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The ipso facto roadblock to recovery

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The recent Senate Economics References Committee enquiry into the performance of ASIC has made recommendations to government in relation to Australia’s insolvency laws regarding corporate restructure and reorganisation. The Committee took the view that greater provision should be made for access to measures to ‘encourage and facilitate corporate turnarounds’. Particular reference was made in submissions to the Committee to US chapter 11 provisions and the detrimental role played by ipso facto clauses in contracts.

The insolvency community remains divided on the appropriateness of a ‘chapter 11-style’ regime in Australia. However, what many practitioners admit is that efforts to restructure struggling companies are frustrated by the self-executing nature of ipso facto clauses in contracts.

Simply put, an ipso facto clause is incorporated into a commercial contract or lease so that, for a defined insolvency event, the contract automatically terminates without any positive action by the parties. In practical terms, this self-executing termination works to deprive the company of valuable business inputs that might otherwise be deployed in generating a turnaround result that could (and perhaps should), enable the company to restructure its activities.

In contrast, creditors argue that their position needs to be protected and that revesting of their commercial interests on the insolvency of a debtor prevents the exacerbation of an already dire situation.

Certainly the American example reflects a different approach. As some commentators have noted;

“[The] emphasis [in the US] on doing business also means that, even in bankruptcy, there is an expectation that American corporations will try to survive. In Australia, on the other hand, we too often call for the screens when there’s even the merest hint of financial troubles for acompany.” 1

A solution may lie in creditors becoming more prepared to entertain the prospects of recovery and taking a longer-term view of their business relationships. This might result in the parties resiling from the ‘automatic’ nature of an ipso facto clause – clearly for commercial ‘bird-in-the-hand’reasons.

In cases where a sale of business is possible or where a restructure would generate a better outcome, it is often the case that an outcome less than 100 cents in the dollar is still preferable to a winding up.

As always, early intervention is the key and with careful and skilled consultation, there are often ways in which business value can be preserved before the issues become terminal. Quality and timely professional advice is paramount.

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