Ipso Facto and Safe Harbour: Recent Changes

2nd Jul 2018

The recent introduction of the safe harbour amendments to the Corporations Act and the newly implemented ipso facto exclusions (effective as of 1 July 2018) have been touted as a means of assisting companies to trade out of their bad times, instead being wound up in insolvency as a first resort. With these amendments, the Government is aiming to assist companies in their profitability whilst maintaining normal business conditions during a period of administration and receivership, to assist in facilitating a successful restructure.

Ipso facto Clauses – what are they?

An ipso facto clause is a standard inclusion in most contracts which allows a creditor to exercise certain rights or terminate or amend a contract upon an insolvency event occurring, such as a company being placed into voluntary administration or a receiver being appointed.

Prior to 1 July 2018, an ipso facto clause could be invoked to terminate a contract even if the company continued to meet its other contractual obligations.

Terminating a contract upon an insolvency event, regardless of the company’s ability to continue its payment obligations, often impacted the company’s ability to maintain its cash flow, improve their financial position and/or restructure its business.

Contracts entered into on or after 1 July 2018, with some exceptions, will be subject to the ipso facto amendments whereby creditors will be stayed from terminating, amending or exercising a right under the contract solely for the reason that the other party enters into voluntary administration, receivership or a scheme of arrangement. The stay is not permanent and only lasts until the administration period ends or when the company is wound up, when the managing controller or receiver’s control ends or 3 months after a scheme of arrangement is announced or if the arrangement application is unsuccessful.

The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (the Amending Act) sets out the ipso facto stay in relation to receivers being appointed at sections 434J to 434M and in relation to a company being put into voluntary administration at sections 451E to 451H.

The Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (the ‘Regulations’) specifies types of contracts which will be excluded from the ipso facto stay provision. These include contracts for defined building work where payments are at least $1 billion, for the supply of goods and/or services for the public health service and contracts which involve a special purpose vehicle for project finance or public/private partnership, among others.

Creditors should note that whilst they are stayed from terminating any contract pursuant to an ipso facto clause, there is no corresponding stay on a creditor terminating the contract due to the company failure to meet its other contractual obligations (ie. failure to meet loan repayments).

How to minimise the impact of Ipso Facto provisions

The new provisions will not be applied retrospectively and will only apply to contracts entered on or after 1 July 2018. Creditors seeking to minimise the impact of the new provisions should consider amending or extending their current contracts as these would not be subject to the provisions due to the original commencement date being prior to 1 July 2018.

As a further safeguard, creditors are advised to strengthen their current default provisions to ensure that they are broad enough to encompass all specific termination rights available, noting that clauses which attempt or purport to circumvent the new amendments may be considered void.

Safe Harbour Amendments – What are they?

Previous legislation promoted a tendency for directors to prematurely protect themselves through insolvency processes rather than fight to keep their company viable. This led to a high number of insolvency events and a significantly risk averse business culture.

In late 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (the Amending Act) amended the Corporations Act 2001 (Cth) (the Corps Act) with the aim of offering potential protection to directors from charges of insolvent trading if they were engaged in legitimate efforts to restructure the company.

Section 588GA of the Amending Act allows directors to avoid liability under section 588G(2) of the Corps Act, when they:

  • Recognise that a company may be or becoming insolvent and takes a course of action that is reasonably likely to provide a better outcome for the company;
  • Incur a debt that is indirectly or directly in connection to this action; and
  • Continue to meet obligations in paying employees and tax.

Section 588GA(2) of the Amending Act determines what is considered as reasonably likely to lead to a better outcome for the company. It considers whether the person is:

  • Properly aware of the company’s financial position; or
  • Taking appropriate steps to prevent misconduct that would negatively affect the company’s ability to pay its debts; or
  • Taking appropriate steps to ensure the company is keeping financial records relevant to its size and nature; or
  • Is obtaining advice from qualified entities with sufficient information; or
  • Is developing or implementing a plan to improve the company’s financial position.

This protection only extends to any debts incurred in relation to the course of action (ie. with the aim of bringing about a better outcome for the company) and ceases when:

  • The director ceases the course of action; or
  • It is no longer reasonably likely to lead to a better outcome; or
  • The company is placed into external administration.

Prior to invoking s588GA of the Amending Act as defence to a claim of insolvent trading, the Court must be satisfied that:

  • The company (and its directors) continued to pay all employee entitlements;
  • It was meeting its tax reporting obligations; and
  • Can retrospectively consider whether the director made the company’s books and records available to any liquidator or administrator within a reasonable time period or when requested.

The protection of safe harbour does not extend to debts incurred where the directors are aware of the company’s inability to meet the new repayment.

The legislation was introduced to reduce the number of premature entries into insolvency processes and to facilitate a positive improvement in Australian business culture to encourage potential entrepreneurs and investors to enter into the Australian business market.

Prior to taking any steps to minimise the impact of the recent legislative amendments, you should always obtain specific legal advice to your circumstances. If you have any queries in relation to your rights as a creditor or your rights as a company in relation to the above amendments, please do not hesitate to contact the Insolvency & Restructuring team at Rostron Carlyle Rojas Lawyers on 07 3009 8444.

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