Contractual rights to be unenforceable when linked to insolvency events

23 February, 2017

The insolvency regime in the Corporations Act 2001 (Cwlth) has been amended to restrict the rights of parties to enforce ipso facto clauses in contracts.

These clauses typically allow a party to terminate or exercise other contractual rights if the counterparty enters into an insolvency. The amendments are intended to protect financially distressed businesses dependent on key contracts that are looking at potential restructure, turnaround or sale.

Contractual rights to terminate will not be prohibited by the amendments. However, a party will be unable to enforce any contractual right for the reason that the counterparty has entered into voluntary administration, a receiver or other managing controller has been appointed or a scheme of arrangement has been announced.

The stay on enforcement does not apply in certain circumstances such as where:

  • the contract is of a type exempted under the regulation
  • the contract was made after the commencement of the formal restructure
  • the liquidator, administrator or scheme administrator consents to enforcement of the right
  • the company is in liquidation without first going into voluntary administration.

The duration of the stay on enforcement is set out in the legislation.

The amendments will apply to new contracts from the commencement date 1 July 2018 unless the amending Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cwlth) is proclaimed earlier.

Ipso facto clauses could be misleading about parties’ rights and any attempt to exercise an unenforceable right to terminate could result in liability for wrongful repudiation of the contract.

Practitioners will need to review their precedent documents and consider the potential enforceability of contractual rights in light of the changes.