New laws associated with Ipso Facto clauses

Posted on Jul 23, 2018 by Janine Wilson   |   Categories: Insolvency & Bankruptcy

If the other party to my contract appoints an administrator, I can get out of that contract, right? Wrong.

Most commercial contracts have a termination clause which says something like “if one party appoints an administrator or otherwise experiences an event of insolvency, the other party can elect to terminate the contract”.

These types of clauses are known as “ipso facto” clauses which is a ye olde latin term which reflects the often automatic triggering of these termination clauses simply by the fact of an insolvency event occurring.

Termination clauses like this are very frequently used when one party enters into a form of external administration.

However as of 1 July 2018, new laws have introduced significant restrictions on the ability of a party to take advantage of that opportunity to terminate a contract in these circumstances. These laws apply to all contracts entered into after 1 July 2018.

The changes are part of a wider Government push to encourage insolvency restructuring and trying to find ways to support risk taking, entrepreneurial activity and development.

That is, if it is harder for parties to get out of contracts when an insolvency event happens, then it should give greater opportunity for the stressed company to try and trade out of its financial problems.

These are wide ranging amendments and will affect contracts in all industries.

The new laws stop the solvent party from exercising a termination right or stays the application of “self-executing” or automatic termination provisions in contracts.

The stay on operation of these clauses last as long as the insolvent company is undergoing some type of restructuring activity or for the length of the insolvency procedure.

The new provisions apply to insolvency events aimed at restructuring a business including administration, receiverships (over the whole or substantially the whole of the company assets) and schemes of arrangement. The new laws do not apply to a situation where a company is placed immediately into liquidation without any type of administration. However, it would appear that the stay applies where a company enters voluntary administration and then liquidation.

These changes create a very significant restriction on the rights of parties to contracts. It will be important for contracting parties to improve their due diligence regarding the financial position of the other contracting party and make sure any available alternative security measures are put in place.

It wouldn’t be a law if it did not come with a raft of complicated exceptions. There are some types of contracts that are excluded from the new laws including some types of financial services contracts and large scale construction contracts. Business and share sale agreements are also excluded.

Please get in touch if you have any questions or concern