25 June 2018

Are your rights enforceable? From 1 July 2018 onwards you will need to check this carefully…

This article was written by Tim Klineberg and Carone Huang.

The new ipso facto reform will commence on and from this Sunday, 1 July 2018.

Rights in contracts, agreements and arrangements entered into on or after 1 July 2018 will be unenforceable against companies in one of the three specified procedures. The three specified procedures are voluntary administration, schemes of arrangement (to avoid insolvent liquidation) and substantial receiverships. [1]

There are carve outs for specific contracts and rights, to which the reform does not apply – the specific contracts that are carved out were recently confirmed in the final form of the Regulations released last week. [2] Rules are expected to be announced in the near future, which will expand the carve outs to specified types of rights. [3]

Hear Tim Klineberg discuss these reforms via podcast or read on below. 

Key implications

  • The new ipso facto regime will apply to arrangements entered into on or after 1 July 2018.
  • The status quo will continue to apply to contracts specified in the Regulations and rights to be specified in the Rules. Other contracts and rights will be subject to the new ipso facto regime.
  • There is a 5 year transitional period for variations or novations of pre-1 July 2018 arrangements. The variations or novations of these arrangements entered into before 1 July 2023 are carved out.
  • The Regulations defer the starting date of the ipso facto regime for building work, construction work or related arrangements with total payments of at least $1 billion until 1 July 2023.
  • Syndicated loans, bonds and promissory notes are exempt and lender rights under those arrangements will remain enforceable. Bilateral facilities and bonding/bank guarantee facilities may be subject to the new ipso facto regime.
  • The long list of carve outs and directly connected arrangements means the status quo, rather than the new ipso facto regime, will continue to apply to many commercial arrangements.
  • It will be important to consider the carve outs and the Rules when structuring and documenting transactions.

Carve outs

Contracts specified in the Regulations (and rights to be specified in the Rules) are not affected.

Broad carve outs apply to certain debt capital markets arrangements, including syndicated loans, bonds, promissory notes and derivatives.

The status quo continues to apply to mergers and acquisitions related arrangements. Examples include business sale agreements, security underwriting or subscription agreements, rights issues and financial investment management arrangements, which are carved out.

These carve outs demonstrate the importance of international debt and equity markets to the Australian economy and business. The explanatory statement accepts that certain ipso facto rights are “inherent to the operation” of certain contracts and “markets have evolved” to depend on such rights. [4]

For contracts or rights that are not carved out in the Regulations or the Rules, there will be significant restrictions on the enforceability of certain rights during one of the specified procedures.

Where ipso facto applies

Key operating contracts are affected, in particular contracts for the supply or purchase of goods or services. The reforms will make it easier for businesses to secure continued supply and continue revenue generating activities while attempting to restructure.

We also see implications for entrenched rights in M&A and option arrangements. Examples include put or call options and conversion triggers under shareholders’ or joint venture agreements and convertible notes. If rights trigger on the entry of a counterparty into one of the applicable procedures, those rights may be unenforceable unless the contract falls within a specific carve out.

These carve outs will require careful review in M&A transactions entered into on and from 1 July 2018.

Policy implications

Whether the reform has struck the appropriate balance between maintaining parties’ freedom of contract and the Government’s original goal of supporting innovation and entrepreneurship by making it easier to restructure distressed businesses remains to be seen.

Given the breadth of the carve outs the reform does not go as far as originally announced. There remain significant reform challenges in the Australian restructuring and insolvency laws which we expect will continue to attract attention from regulators and market participants in coming years.

What the long list of carve outs do emphasise is the importance to a successful restructure of careful planning to ensure that the business is funded to continue to trade. Early engagement with key contract counterparties, including financial stakeholders remains key to achieving good outcomes.

This is not new, but it is a timely reminder of the importance of planning and stakeholder engagement for businesses attempting to restructure, particularly for those using one of the applicable procedures.

What this means for you

To assist your review, we have summarised the key implications for stakeholders in restructuring. Click on a stakeholder group below to see more:

Trading companiesTrading companies

Carve outs in Regulations

Implications of new ipso facto regime

Contracts for the sale of all or part of a business, including share sales

Novation or variations, of pre-1 July 2018 contracts, entered into before 1 July 2023

Code and software escrow arrangements

New regime applies

  • Operating contracts (e.g. contracts for the supply of goods or services) are subject to the ipso facto protection, but contract counterparties can still terminate for other breaches or defaults (e.g. the debtor’s non-payment or non-performance).  Contracts still expire at the end of their term, unless extended. 
  • In administration, administrators remain personally liable for goods and services supplied to them.  They still need access to financing to keep key operating contracts on foot.
  • The ipso facto protection only applies to companies that are subject to one of the specified procedures.  It does not apply to rights that trigger on consensual restructuring, bondholder consent solicitations, execution of deed of company arrangement or rights exercisable against other members of the corporate group.  These rights will need to be suspended or restricted under standstill or forbearance arrangements.
  • Carefully consider whether call/put options, including under joint venture arrangements, or convertible notes have ipso facto protection.

Private equity sponsorsPrivate equity sponsors

Carve outs in Regulations

Implications of new ipso facto regime

Contracts for the sale of all or part of a business, including share sales

Underwriting, or subscription agreements for or agreements to issue securities, financial products, bonds, promissory notes or syndicated loans

Some priority arrangements

New regime applies

  • The extension of ipso facto protection to the operating contracts in the underlying business is expected to be value accretive for sponsors and to improve the bankability of the underlying business.
  • The status quo continues to apply to draw stops in financing agreements.  Sponsors have the option to consider funding the distressed company’s continued operations – any contractual priority for the funding is not affected by the ipso facto stay. 
  • Sponsors should consider whether call options, for example under shareholder agreements, have ipso facto protection.  This could affect the point in the cycle at which Sponsors exit their positions.

Special situations investorsSpecial situations investors

Carve outs in Regulations

Implications of new ipso facto regime

Contracts for the sale of all or part of a business, including share sales

Some priority arrangements

Novation or variations, of pre-1 July 2018 contracts, entered into before 1 July 2023

Rights issues

Underwriting, or subscription agreements for or agreements to issue securities, financial products, bonds, promissory notes or syndicated loans

Limited changes to the status quo

  • There is limited impact on the ability to trade into syndicated positions.  In syndicated credits, debt trading is unaffected – a transfer entered before 1 July 2023 of a pre-1 July 2018 credit does not result in the credit being subject to the ipso facto regime and trading rights that arise following insolvency events of default are still enforceable.  Sale or purchase of business agreements are unaffected – insolvency termination rights are still enforceable.
  • Carefully consider whether rights in convertible notes or call/put options have ipso facto protection.
  • Bridge lending remains unaffected if there are appropriate drawstops or if the lending is to an administrator, scheme administrator or receiver.
  • Bilateral credits written before 1 July 2018 will have a different set of rights to credits written after 1 July 2018 – those written after 1 July 2018 could be subject to the ipso facto protections.  It remains to be seen whether trading of bilateral credits will be protected in the Rules.  See “Financiers” below.

FinanciersFinanciers

Carve outs in Regulations

Implications of new ipso facto regime

Syndicated loans

Bonds and promissory notes

Underwriting, or subscription agreements for or agreements to issue securities, financial products, bonds, promissory notes or syndicated loans

Covered bonds and directly connected arrangements

Tapping issuances

Some priority arrangements

Flawed asset arrangements

Factoring and directly connected arrangements

Margin lending facilities and directly connected arrangements

Limited changes to the status quo for syndicated loans, bonds and promissory notes

New regime applies to other facilities, e.g. bilateral facilities, bonding/bank guarantee facilities

  • Syndicated loans, bonds and promissory notes are carved out of the ipso facto stay.  The application of the new ipso facto regime and the Rules when made to bilateral facilities and bonding/bank guarantee facilities should be considered carefully. 
  • There are a limited number of bilateral lender rights that are carved out of the ipso facto stay, including secured lender rights to appoint receivers during the decision period. 
  • While the stay for the appointment trigger is clear, the ambit of the financial position trigger is unclear and potentially broad.
  • Financiers should consider additional risks that arise from the ipso facto regime, e.g. where termination rights for derivatives are unaffected, the borrower may be left with an unhedged position, and appropriate protections for those risks.  Check indemnity rights are exercisable against other members of the corporate group.

SecuritisationSecuritisation

Carve outs in Regulations

Implications of new ipso facto regime

Arrangements involving special purpose vehicles for securitisation securitisation

Derivatives and directly connected arrangements

Some priority arrangements, including flip clauses

Factoring and directly connected arrangements

Limited changes to the status quo

  • SPV is not defined, but the explanatory statement describes this as a company, trust or partnership “with no business record” and “created to carry out a specific business purpose or activity”. 
  • Where the SPV arrangements are part of a broader structure, carefully consider whether each part of the structure is within the carve outs or otherwise operates as intended.

Derivative counterpartiesDerivative counterparties

Carve outs in Regulations

Implications of new ipso facto regime

Derivatives and directly connected arrangements

Securities financing transactions

Close-out netting contracts and security over financial property in respect of eligible operations

A range of types of contracts in relation to certain financial market infrastructure

Limited changes to the status quo

  • Close-out netting contracts and certain types of security structures, will continue to be protected in accordance with the Payment Systems and Netting Act 1998 (Cth).
  • These carve outs are consistent with the primacy the ipso facto regime confers on the Payment Systems and Netting Act 1998 (Cth).
  • Additional carve-outs, including the carve-out for derivatives, may also be relevant.
  • Where a derivative is part of a broader structure (including a prime brokerage arrangement or facility-linked hedging arrangement), carefully consider whether each part of the structure is within the carve outs or otherwise operates as intended.

Aircraft financiersAircraft financiers

Carve outs in Regulations

Implications of new ipso facto regime

Agreements within the Cape Town Convention on International Interests in Mobile Equipment

Derivatives and directly connected arrangements

Limited changes to the status quo

  • Aircraft leasing or security interests in aircraft financing arrangements are carved out of the ipso facto regime.
  • These carve outs are consistent with the primacy the ipso facto regime confers on the International Interests in Mobile Equipment (Cape Town Convention) Act 2013 (Cth).
  • Where the aircraft leasing or security interests are part of a broader structure, carefully consider whether each part of the structure is within the carve outs or otherwise operates as intended.
  • Check indemnity rights are exercisable against other members of the corporate group.

UnderwritersUnderwriters

Carve outs in Regulations

Implications of new ipso facto regime

Underwriting, or subscription agreements for or agreements to issue securities, financial products, bonds, promissory notes or syndicated loans

Rights issues

Financial investments management

No changes to the status quo – termination rights continue to apply

Real estate & constructionReal estate & construction

Carve outs in Regulations

Implications of new ipso facto regime

Arrangements involving special purpose vehicles for PPPs or project financing

Until 1 July 2023, arrangements for providing building work, construction work or related goods and services with total payments of at least $1 billion

Some priority arrangements

New regime applies

  • SPV is not defined, but the explanatory statement describes this as a company, trust or partnership “with no business record” and “created to carry out a specific business purpose or activity”. 
  • The explanatory statement recognises PPP is a term of art, but its principal features are provision of service-enabling infrastructure, risk sharing, Government contribution and payment for service delivery.
  • Rights against third parties are not subject to the ipso facto regime, however, consider implications of undertakings given to the distressed company, e.g. not calling on bank guarantee, and on indemnity rights.
  • Consider long term build contracts and credit risk allocation where one party incurs obligations for a significant period of time before cash flows from other party.

Projects, energy & resourcesProjects, energy & resources

Carve outs in Regulations 

Implications of new ipso facto regime

Arrangements involving special purpose vehicles for PPPs or project financing

Government licenses or permits

Derivatives and directly connected arrangements

Novation or variations, of pre-1 July 2018 contracts, entered into before 1 July 2023

Limited changes to the status quo for SPVs involved in PPPs or project financing

New regime applies to other SPVs and non-SPVs

  • SPV is not defined, but the explanatory statement describes this as a company, trust or partnership “with no business record” and “created to carry out a specific business purpose or activity”. 
  • The explanatory statement describes project finance arrangements as financial accommodation that funds a project and that is discharged primarily from the project cash flow.
  • Where the SPV arrangements for PPPs or project financing are part of a broader structure, carefully consider whether each part of the structure is within the carve outs or otherwise operates as intended, e.g. guarantees.
  • Rights against third parties are not subject to the ipso facto regime, however, consider implications of undertakings given to the distressed company, e.g. not calling on bank guarantee, and on indemnity rights.

Operating contractsOperating contracts

Carve outs in Regulations 

Implications of new ipso facto regime

Novation or variations, of pre-1 July 2018 contracts, entered into before 1 July 2023

Until 1 July 2023, arrangements for providing building work, construction work or related goods and services with total payments of at least $1 billion

Supply arrangements to a public hospital or public health service

New regime applies

  • Rights following non-performance or non-payment are not subject to the ipso facto regime.
  • Consider ipso facto risk allocation, including against guarantors, other members of the corporate group or bank guarantees.  Actively monitor contractual rights and preserve any rights arising before the procedure under standstill or forbearance arrangements.
  • Aggrieved counterparties may apply to Court for relief from the ispo facto stays.  The counterparty would need to establish that this is “appropriate in the interests of justice”. 


[1] Affected receiverships are those applying to the whole or substantially the whole of a corporation’s property.

[2] Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 (Cth) (Regulations).

[3] Expected to be Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (Cth) (Rules).

[4] Explanatory Statement to the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018.

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