New Regime: Can a Contract be Terminated if a Party is Insolvent?

In summary

From 1 July 2018, a party to a contract will no longer have an automatic right to terminate that contract if the other party suffers an insolvency event (“Reforms”). An “insolvency event” may include voluntary administration (that is, say, where a company chooses to wind up voluntarily).

The focus of legislation in this area has now shifted. The emphasis is now more on restructuring companies and maintaining contractual relationships which allow a company facing insolvency to continue to trade through to recovery rather than being forced to wind up.

These new rights do not apply retrospectively and will only apply to contracts entered into from 1 July 2018.

Increased risk: What you need to be aware of

Historically (and subject to specific terms negotiated between the parties), contracts in trade and commerce have generally included clauses allowing a party to terminate a contract if the other party suffers an insolvency event regardless of whether the other party is in a position to continue their obligations under the contract.

With the introduction of the “ipso-facto” Reforms, the right of a party to rely on a contractual right to terminate that contract is now restricted. The Reforms impose a temporary stay on enforcing those termination provisions in the contract. This stay on enforcement ends when the period of voluntary administration ends or when the company is wound up.

Anti-avoidance provisions have also been introduced which require a party to obtain permission of the court to exercise certain rights under the contract which are inconsistent with the Reforms. For example, exercising a right to call on a guarantee or taking possession of a security asset.

The Reforms will not impact a situation where a party cannot pay its debts as and when they fall due. If a party is unable to perform under a contract, the other party is permitted to terminate for non-performance of the contract.

Exceptions

The Reforms do not apply to the sale of a business (including a sale of securities or financial products) and do not apply to renewals or variations of contracts which were entered into before 1 July 2018.

If you have any queries on your contractual rights in your business arrangements or any other commercial or business matter, please contact Meghan Warren or Daniel Mainzer of our office on mwarren@burkes-law.com or dmainzer@burkes-law.com for further assistance.