Stuck on a sinking ship? New restrictions on enforcing ipso facto insolvency clauses

So-called “ipso facto” (‘by the fact itself’) insolvency clauses are contractual provisions that allow a party to unilaterally amend, suspend or terminate a contract where a contract-partner becomes insolvent or is placed into administration, receivership or liquidation.  Widely used in transport and logistics contracts including charter parties, contracts of affreightment, terminal services agreements and freight contracts, such clauses provide a level of protection to a contracting party by allowing it to cease supplying goods or services, or to otherwise exercise certain rights under a contract (such as calling on a bank guarantee), in circumstances where a contract-partner’s precarious financial position makes it unlikely that the former will ever be paid.

However, ipso facto clauses are controversial as the termination of contractual obligations under such circumstances, particularly by parties providing services, will often consign a company in financial distress to certain failure.  As was arguably the case with the dramatic collapse of Hanjin Shipping last year, for example, the suspension or termination of key contracts can often cause irreparable damage to a distressed company’s balance sheet thereby making it difficult or impossible for that company to trade on as a going concern or to successfully restructure its operations.

From 1 July 2018, and in an effort to give companies a better chance to recover from financial hardship, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) will amend the Corporations Act 2001 (Cth) to impose a “stay” on the enforcement of ipso facto clauses in new contracts (and of any provision in a new contract that is, in substance, an ipso facto clause) in certain circumstances.  The new provisions will effectively prevent a party from enforcing a contractual right to amend, suspend or terminate solely because a contract-partner enters into a scheme of arrangement, voluntary administration or receivership.

It is worth noting that the stay will not be applicable in circumstances where a contract-partner either appoints managing controllers or goes straight into liquidation.  Furthermore, the stay will only operate whilst the scheme of arrangement, voluntary administration or receivership is ongoing and will cease once an application is made to have the company in question wound up.  Finally, despite the operation of the statutory stay, a party will generally still maintain any “non-ipso facto” rights to terminate or amend an agreement for any other reason, including for convenience or for a material breach involving non-payment or non-performance.

While the above reforms have been long awaited by certain sectors and mirror the position in other jurisdictions (including, most notably, the United States), it is clear that transport and logistics operators will need to be more vigilant than ever in their due diligence to avoid becoming stuck on, and unable to abandon, a contract-partner’s sinking ship.

For more information on the above, please contact the Thomas Miller Law Sydney Office.