Latest round of corporate insolvency reforms in Australia may have significant consequences for financiers

In brief…

The Australian corporate insolvency regime is undergoing significant reform. A suite of new amendments hasbeen implemented or proposed. The new ipso facto amendments that have been implemented as part of the second wave of reforms apply to all contracts entered into after 1 July 2018 unless they are specifically excluded.¹

The primary purpose of the ipso facto reforms is to prevent a counterparty terminating a contract when a company is implementing a formal restructure or is the subject of certain insolvency processes. However, the reforms are not limited to termination and will impact all contracts and contractual rights that are not excluded from the new regime. Financiers should be actively reviewing their standard form agreements and the structure of their facilities and security.

Background

An ipso facto clause allows one party to terminate, modify or exercise other contractual rights upon the occurrence of a specified event (ie, an insolvency event). Examples include the ability to charge default interest, accelerate a loan on default or terminate a lending commitment.

The aim of the amendments is to allow breathing space for a company to continue trading during a formal restructure. Ipso facto termination rights have historically been problematic for the sale of a distressed company or forthe facilitation of a formal restructure. The agreements in place with the company are generally fundamental to the underlying value of the business, and accordingly, ipso facto clauses have been criticized for reducing the scope for a successful restructure, destroying the enterprise value of a business entering formal administration and preventing the sale of a business as a going concern.

Overview of amendments

The ipso facto amendments will apply where a counterparty enters certain insolvency processes, including administration, the appointment of a managing controller (including a receiver and manager) to the whole or substantially the whole of a counterparty’s property, or where the counterparty pursues or announces a scheme of arrangement (together Processes).

If a counterparty is subject to one of the Processes, then a party to a contract will not be able to rely on any contractual rights that arise by reason only:

• That the counterparty has entered one of the Processes
• Of the counterparty’s financial position while it is in one of the Processes
• Of a reason prescribed by regulations, or
• Of a reason that, in substance is contrary to the above

Exclusions

Counterparties will retain the right to terminate a contract for any other reason, including non-payment or non- performance.

Certain contracts have been excluded from the operation of the ipso facto amendments.² Accordingly, all contractual rights (including acceleration and termination rights) under those excluded contracts will still be enforceable. Without being exhaustive, exclusions include syndicated loans, derivatives (including the ISDA master agreement), close-out netting contracts and approved netting arrangements, flawed asset arrangements, margin lending facilities, certain contracts involving a special purpose vehicle and covered bonds.

Certain contractual rights have also been excluded from the operation of the ipso facto amendments and will therefore remain enforceable.³ However, the balance of the contract will be subject to the stay. Without being exhaustive, contractual rights that have been excluded from the stay include termination rights in a standstill or forbearance arrangement, uplift clauses, indemnification clauses (relating to the default), flip clauses, rights of set-off and assignment and novation rights.

Where a financier holds security and a controller has been appointed to an asset of a company in a process, thenthe financier is likewise entitled to appoint a receiver or controller. This is to ensure that the priority of secured creditors is not disturbed by the ipso facto amendments and to avoid a situation where there is a race to appoint a receiver or controller.

Of special mention

Financiers’ obligation to advance funds and roll over loans

Where a financier is precluded from exercising its rights against a borrower under the ipso facto amendments, the financier will not be obliged to comply with an obligation to provide the borrower with ‘a new advance of money or credit’. This is designed to protect financiers from being bound to advance further funds to a company that has entered certain insolvency processes.

The term ‘new advance of money or credit’ is not defined. Consequently, the scope of the stay is open to interpretation and will likely attract judicial consideration. We anticipate that a financier would not be required to continue to advance funds within the limits of an overdraft facility or honor other undrawn commitments under term or revolving facilities.

However, there is more uncertainty in respect of certain roll-over loans under revolving facilities. A roll-over loan is a loan under a revolving facility where the new advance or loan is made to repay a previous advance or loan on its repayment date (being the last date of its interest period). If the facility does not include standard cashless roll-over language, the full amount of the advance or loan may be repayable on the repayment date and the new advanceis used to repay the first advance. It is not clear how the added protection would work given that technically on the repayment date, there is a new advance of money to repay the existing amount. But as a matter of practice there is merely a rolling over of the existing loan on the same or different terms. If the financier was not bound to make a new advance, then the full amount of the loan would be due and owing on the repayment date. If that amount was not paid then this would give rise to a non-payment default which is not subject to the ipso facto stay.

Cross-collateralized facilities

Surprisingly, the ipso facto amendments do not provide any specific direction in respect of cross-collateralized facilities made available to a number of companies in a group as borrowers and guarantors. Generally, if one company in a group enters into an insolvency process, then it is an event of default enforceable against all of the companies in the group. The ipso facto amendments are silent as to the impact of the extension of the stay in respect of the other companies in the group under the cross-collateralized facilities. On a strict reading of the ipso facto amendments, the stay would not extend to the other companies in the group. That would have the odd effect of the financier having the right to terminate the facility (and accelerate the loan) against other companies in the group while the arrangement with the company in the insolvency process would be on foot.

A similar issue arises in respect of guarantees where the other companies in the group have guaranteed the obligation of the company in the insolvency process.Previously, where one company entered into an insolvency process, the financier could accelerate the debt against that company and then pursue the other companies in the group under the guarantees for an amount that is due and payable by the company. However, a financier will now be precluded from accelerating the loan against the company in default. Accordingly, the principal debt will not be due and owing and as a result there would be no debt to call on under the guarantee.

The effect of the ipso facto amendments is somewhat mitigated because if there is a default under the loan for non-payment, the financier will be able to accelerate the loan based on the non-payment default. The financier could then pursue the guarantors for the accelerated debt which would be due and owing by the company under the facility. We note that there are still limited rights to accelerate a debt for the purpose of set-off.

It will be important to consider whether any additional contractual rights could be incorporated into the facility and associated security, including guarantees. Further, as syndicated loans are exempt from the stay, financierscould be incentivized to structure the loan with more than one financier.

Next steps

Prudent financiers entering into any contract with an Australian company should obtain advice as to the implication of the new ipso facto amendments and whether they will apply. The new ipso facto amendments may apply to the agreement or facility even if it is governed by the law of another jurisdiction by way of a choice of law clause. We recommend that financiers consider how they best structure their facilities to improve their position going forward.

¹ The ipso facto amendments are set out in the Treasury Law Amendment (2017 Enterprise Incentives No.2) Act 2017 (the Amendment Act) which inserts additional provisions to Chapter 5 of the Corporations Act 2001 (Cth). Chapter 5 governs the external administration of companies in Australia.
² Set out in the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018.
³ Set out in the Corporations (Stay on Enforcing Certain Rights) Declaration 2018.