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Can you terminate a construction contract for insolvency?

Termination for Insolvency clauses in Construction Contracts – New changes starting 1 July 2018

Major changes to the Corporations Act 2001 (Cth) coming into effect from 1 July 2018 will have a dramatic impact on the construction industry.

On 18 September 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017 was provided Royal Assent. This Bill amended the Corporations Act by introducing:

  1. Safe harbour provisions which will provide an exception to the prohibition on insolvent trading by company directors (commenced on 19 September 2017)[1]; and
  2. A stay on the enforcement of ‘ipso facto’ clauses in a contract (effective from 1 July 2018).

This article will focus on the changes to ipso facto clauses in construction contracts.

What is an ipso facto clause?

Ipso facto means ‘by that very fact or act.’ The current law allows for most construction contracts, and ften most contracts, to be terminated in event that that there is an insolvency event.

Generally, a contract will contain wording that allows for an owner or principal to exercise its ipso facto rights under the contract. This includes the ability to:

  1. Suspend works or take the works out of the other party’s hands;
  2. Terminate the contract;
  3. Call upon a bank guarantee, cash retention or security;
  4. Set off claims against payment claims; and
  5. Step in rights to mitigate loss and engage other contractors to finish any outstanding works

should an insolvency event occur.

Ipso facto clauses provides for a fact based position to enforce the right to terminate rather than relying on a default.

As can be appreciated, it is considerably difficult for a subcontractor to trade out of their problems where their contracts are automatically terminated.

Starting from 1 July 2018 certain ipso facto rights will be unenforceable.

What does it mean for you?

The reforms[2] will mean that ipso facto clauses such as the above will be ineffective in the event that a party to a contract:

  1. Announces that it has entered into a compromise of arrangement with its creditors (or files an application under s.411 of Act) for the purpose of avoiding being wound up in insolvency;
  2. Appoints a managing controller of the company’s property; or
  3. Goes into administration.

The stay on the enforcement of an ipso facto clause will affect the right to:

  1. Terminate the contract;
  2. Vary the contract;
  3. Call in bank guarantees, cash retention or other form of security;
  4. Suspend the works; and
  5. Step into the contract.

The period of the stay will vary depending on the type of insolvency process.

The stay also does not prevent a party from applying to the court for orders in the interests of justice with permitted leave of the Court to enforce rights against the company.

These new laws will be apply to new contracts entered into from 1 July 2018 and is not retrospective and cannot be contracted out of.

This means it will not be applicable to existing contracts and can only provide protection where a company’s restructure is ongoing. If a company has fallen into receivership or liquidation, the former laws will be applicable.

In the event of any variation or amendments that occurred after 1 July 2018 on contracts that were entered into prior to 1 July 2018, the new laws are not applicable.

The new law reforms will have an impact on the construction and infrastructure sector and in light of the legislative reform, it will paramount for contracting parties to ensure they gain a thorough understanding of the new laws. If you have any inquiries into how the new law reforms will affect you or advice around how to manage your contracts, contact Michael Morrissey (m.morrissey@morrisseylaw.com.au) or Hamish Geddes (h.geddes@morrisseylaw.com.au) or call our office on (02) 4038 1620.

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[1] See ss.588E, 588GA, 588GB, 588H, 588HA, 588WA of Corporations Act 2001 (Cth).

[2] See Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 and ss. 415D-G, 434J-LM and 451E-H of Corporations Act 2001 (Cth).

Disclaimer: This publication by Morrissey Law & Advisory is for general information and commentary only and should not be considered or relied upon as legal advice. Formal legal advice should be sought in relation to any matters or transactions that may arise in relation with communication.

2018-07-11T11:18:44+00:00 July 2nd, 2018|Construction Contracts|