On 1 July 2018, the highly anticipated ipso facto laws came into force. The new laws introduce a stay on the enforcement of certain contractual rights (including termination, acceleration and enforcement rights) against a counterparty that is subject to voluntary administration, a scheme of arrangement, or a receivership over the whole or substantially the whole of the counterparty’s assets.
Need for reform
Australia’s insolvency regime has long been criticised for not protecting distressed companies from counterparties exercising ipso facto clauses based on insolvency related events, regardless of otherwise continued performance of the contractual obligations by the distressed company. It has been argued that the unfettered operation of ipso facto clauses can destroy the enterprise value of certain businesses entering an external administration process, reduce the scope for a successful restructuring, or prevent the sale of a business as a going concern.
The new laws are an attempt to address these issues by introducing a stay on the enforcement of certain rights in contracts that were seen as counterproductive to a successful turnaround of a distressed or insolvent company that is using voluntary administration, a scheme of arrangement or a receivership as a method of implementing a restructuring.
The new laws – a brief overview
The stay only applies to rights that can be exercised (or self-execute) upon a company entering into voluntary administration, a scheme of arrangement, or receivership over the whole or substantially the whole of the counterparty’s assets, or the company’s financial position resulting from those circumstances. The stay will not apply to a right to terminate or alter a contract that arises on failure to pay or to perform under that contract.
Due to the numerous carve-outs to the laws, the reforms are not as comprehensive as initially anticipated. Although some of the carve-outs are practical and necessary to meet the policy objectives of the laws (such as some financing arrangements being broadly carved-out), other carve-outs are defined more broadly than what would arguably be required (such as the broad exclusion of government and authority issued licences, permits or approvals).
The laws only apply to contracts, agreements and arrangements (collectively, ‘arrangements’) entered into on or after 1 July 2018, with the exception of a five-year transitional period for arrangements that are entered into or renewed as a result of either the novation, assignment of variation of an arrangement entered into before 1 July 2018 (such ‘new’ arrangements will be exempt until 1 July 2023). Therefore, we are potentially some years away from companies in financial distress being able to fully benefit from the new laws. These transitional arrangements also mean that in future distressed situations, certain contractual counterparties or credits may have different legal positions in respect of the exercise of their contractual ipso facto rights.
A five-year transitional period will also apply for major building and infrastructure projects with a value of at least $1 billion, with any existing or new arrangements for building and construction works and related goods and services entered into prior to 1 July 2023 being exempt from the stay.
To have the benefit of the stay under the new laws, a restructuring of a financially distressed company will need to utilise voluntary administration, scheme of arrangement, or receivership over the whole or substantially the whole of the counterparty’s assets. In the context of a voluntary administration, the stay introduced by the new laws can be viewed as a helpful extension of the existing moratorium on enforcement of creditors’ rights. However, because of the numerous carve-outs, it is not a perfect moratorium so careful consideration of the application of the new laws on a distressed company’s contracts will be necessary if voluntary administration is to be used to implement a restructuring.
Certain financing arrangements are carved-out from the new laws, including carve-outs for contracts or arrangements relating to securities, financial products, bonds, promissory notes, or syndicated loans. However, bilateral loans have not been carved out and therefore will be subject to the laws (although certain rights typically found in bilateral loans have been excluded by declaration including rights to charge default interest, rights of set-off, indemnity, assignment and novation etc).
Practical implications and structural considerations
Key creditors: The main policy aims of the new laws is to provide more confidence to stakeholders that a planned restructuring that utilises voluntary administration, schemes of arrangement or receivership can be implemented without losing key contracts with trade creditors, suppliers and lessors. Provided that a distressed or insolvent company can continue to perform their obligations under their contracts (and assuming that the contracts are not subject to pre-1 July/transitional carve-outs), those key trade creditors, suppliers and lessors will also have to continue performing under their contracts. The hope is that this will result in greater scope for a successful restructuring and better prospects of a sale of the distressed company as a going concern.
Mergers and acquisitions: The news laws provide broad carve-outs for M&A activity including for securities underwriting and arrangements for the sale of all or part of a business, including by way of the sale of securities or financial products. For key structural and documentary considerations when seeking to utilise this carve-out, please see our previous article entitled ‘Sale of business likely to be excluded from stay on ipso facto rights’.
Bilateral and syndicated loans: The laws have made a distinction between bilateral loans and syndicated loans with syndicated loans being completely carved-out but bilateral loans remaining subject to the stay (save for certain rights that are specifically excluded). The policy aims of making such a distinction are not immediately clear. The difference in treatment between loans may lead to unintended complications in a restructuring where there are both syndicated and bilateral facilities. It also raises some structuring considerations for financiers entering into new facilities with counterparties – for example, could those facilities be structured as a syndicated loan or a bond issuance? There are also practical questions around what makes a loan syndicated for the purpose of the legislation (eg is it having syndicated provisions in the document, is it offering the loan for syndication?).
Acceleration: In our previous article entitled ‘Caution for financiers – the appointment of receivers without acceleration of the debt’, we flagged a potential issue with the draft regulations and declaration that would have had an impact on the right of a secured financier to accelerate the principal debt on an insolvency event, and limited the receiver appointed by the secured financier to recover only those amounts presently due and payable. Whilst the structural considerations suggested by us in that article would also generally apply to the documentation of most security arrangements (irrespective of the reforms), the acceleration issue has been resolved in the final form of the regulations and declaration. This means that a secured creditor with security over the whole or substantially the whole of the property of the distressed or insolvent company may rely on its usual contractual right to accelerate the principal debt when it is exercising its right to appoint a receiver.
Featherweight security: As there are carve-outs in the laws for creditors with security over the whole or substantially the whole the company’s assets, there may be greater adoption of ‘featherweight’ security interests as a device to enable a creditor to take advantage of these carve-outs. Such security interests are essentially a charge which floats over all assets of the grantor, with no restrictions in how the grantor can deal with its assets, nominal monetary security, and crystallisation of the charge usually limited to the appointment of an administrator. Assuming that such a charge is enforceable, a secured creditor with specific asset security may seek to utilise such a charge to reduce its credit risk.
Links to the laws
For more information on the ipso facto laws, please also see our previous articles on the subject: