Contracts Won’t Self-Destruct With Onset Of Insolvency

“Ipso Facto” Escape Hatch Prohibited Under Insolvency Reforms

Contracts Won't Self-Destruct With Onset Of Insolvency

Once, if a company got into financial difficulty, a party who had a contract with the company could terminate the contract, even if the company had been meeting all its obligations.

The “ipso facto” clause was the contract’s device that allowed this termination to take place. A Latin term that means, rather unhelpfully, “by the fact itself”, the ipso facto clause acted like a trip switch in a fuse box that the contractor could flick on the happening of an insolvency event, pulling the plug on the contract and bringing an end to the business trading relationship. Not so now.

Contracts Will No Longer Self-Destruct At Onset Of Insolvency

As part of the sweeping insolvency reforms that came into operation on 1 July 2018, new legislation has prohibited ipso facto clauses that once provided for a contract to self-destruct in the event of insolvency.

An insolvency event can include voluntary administration, receivership and schemes of arrangement. These are all processes where the company is trying to work its way out of financial difficulty.

The activation of these clauses has been particularly prevalent in the construction industry where parties seek to withdraw the obligation to continue providing their services in what they consider to be a risky business environment.

Ipso Facto And Safe Harbour Share Common Purpose

The new ipso facto provisions and the safe harbour reforms share a common purpose – to discourage directors and contracting parties from bailing down the escape hatch and to get them to keep trading.

The essence of the ipso facto reform, that only applies to contracts, agreements or arrangements entered into after 1 July 2018, is to provide for a “stay” against the enforcement of those ipso facto clauses.

In other words, any action taken by a party relying on an ipso facto clause to get out of a commitment to stay the distance of the contract, will be suspended to allow the company to continue trading for the benefit of its creditors and employees, until the administration ends or the company is wound up.

A contracting party can apply to the court for an order that a stay on enforcement rights be lifted if it is appropriate in the interests of justice or, in the case of a scheme of arrangement, if the scheme was not for the purpose of the company being wound up in insolvency.

The very positive side of the change for creditors and employees is that the company experiencing financial difficulty can continue to trade while it still meets its obligations under the contract – without the other party pulling the contractual rug from under its feet.

Disclaimer: The information on this page is for general information purposes only and is not specific to any particular person or situation. There are many factors that may affect your particular circumstances. We advise that you contact Mathews Tax Lawyers before making any decisions.

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