FINSights: Insolvency shake-up to impact financiers

5 mins 28.06.2018

Some of the most far-reaching Australian insolvency law changes are taking effect. These new laws will restrict the enforceability of a whole class of common clauses in contracts –so called 'ipso facto' clauses.

In this edition of FINSights, we explore what these changes mean for financiers, and outline key tips and issues they should consider as we move forward into the new regime.

What are ipso facto clauses?

Clauses that allow one party to terminate or modify a contract when a specific event occurs, regardless of continued performance by the other party. Examples include rights to:

What circumstances restrict enforcement?

You cannot enforce a right under an ipso facto clause if the right arises from the trigger events noted below. Ipso facto clauses triggered by any of these events are ‘stayed’.

The Trigger events are:

Voluntary administration;
Receivership over all assets;
Creditors’ scheme of arrangement; and
Events related to the party’s financial position (if any of 1 to 3 above has also occurred).

The new law is not a reason to remove ipso facto clauses from finance contracts. They will still work, absent a current trigger event.

Why?

Intended to give companies breathing space to implement a restructuring plan
Supports VA work out regime by preventing termination of vital contracts during administration

When?

Stay applies to ipso facto clauses in contracts which are entered into on or after 1 July 2018
Does not apply to contracts made before 1 July 2018

Exclusions

Carve outs by regulation or declaration:

Drawstop

A lender is not obliged to fund an undrawn commitment under a facility agreement while a stay is in place.

Negative pledges

A simple negative pledge restriction (for example not to grant security) should not be affected.

What financing clauses will be affected?

Default rights arising from:

Insolvency
Financial covenant breaches
Rating downgrades
Material Adverse Event (if related to financial position)
(sometimes) Cross default

Affecting default rights to (among others):

Accelerate debt or enforce security
Terminate a lending commitment
Revalue an asset
Apply insurance proceeds in debt reduction
Lock up distributions and equity returns

Tips and issues for financiers to consider

Competing debt: does your borrower have any facilities or note issues that will notbe stayed (eg pre-July debt)?

Default events: are there critical events which should be defaults, unrelated to the borrower’s financial position?

Revolving facilities preferred: rollover loans need not be readvanced (potentially giving rise to a payment default).

Syndicated loans: syndicated loans exempted.

Special purpose vehicles: contracts with SPVs in securitisation and project finance transactions exempted. Structure accordingly!

Security considerations:

Cash retention accounts effectively exempted, and should be able to be accessed during a stay.
All asset security has significant advantages.

New rules will also apply to trustee borrowers (even if the trust is not affected by trustee insolvency).

Third parties: Termination of contracts with third parties (builders, lessees, purchasers etc) more difficult.

Contact

Tony Berriman

With more than 20 years' experience in the field Tony Berriman is a leading practitioner in corporate and property finance, acting primarily for financiers and arrangers. He heads the firm’s Property Finance practice.
Michael Hughes

With more than 30 years experience, I have developed a specialist practice in insolvency and reconstruction, security enforcement and commercial litigation. I have an extensive experience in high, federal and state courts, tribunals, arbitrations and alternative dispute resolution processes.