Termination for Insolvency: Not so fast!
You hear on the grapevine that a company that you have contracted with is “going under”. Quickly pulling the dusty contract out of your bottom drawer you flick through to the termination clauses and voila! a clause allowing you to terminate if the other party is insolvent. Great, time to pull the plug…but not so fast! Thanks to the Corporations Act 2001 (Cth) (“Corporations Law”) you may be doing so unlawfully.
What are ipso facto clauses?
A common term in any written contract is the ability to terminate the contract if the other party is insolvent. These are known as ‘ipso facto’ clauses (meaning by the fact or act itself). Typically, an ipso facto clause will allow one party to terminate the agreement if one of several insolvency events have occurred, these may include:
- becoming subject to bankruptcy, liquidation or winding up procedures or otherwise becoming insolvent; or
- a receiver, receiver/manager, controller, administrator or voluntary administrator is appointed, or a mortgagee takes possession of all or a substantial part of its assets or the party is placed under official management.
Whilst armed with this contractual right to terminate, don’t be so hasty to do so before checking if the Corporations Law applies.
Parts 5.1, 5.2 and 5.2 of Chapter 5 of the Corporation Law imposes a stay (or pause) on the enforcement of your right to terminate pursuant to an ipso facto clause if:
- a managing controller (includes a receiver) is appointed;
- the company enters administration; or
- the company is undertaking a scheme of arrangement to avoid being wound up.
This applies to most contracts, whether public or private (there are some limited exceptions).
It doesn’t prevent you from relying on your ipso facto clause but rather it forces you to stay on the enforcement of the right for periods defined in the Corporations Law. As to how long the stay lasts depends on the form of insolvency and subject to any court orders, the stay may last:
- from the date of appointment of a receiver or administrator until the receivership or administration ends or the company is fully wound up; or
- from the time when a public announcement or scheme application is made, until three months after the announcement, when the application is unsuccessful or dismissed, or the company is fully wound up.
These restrictions do not apply to:
- contracts entered prior to 1 July 2018; or
- a party undertaking an informal restructure (and falling outside of the relevant provisions under the Corporations Law); or
- a limited number of contracts including certain government contracts and those relating to financial products.
The rationale behind these provisions in the Corporations Law is to enable a company that may be in financial distress to salvage their situation, organise its affairs and have a chance to ‘trade out’ of their financial difficulties without actually going into liquidation.
Can I get around the Corporations Law?
Yes and No.
You cannot contract out of these provisions, however, if the stay on the enforcement will cause undue hardship or potentially affect your own solvency status then you may be able to apply to the court to have the stay lifted.
If possible, look to see if there is an alternative basis upon which you can terminate the contract. For example, is the other party in breach of another term of the contract? Sometimes that breach may not be obvious. Take construction contracts: a builder is obliged to hold and maintain a licence from the QBCC to enable it to carry out the works. A builder cannot hold a valid licence if its insolvent. The breach of contract (and thus enabling termination) is not the builder’s insolvency but rather their failure to hold a valid licence in accordance with the terms of the contract. Remember that not every breach of contract entitles you as the innocent party to terminate, so seek advice first.
Manage your risk
Before entering into a contractual relationship with another corporate party, do some basic due diligence:
- carry out an ASIC historical company check which contains a credit rating;
- search the court database for any recent/current disputes;
- undertake a credit search using independent credit agencies such Dun and Bradstreet or Equifax;
- carry out a PPSR search to ascertain any current securities against the company and understand the level of risk.
Depending on the nature of the contract, consider stricter payment controls or step in rights. Consider entering into securities that may be registered with the PPSR to provide you with additional rights upon insolvency.
Seek legal advice before terminating a contract, otherwise you are at risk of unlawfully terminating the contract and potentially liable for a claim against you in damages.
Reliance on content the material distributed is general information only. The information supplied is not and is not intended to be, legal or other professional advice, nor should it be relied upon as such. You should seek legal or professional advice in relation to your specific situation.