Federal Court confirms the ‘Ipso Facto Regime’

The introduction of the ‘ipso facto regime’ in 2018 had a widespread impact on the drafting and application of termination provisions in commercial contracts, casting doubt on the longstanding practice of allowing a right to terminate a contract when another party to the contract becomes insolvent.

Recently, a Federal Court decision has confirmed the ‘ipso facto regime’ operates in the expected manner – i.e. the ipso facto stay applies when the contractual termination right arises due to a company entering into administration and it is that stay which continues through any subsequent liquidation. It does not apply where the right to terminate arises purely as a result of liquidation or non-performance.

The decision was handed down by Justice O’Bryan in Rathner, in the matter of Citius Property Pty Ltd (Administrator Appointed) [2023] FCA 26 (Rathner).

The Ipso Facto Regime

An ‘ipso facto’ clause is a commonly used contractual clause which triggers a contractual right for a party to terminate a contract if the counterparty becomes insolvent or formal insolvency proceedings are commenced, such as entering into administration. The termination right will arise regardless of continued performance of the contract by the counterparty.

In 2017, the Treasury Laws Amendment Act (2017 Enterprise Incentives No. 2) Act 2017 introduced a statutory regime which became effective in 2018, commonly known as the ‘ipso facto regime’, to stay the enforcement of ipso facto clauses while a company is under administration providing the insolvent company with the ability to restructure successfully or otherwise sell the business as a going concern.

Relevantly, section 451E(1) of the Corporations Act provides that an express right in a contract, agreement or arrangement is not enforceable against a company only because of:

  • the company entering into administration; or
  • the company’s financial position while under administration.

The decision in Rathner

The decision handed down in Rathner has provided much anticipated, and very timely, clarity on the scope and operation of the ipso facto regime.

The case involved Citius Property Pty Ltd (Citius), a company which was put into voluntary administration in December 2022 following the delivery of an adverse judgement. The principal asset of Citius was an agreement with DWPL Nominees Pty Ltd and Dexus Wholesale Management Limited (Dexus) for the provision of project management services (Dexus Agreement) which contained an ipso facto clause giving Dexus the right to immediately terminate the agreement if an “Insolvency Event” occurs. In the Dexus Agreement, an “Insolvency Event” includes “tak[ing] any step to obtain protection or is granted protection from its creditors, under any applicable legislation or an administrator is appointed”.

While Dexus had not sought to enforce this termination right and the Dexus Agreement was still being performed by Citius, the administrator of Citius (Administrator) sought orders from the court to provide certainty as to the operation of the ipso facto regime. The Administrator sought orders pursuant to s 451E(3)(a) of the Corporations Act “to the effect that, if the administration of Citius ends because of a resolution or order for Citius to be wound up, the stay on the enforcement of certain contractual rights described in s 451E(1) of the Act continues to operate until the winding up of Citius is complete, and that the Administrator is justified and acting reasonably in proceeding on that basis”.

The Administrator proposed that such orders were necessary as the stay provided in section 451E(1) applies to companies in administration which subsequently enter into liquidation, while, companies which went into liquidation and had not been in administration immediately prior would not have the benefit of the ipso facto regime.

Justice O’Bryan found that the Administrator’s concerns were unwarranted and accordingly declined to make such orders. O’Bryan J clarified that section 451E(1) does not apply to a contractual right arising due to a company being wound up or the company entering into liquidation. Rather, the stay under section 451E(1) applies only where the right to terminate arises by reason of the company entering administration or the company’s financial position during administration. It is this stay which continues through the period of administration and any subsequent liquidation.

It was confirmed: “the stay under s 451E does not apply to contractual rights that may arise by reason of the winding up. If the counterparty has a right to terminate a contract by reason of the company’s entry into liquidation, s 451E does not operate to stay that right. The stay only applies to a right that arises by reason of the company entering administration or the company’s financial position during administration. It is the stay of such a right that continues during a subsequent liquidation. The section does not stay the exercise of a right that arises by reason of liquidation.”

Accordingly, the statutory stay on Dexus’s right to terminate the Dexus Agreement applies and continues for the period of administration and ‘endures’ despite the administration ending because Citius enters into liquidation until the winding up is complete. However, O’Bryan clarified that the stay provided under section 451E(1) is constrained to the right to terminate due to Citius being in administration and therefore does not prevent Dexus terminating the agreement by virtue of another right, such as Citius’s entry into liquidation or non-performance.

Key takeaways

The decision in Rathner has provided clarity on the scope of the ipso facto regime. It has been made clear that the stay of an express contractual right to terminate or modify a contract under section 451E(1) of the Corporations Act applies only to a right arising due to a party entering administration and does not impose a stay if a right is triggered due to a company entering liquidation alone. Furthermore, the ipso facto stay will only apply to express contractual rights to terminate or modify a contract for a company entering into administration and their financial position during administration but will not impact other rights of termination such as non-performance.

Accordingly, the decision in Rathner highlights the importance of drafting ipso facto clauses in such a way to distinguish the right to terminate due to administration from other termination rights. To draft an effective ipso facto clause entitling termination due to insolvency related events, the right of termination for entry into insolvency, administration or a deed of company arrangement must be clearly distinguishable limbs.

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