Ipso Facto Clause Amendments – Simple Precautions to Protect Your Business

Construction Litigation

Upcoming Corporations Act amendments affect “ipso facto” clauses. That is, provisions which allow parties to terminate if external administrators are appointed to the other party.

Below we discuss what these amendments are and how some practical steps will help protect your business.

What’s an Ipso Facto Clause Anyway?

I never would have predicted that I was going to write an article with the words “ipso facto” in it as often as this one will. But since the legal industry in its infinite wisdom has decided that Latin isn’t as dead as everyone thinks, I guess we’ll go with that. Sorry.

Relevantly for us, an ipso facto clause is a provision that allows one party to terminate if the other party experiences an “insolvency event”.

An Example Ipso Facto Clause

Here’s a common example from the construction industry, plucked from AS4902-2000:

39 – Insolvency

If:

a) a party informs the other in writing, or creditors generally, that the party is insolvent or is financially unable to proceed with the Contract;

b) execution is levied against a party by a creditor;

c) a party is an individual person or a partnership including an individual person, and if that person:

i) commits an act of bankruptcy;

ii) has a bankruptcy petition presented against him or her or presents his or her own petition;

iii) is made bankrupt;

iv) makes a proposal for a scheme of arrangement or a composition; or

v) has a deed of assignment or deed of arrangement made, accepts a composition, is required to present a debtor’s petition, or has a sequestration order made, under Part X of the Bankruptcy Act 1966 (Cwlth) or like provision under the law governing the Contract; or

d) in relation to a party being a corporation:

i) notice is given of a meeting of creditors with a view to the corporation entering a deed of company arrangement;

ii) it enters a deed of company arrangement with creditors;

iii) a controller or administrator is appointed;

iv) an application is made to a court for its winding up and not stayed within 14 days;

v) a winding up order is made in respect of it;

vi) it resolves by special resolution that it be wound up voluntarily (other than for a member’s voluntary winding up); or

vii) a mortgagee of any of its property takes possession of that property,

then, where the other party is:

A) the Principal, the Principal may, without giving a notice to show cause, exercise the right under subclause 39.4(a); or

B) the Contractor, the Contractor may, without giving a notice to show cause, exercise the right under subclause 39.9.

The rights and remedies given by this subclause are additional to any other rights and remedies. They may be exercised notwithstanding that there has been no breach of contract.

The reason it matters is that you don’t need to establish any kind of breach other than the happening of the event. So even if the other party was completely fine to complete the contract, you could terminate anyway.

That’s about to change, but the downside is manageable if you take some practical steps.

What’s Changing for Ipso Facto Clauses?

As of July 2018, you won’t be able to use an ipso facto clause to terminate your contract when administrators or receivers and managers are appointed to the other party, or it enters into a scheme of arrangement.

The way its phrased at the moment, you would be “stayed” (that is, lawfully prevented) from exercising your rights to terminate, whether because of the insolvency event or because of the surrounding financial position of the company.

That prohibition is going to apply whether your rights to terminate are found in contract or in a piece of legislation somewhere.

What’s the Concern About the Ipso Facto Changes?

There are a few big concerns:

  1. Subcontractors will be forced to keep working for contractors who can’t pay;
  2. Contractors will be forced to keep working for developers who can’t pay;
  3. Developers will be forced to continue an engagement with contractors who are financially unable to complete the job.

These concerns are less grave than they might seem on the face of it.  Below we explain why.

You Can Still Terminate On Other Grounds

The changes make no difference to your ability to terminate during a company’s insolvency – they simply affect the grounds on which you can do it.

If you can establish an actual breach of contract (other than the insolvency event or financial position) that gives rise to a right to terminate, then nothing will stop you from lawfully doing that.

Although you’d obviously have to check your contract, some common examples of other reasons to terminate might include:

  • Abandonment of the site;
  • Previous failures to pay outstanding invoices;
  • Failure to complete on time or progress the works;
  • Failure to follow site directions;
  • Failure to rectify defects;
  • Failure to obtain government approval;
  • Failure to supply materials by a particular date.

If none of those work, and you can’t find another ground of termination, then take some comfort from the following points.

Not Applicable to Liquidation

Here are three more common types of insolvency event:

  1. The appointment of administrators
  2. The appointment of receivers and/or managers
  3. The appointment of a liquidator.

The ipso facto changes only apply to 1 and 2, and to schemes of arrangement which we’re not going to talk about much here.

Why is this important? Because each of these 3 different type of insolvency events are unique and arise in different circumstances as discussed here.

The result is that the the risks to you as the “solvent” party when contracting with a company in receivership or administration is much lower than you might think.

Administrators Have to Foot the Bill

For a company in administration, the administrators will generally be liable for debts they incur after their appointment.

That is: personally liable.

And in the land of accountants and lawyers, you can probably imagine how cautious administrators are about incurring personal liability, can’t you? The chances that John and Mary, the administrators of company X, are going to engage you to do something that they can’t afford to pay for is extremely low.

Here’s section 443A of the Corporations Act which spells it out:

(1)  The administrator of a company under administration is liable for debts he or she incurs, in the performance or exercise, or purported performance or exercise, of any of his or her functions and powers as administrator, for:

(a)  services rendered; or

(b)  goods bought; or

(c)  property hired, leased, used or occupied, including property consisting of goods that is subject to a lease that gives rise to a PPSA security interest in the goods; or

(d)  the repayment of money borrowed; or

(e)  interest in respect of money borrowed; or

 (f)  borrowing costs.

 (2)  Subsection (1) has effect despite any agreement to the contrary, but without prejudice to the administrator’s rights against the company or anyone else.

Receivers Have to Foot the Bill Too

This one is a little more complicated, and you should take some precautions to ensure that the receivers are paying your invoices if you might get engaged by them.

However, often receivers and managers who contract parties to complete works will be personally liable for the debts they incur.

Sometimes a bit of complexity can arise with pre-existing contracts, so you want to ensure that any post-receivership work is transparently and expressly being funded by the receivers, not the company.

By this, I mean that you should actually email the receivers or write to them, and get their signed agreement that :

in the event that Company X cannot or does not pay our invoices issued for works on and from date, the receivers and managers accept that they will be personally liable for those invoices as debts due and owing from the receivers and managers to us

or something along those lines (as you’d expect, that’s not legal advice catered to your circumstances – get proper advice and don’t rely on general comments in website articles).

Here’s section 419 of the Corporations Act. It’s a bit ugly but spells out the liability of the receivers:

A receiver, or any other authorised person, who, whether as agent for the corporation concerned or not, enters into possession or assumes control of any property of a corporation for the purpose of enforcing any security interest is, notwithstanding any agreement to the contrary, but without prejudice to the person’s rights against the corporation or any other person, liable for debts incurred by the person in the course of the receivership, possession or control for services rendered, goods purchased or property hired, leased (including a lease of goods that gives rise to a PPSA security interest in the goods), used or occupied.

Simple Precautions

You shouldn’t read this article and think that you’re risk free when it comes to dealing with companies in financial distress.

In the land of construction litigation, one of the most common causes of problems is when someone assumes something.

Don’t assume anything.

If a company that you’re contracting with goes into administration, receivership or liquidation, the best thing you can do is to ask questions, get things in writing, and make sure that there are no assumptions.

If people are dancing around your questions or saying things like “don’t worry it’ll all be sorted out” then alarm bells should go off in your head and you should insist on answers to your queries.

The same general principles apply even when dealing with companies in financial distress, whether or not anything formal has been done.

Put it this way – would you rather ask questions that might seem to be simple, or would you rather clock up a huge pile of invoices that never get paid?

Or give us a call and we’ll help you out.

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