The Devil’s in the Detail - an update to the impact of ipso facto laws

Following on from part 1 of our series of updates titled “The Devil’s in the Detail”, this Property and Leasing Update continues to explore some of the Exemptions that may apply to the ipso facto “stay” provisions in the context of property related transactions. If you missed part 1, click here.

Relevant terms:

  • Act Corporations Act 2001 (Cth)
  • Amending Act Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth)
  • Amending Regulations Corporations (Stay on Enforcing Certain Rights) Regulations 2018 (Cth) together with an explanatory statement
  • Declaration Minister’s Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (Cth) together with an explanatory statement
  • Exceptions those agreements, arrangements and contracts that are excepted from the automatic “stay” provisions under ss 415D, 434J and 451Eof the Act)

Sale of Business

This Exemption also includes securities and financial products as specified under the previous update, but is much wider.

The objective appears to be that it is preferable for a purchaser of a business, where the seller becomes “insolvent” after the contract date, to terminate the sale contract rather than reducing the sale price, which may be the only option if the “stay” proceedings were to be effective.

If the sale contract is terminated, the business would then be able to complete the insolvency or restructuring process, with the intent to continuing to operate or sold with the external administration (at least as to that asset) having been finalised by completion. It is expected that in this instance, the business could achieve a higher sale price than under the initial contract.

Although the explanatory statement to the Amending Regulations sets out this example, this Exception is not restricted to such circumstances.

Often, for tax and other purposes, a “person” that owns the land from which they operate their business will hold the land and business in two different entities. The business entity leases the property from the land holding entity. As a consequence, a sale of the business will often include a sale contract for the land (or alternatively, a lease or assignment of lease) and a sale contract for the business. A sale of land contract is not included in the Exemptions.

In these instances, the two contracts will be conditional upon each other and include a term where upon the termination of one contract, the other contract automatically terminates.

If the sale of business contract was to terminate due to an insolvency event of the seller, we do not anticipate that the land sale contract (or lease/assignment of lease) could not be terminated, providing the contracts are conditional upon each other. Often, the land is required for the continued operation of the business. There is case law that accepts this point, albeit related to the question of GST1. However, there is no legislative or judicial guidance at this point in time that these new laws will permit the termination of a related “non-excepted” contract based on the termination of contract that may be terminated under an ipso facto clause.

Anti-avoidance

If parties include “creative” clauses to circumvent the intended application of the stay, it is unlikely that those provisions will be enforceable. The Amending Act provides that the “stay” provisions will extend to a right that is exercisable for “a reason that, in substance, is contrary to this subsection2.

Other Securities and Alternatives

Parties to contracts and agreements where the ipso facto clauses are unenforceable may need to consider taking alternative forms of security, such as bank guarantees. Personal or alternative corporate guarantees may also be warranted. However, those ipso facto stay provisions will apply if a guarantee entity becomes insolvent.

The right to set-off under an agreement is an Exception and will be of benefit in certain arrangements where each party is obliged to pay the other monies from time to time. This may include under a lease where a refund, say for over estimated outgoings, is due to the tenant who is “insolvent”.

Further, if an ipso facto provision in a contract would have applied but for the “stay” provisions, enforcement rights for another breach or default may be enforced.

Another option for additional rights upon an insolvency event, is the inclusion of charging provisions (including from any guarantors). An equitable chargee is a secured creditor. If the charge extends to real property, a caveat should be lodged. Any interest in personal property should be registered on the PPSR.

The Declaration confirms that the right to appoint a controller is an Exception, so that the rights and priorities of the secured creditors are not affected.

Instances where solvent party may suffer losses and cannot mitigate

However, in some instances this will be insufficient to offset the losses suffered by the “solvent” party due to its inability to terminate a contract because of the other party’s insolvency. A situation where we can envisage this scenario applying is where a landlord has entered into an agreement for lease (AFL) and lease and under the AFL the landlord is obliged to construct the premises for the tenant.

If prior to, or during, the construction phase the tenant becomes insolvent, the landlord would be required to continue to comply with its obligations under the AFL, which could include expending money for development approvals and construction.

Because the tenant has minimal obligations during this period, the tenant is unlikely to be in breach of another term of the AFL. A landlord could suffer significant losses and would unable to mitigate some of those losses, on the basis that it cannot terminate the AFL and procure a new tenant. The landlord also may be obliged to continue with the construction of a premises that was bespoke to that particular tenant and not suitable to a large pool of alternative tenants.

If, in the situation of an AFL and/or lease, the tenant is undertaking the construction of the fitout works, step in rights should apply (at the landlord’s option) on the occurrence of an insolvency event of the tenant. Step in rights are an Exception. Step in rights may also apply to a joint venture or project management agreement.

Similar issues arise for sellers of off the plan sale contracts and sale of the land contracts with an extensive period between contract date and settlement.

Statutory options

Although the administrator, receiver or scheme administrator could agree to terminate a contract, we do not expect this to occur regularly. During the “stay” period, the insolvent party is not suffering any significant loss or detriment.

The final option is for the “solvent” party to apply to the court for an order that the “stay” does not apply to the contract. If successful, the contract could be terminated under the relevant ipso facto clause. Again, there is no substantive direction in the legislation or case law as to how to apply for such and order and the likelihood of success.

Conclusion

We do not expect the Amending Act, Amending Regulations and Declaration to be the last legislative documents to these reforms. The law around these reforms will continue to develop, from the courts and the legislature. You should be considering if these ipso facto clauses apply in relation to almost every agreement, arrangement and contract you consider entering into. We are here to assist you.

 

01 August 2018
Property Updates
AUTHOR
Peter Beekink
Partner
AUTHOR
Anka Burns
Special Counsel