Insights / March 20th, 2023

Clear as mud? Ipso facto provisions explained for the first time

For the first time, a higher court has provided guidance on the operation of the ipso facto provisions. The reasoning raises new questions and may have significant effects on contract drafting.

This article considers the recent decision of In the matter of Citius Property Pty Ltd (Administrator Appointed) [2023] FCA 26.

“Ipso facto” provisions

Commercial contracts frequently include clauses known as “ipso facto” provisions. Such clauses provide a contractual right for one party to terminate the agreement upon defined certain “insolvency events” occurring, regardless of the counterparty’s performance of its obligations under the contract.

A series of provisions of the Corporations Act 2001 (Cth) (Act) affect the enforceability of “ipso facto” provisions in cases of schemes of arrangement, administration and small business restructuring. Until now the operation of these provisions has not been considered by a higher Court.

Section 451E (which applies to administration) in summary provides that any rights in a contract entered into by a company after the provisions took effect cannot be enforced against the company for the reason that the company has entered or is under administration and/or its financial position whilst in administration. This stay will apply until the later of, usually, the administration ends or if the administration ends because of a resolution or order for the company to be wound up – when the company’s affairs have been fully wound up.

The Case

The Administrator brought the application primarily to obtain orders extending by a significant period the convening period under s 439A so that the company, which provided consulting services in property development, could complete its obligations under a contract and therefore receive full payment under the contract. The extension, it was submitted, would result in a better return to creditors because liquidation would have followed otherwise. The importance of obtaining an extension was that the longer the company was in administration (before a second meeting needed to be convened), the longer the stay of enforcing the “ipso facto” clause could apply.

The facts are somewhat unusual as the counterparty was informed of the application but did not take part, the company had few if any non-director employees and the individual consultant working on the project governed by the contract (who was a creditor) indicated a willingness to keep working in the administration period.

The Administrator also sought orders concerning the operation of s 451E. The Administrator submitted that the stay regime on its face was available to companies in administration that transition to liquidation, but not to companies that are liquidated without first having been in administration.

The relevant contract contained an “ipso facto” clause pursuant to which the counterparty was entitled to immediately terminate the agreement by written notice to the company upon the occurrence of certain events, including an “Insolvency Event”. “Insolvency Event” was defined in the agreement as including “tak[ing] any step to obtain protection or is granted protection from its creditors, under any applicable legislation or an administrator is appointed”.

Interpretation of s 451E

Despite there having been industry-level uncertainty about the operation of s451E, the Court considered the language and purpose of the section was “clear on its terms”.

The Court considered s451E “operates to restrain a counterparty from exercising rights arising in a contract, agreement or other arrangement by reason of the fact of a company’s entry into administration or its financial position during the period of administration. The stay operates for the length of the administration and, if the administration concludes because of a resolution or order for the company to be wound up, until the winding up is complete”.

The Court found that s 451E did not apply to contractual rights that arise by reason of winding up and that if a counterparty has a right to terminate a contract by reason of the company’s entry into liquidation, s451E does not operate to prevent such termination.

The stay only applies to a right that arises by reason of the entry into administration or the company’s financial position during administration. The operation of clauses allowing termination on such grounds (administration and financial position) continue to be stayed during a subsequent liquidation.

Practical effect

On one level, the Court’s decision not to make an order as to the operation of the stay is unsurprising. If a company proceeds to liquidation it seems unlikely that a counterparty would rely on an earlier administration (or the financial position of a company during administration) as a basis to terminate, though this depends on individual drafting. In our experience, most clauses would be detailed enough to provide for termination based on liquidation where liquidation followed administration.

What is perhaps more interesting about the case is how the administrator has shown that the administration procedure, coupled with the stay, can be used to create much longer trade on appointments for the benefit of creditors where the factual background to the administration suggests that it may be the most appropriate course.

For further information in relation to this topic, please get in touch with our Insolvency & Turnaround team.

This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice. You should not act upon the information contained in this publication without obtaining specific professional legal advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.