Terminating for insolvency? A temporary stay may apply

Construction contracts frequently allow the principal to terminate when it appears the contractor may become insolvent. Reforms to the Corporations Act 2001 (Cth), coming into operation on 1 July 2018, will impact on the ability to exercise those rights.


The legislation follows recommendations made by the Productivity Commission and will operate to put a ‘stay’ on the exercise of rights in those clauses (termed ‘ipso facto’ clauses) in certain circumstances. These changes aim to increase the chances of a potentially insolvent company successfully restructuring.


Ipso facto clauses are, broadly speaking, mechanisms altering the operation of a contract following the occurrence of certain specified events. In the context of construction contracts, ipso facto clauses are generally used to give a principal a right to terminate when the contractor becomes the subject of an insolvency event.


Key Provisions


The new provisions render the rights in ipso facto clauses unenforceable during specified periods, to allow the insolvent party the chance to restructure. Broadly, a stay will automatically apply to the exercise of rights in ipso facto clauses if they would be triggered by (among other things):


[if !supportLists](a) [endif]a company announcing it will enter into, or actually entering into, a scheme of arrangement;

[if !supportLists](b) [endif]a company appointing a managing controller over its property;

[if !supportLists](c) [endif]a company entering into administration; or

[if !supportLists](d) [endif]the company’s financial position under certain circumstances.


Limitations


The length of the stays applied under this regime vary depending on the triggering event. The stay will, for example, come to an end three months after the announcement to enter into a scheme of arrangement is made (or if the application is withdrawn), or when the managing controller stands down, or when the company is wound up.


On application to the court, a party can lift the stay if the court is (among other reasons) satisfied that it is in the interests of justice to do so.


For more information, the amending legislation (the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth)) is available here.

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