclusions to the ipso facto reforms

The draft regulations set out a long list of arrangements which are proposed to be excluded, including:

• arrangements relating to laws and international obligations, including agreements under the Cape Town Convention (which regulates security interests in certain movable property, generally aviation parts)
• government licences or permits
• arrangements relating to securities and financial products, including derivatives, underwriting securities or financial products, various arrangement in relation to securities, sale of business, margin lending facilities and issuing of covered bonds
• complex arrangements between sophisticated parties including, where a special purpose vehicle is a party, those that relate to keeping source code in escrow, and arrangements for the commercial charters of ships
• arrangements relating to debt and the ranking of creditors, including arrangements relating to subordination, flawed assets and factoring
• arrangements relating to financial markets and clearing and settlement facilities
• netting arrangements, including a number of arrangements relating to approved RTGS systems and
• novations, assignments or variations renewed after the reform takes effect, but entered into before 1 July 2018.

The draft declaration sets out the types of rights which are to be excluded from the stay on ipso facto clauses, including:

• uplift and indemnification clauses, such as a lender’s right to charge a higher rate of interest following a relevant insolvency event, or the right to be indemnified for any losses or expense incurred by reason of the insolvency event
• termination rights in a standstill or forbearance arrangement
• right to change the priority in which amounts are to be paid
• rights of set-off and acceleration of such rights
• rights of assignment and novation
• rights of assignment and novation and
• step-in rights, which are commonly found in construction contracts.

Final Remarks

The ipso facto reform is a significant development in the law. The proposed exclusions are broad and are generally designed to ensure they do not unduly disrupt long established business practices, particularly in Australia’s capital and financial markets sector. Notwithstanding the exclusions, businesses which rely on ipso facto clauses to protect themselves against the insolvency of a counterparty, need to carefully review their contracts and operations, and prepare for scenarios where those clauses cannot be enforced.

For more information about the Exposure Drafts see the Treasury’s webpage. To enquire about how the reforms may affect your business, contact Hall & Wilcox.