Insolvency Initiatives: Changes to Bankruptcy and ‘Ipso facto’ Termination Clauses
Two weeks ago we covered the government's proposed changes to insolvency laws in 2017, with particular focus on the slated introduction of a 'safe harbour' for company directors facing insolvency. The crux of the proposal was to give businesses more maneuverability and options during insolvent trading by offering limited protections to directors from personal liability if they accepted business restructuring advice from accredited professionals.
Further proposals have also been announced, in line with the government’s agenda to promote business activity and increased innovations in the Australian economy, including:
Reducing the period of bankruptcy from three years to one year.
Restricting the enforceability of ‘ipso facto’ clauses, that would otherwise allow one party to terminate a contract upon the occurrence of an insolvency event to the counter-party (in circumstances where that counter party is undertaking a restructure).
Reducing the period of bankruptcy is proposed for the purpose of encouraging entrepreneurship by softening the consequences of business failure for sole traders and partners. The reduction will also help to reduce the stigma associated with declarations of bankruptcy, allowing individuals to re-enter the market at a faster rate, aiming to support rather than punish failed business ventures. A recent report by the Productivity Commission asserts that business-related bankruptcy makes up approximately 20% of all bankruptcies in Australia.
‘Ipso Facto’ Termination Clauses
‘Ipso facto’ refers to ‘by the fact itself’ and within the context of termination clauses; allows a party to immediately terminate a contract against another party upon the occurrence of an insolvency event.
Restrictions on the enforcement of ‘ipso facto’ clauses will be a completely new feature within Australia’s corporate insolvency landscape. However, there exists extensive experience in the United States (and other jurisdictions) of similar restrictions, and an equivalent restriction on termination rights already exists in Australia’s personal insolvency laws (as opposed currently to business insolvency).
The proposed reforms at this stage leave many questions unanswered. Arguably, the largest question is whether or not, if ipso facto clauses are rendered unenforceable, counterparties could build in contractual protections to permit the renegotiation of key terms on insolvency (for e.g. by swapping from existing supply terms to cash on delivery or cash on account). This aspect of the recommendation will require careful consideration prior to the implementation of any legislation.
A proposal paper covering these insolvency and bankruptcy initiatives is expected in 2016, with legislation expected to pass in mid-2017 according to the Turnbull Government’s scheduling.