Right to terminate contracts for insolvency
“Ipso facto” clauses are clauses which allow a party to terminate a contract if the other party suffers an insolvency event. These provisions are enforceable even if the insolvent party has otherwise continued to perform its obligations under the contract.
Some important reforms came into force on 1 July 2018 which restrict the operation of ipso facto clauses. The right to terminate (or to enforce security) is now not enforceable to the extent that it is triggered by a party suffering an insolvency event (such as entering into administration, appointing a receiver, or implementing a scheme of arrangement). The non-enforcement period lasts from the date of appointment of the receiver or administrator until the administration or receivership ends.
The intention is to promote business turnaround and recovery by assisting businesses to continue to trade when they find themselves in financial difficulty. By preventing the termination of trading relationships in these circumstances, the reforms should help businesses to retain their enterprise value and increase the likelihood of a sale of the business as a going concern.
Note that the actual right to terminate or amend an agreement for non-performance or default remains enforceable notwithstanding the new rules. The new rules apply only to contracts entered into after 1 July 2018, and there are also quite a few exemptions which have broad application to commercial agreements. These include:
- Contracts relating to the issue of securities or the sale of a business
- Contracts where the controller consents
- The right of indemnity for certain costs
- Step-in rights under certain contracts (such as construction contracts and long term services contracts)
- Set off, assignment and novation rights.
It is probably a good idea to use a modified version of your existing ipso facto clauses in any new agreements, and if you want to avoid the restrictions in relation to contracts entered into before 1 July, you can seek to extend, vary, novate or assign the rights under existing contracts (rather than enter into new ones), as the existing agreements will not be affected by the new rules.