The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (the Amending Act), which was introduced by the Federal Government late last year, inserted provisions into the Corporations Act 2001 (Cth) which will prevent contracting parties from enforcing ‘ipso facto’ clauses (the Ipso Facto Stay).
The Ipso Facto Stay will apply to all contracts entered into on or after 1 July 2018.
What is an ‘ipso facto’ clause and why are they important?
An ‘ipso facto’ clause is a contractual provision which entitles a party to terminate or amend a contract where the counterparty experiences an insolvency event (e.g. entering voluntary administration). The intention of an ‘ipso facto’ clause is to provide protection for principals and head contractors by allowing them to promptly terminate the contract and engage a replacement contractor.
When will the Ipso Facto Stay apply?
Under the Amending Act, an ‘ipso facto’ clause will not be enforceable where a company:
- enters a scheme of arrangement;
- appoints a managing controller; or
- has come under voluntary administration,
except in limited circumstances.
The Federal Government recently released exposure drafts of the:
- Corporations (Stay on Enforcing Certain Rights) Declaration 2018; and
- Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018,
(the Drafts).
The Drafts clarify the exemptions to the Ipso Facto Stay, which should provide some level of comfort for principals and head contractors.
Exemptions
Contracts already on foot
The Ipso Facto Stay will not apply to:
- contracts or agreements entered into before 1 July 2018;
- the novation or assignment of contractual rights after 1 July 2018, in respect of a contract that was entered into before 1 July 2018;
- variations to a contract after 1 July 2018, in respect of a contract that was entered into before 1 July 2018.
Special Purpose Vehicles (SPV)
The Drafts propose that the Ipso Facto Stay will not apply to contracts, agreements or arrangements of which an SPV is a party.
However, we expect that this exemption will be the subject of careful scrutiny before the Drafts are finalised. It is unlikely that the Federal Government’s intention is to enable principals and head contractors to escape the Ipso Facto Stay by simply contracting through a different SPV for each project.
Step-in Rights
‘Step-in’ rights will not be affected. Parliament expressly stated that provisions which allow parties to ‘step-in’ the shoes of counterparties that have become insolvent and perform obligations of that party are ‘designed to keep the contract on foot where it might otherwise be terminated’ and thus ‘support the overarching policy objectives’ of the Amending Act.
Key takeaway
In the circumstances outlined above, principals and head contractors may be obligated to continue to perform a contract with what a contract deems an insolvent entity, unless an exemption applies.
Importantly, the right to terminate in the event of an insolvency can be preserved if the relevant contract has a termination for convenience clause, which is not an ‘ipso facto’ clause.
Principals and head contractors should ensure their contracts are appropriately amended by 1 July 2018 so that they are adequately protected in the event of a lower tier contractor or subcontractor’s insolvency. In particular, principals and head contractors should at least ensure that their contracts include a termination for convenience clause and a right to ‘step-in’ upon the occurrence of an insolvency event.
We recommend that this ‘step-in’ right includes (at a minimum):
- the right to take possession of design documents;
- the right to take possession of, and use, existing materials, equipment, plant and other things on site for the completion of the works; and
- the right to suspend payment until any works which have been taken over have been completed, and a proper reconciliation has been carried out of any additional cost incurred.
We will keep you abreast of any further changes to the Drafts, which are expected to be finalised in the coming weeks.
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