Beware: Construction contracts and ipso facto insolvency reforms

Where a contractor, such as a builder or sub-contractor, suffers from an event of insolvency or is actually insolvent, most standard building contracts currently grant a principal, such as an owner or head-contractor, “ipso facto” rights, such as the rights to suspend building works, call upon and enforce any security given by the contractor, and terminate the building contract.

Insolvency reforms to take effect on 1 July 2018 will instead prevent the enforcement of ipso facto rights, to provide opportunities for insolvent companies to restructure.

The reforms will affect a range of commercial contracts, not just construction contracts.

The policy intent of the reforms is to maintain the continuity of a contractor’s business and the value of the business, to provide a better potential for the contractor’s business to be restructured, for example, by “trading out” of insolvency.

The enforcement of ipso facto rights will be stayed where a right arises because a company has an administrator appointed, a managing controller is appointed to the whole or substantially the whole of the company’s assets, or a scheme of arrangement is made or announced.

Exceptions or proposed exceptions include rights under “set-off” and “step-in” clauses and exceptions to permit a party to enforce certain rights with the consent of an administrator, receiver, scheme administrator, or the Court.

The reforms will only apply to contracts entered into after 30 June 2018. The reforms will not apply to contracts entered into before 1 July 2018, including amendments to contracts where the underlying contract was formed before 1 July 2018.

The result of the reforms is that principals may need to be more risk averse when doing business, including as to whom they contract with, how they exercise their contractual rights, and which contracts they utilise.

If a principal were to purport, for example, to terminate a contract utilising a stayed right, the purported termination could open the principal up to a raft of problems, including contractual repudiation and breach of contract, termination for repudiation, and, or, a claim for contractual damages.

Therefore, principals will need to ensure that they do not fall afoul of the reforms by, for instance, purporting to terminate a contract in reliance upon a stayed right. Principals should also start reviewing existing contracts to ensure that the contracts do not fall afoul of the reforms by, for example, containing “self-executing” ipso facto clauses.

You can read more on The Treasury’s website at www.treasury.gov.au