4 December, 2017
The reforms do not make “ipso facto” clauses in insurance contracts unlawful but they will not always be enforceable.
In the context of insolvency, “ipso facto” clauses are contractual rights that allow a counterparty to terminate or amend a contract merely because a company has suffered an insolvency event. In insurance contracts these clauses are sometimes referred to as “Special Termination Rights”. They are also sometimes included in conjunction with clauses allowing termination where the insurer’s financial strength rating has fallen below a minimum required level. Such clauses may create a right for an insured to terminate the insurance contract if the insurer becomes insolvent or is placed into liquidation or receivership.
As part of the Government’s National Innovation and Science Agenda these clauses were reviewed and on 12 September 2017 reforms were passed to protect corporations in financial difficulties by making “ipso facto” clauses unenforceable during certain formal insolvency processes.
Reforms
The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 (Cth) (Act) will amend the Corporations Act 2001 (Cth) and introduce a “stay” on enforcing contractual rights that arise by reason of certain insolvency events.
The insolvency events that will trigger a “stay period” include:
Scheme of Arrangement
A “body” publicly announces that it will apply for and, in fact applies for or enters into, a scheme of arrangement (but only where the company’s application to commence the scheme states that it is being made to avoid being wound up in insolvency).
Receivership
A receiver or other managing controller of the whole or substantially the whole of a “corporation’s” property is appointed or exists.
Administration
A “company” enters into voluntary administration.
The “stay” will not apply:
- To agreements made after the commencement of a scheme, receivership or other managing controllership or voluntary administration;
- To companies that are in liquidation (unless it was in voluntary administration before being liquidated) or engaged in insolvent trading;
- If the liquidator, administrator or person appointed to administer a scheme of arrangement has consented in writing to the enforcement of the right;
- To rights to terminate for other reasons
- (e.g. for convenience); and
- To rights prescribed by the regulations or declared in a Ministerial determination.
The changes commence on 1 July 2018. However the Governor-General may announce an earlier commencement date. The changes will only apply to contracts made after the Act comes into force. Therefore, any rights linked to insolvency events that are included in existing contracts may still be able to be enforced despite the changes made under the Act.
Impact of the reforms
The reforms do not make “ipso facto” clauses in insurance contracts unlawful but they will not always be enforceable. Some parts of “ipso facto” clauses may not be impacted if they provide rights of termination not dependent on the prescribed insolvency events.
Unless regulations are made to exclude rights to terminate insurance contracts from the operation of these amendments, an insured will no longer be able to enforce a right to terminate a contract of insurance merely because the insurer commences a scheme, receivership or other managing controllership or voluntary administration.
An insured who seeks to exercise a right to terminate that is “unenforceable” may be found to have wrongly repudiated the contract (given it had no enforceable right to terminate) and subsequently be liable for damages.
Insureds should:
- Be proactive when placing or renewing insurance policies and carefully consider financial strength ratings.
- Seek legal advice before exercising contractual rights (particularly rights to terminate) on the basis of an actual or possible insolvency event.
- Consider seeking to include a right to terminate for convenience in their insurance contracts.
Insurers should:
- Consider the terms of such clauses in their policies. While not unlawful, such clauses could be misleading as to the insured’s right to terminate.
Brokers should:
- Ensure that insureds understand whether such rights in insurance contracts are in fact enforceable.
- Consider including rights for the insured to terminate for convenience.
- Advise insureds not to seek to exercise such contractual rights without first obtaining legal advice.
Our “Commonwealth Alert” Contractual rights to terminate for insolvency may be unenforceable also discusses the implications of the changes.
For further information, please contact:
Rehana Box, Partner, Ashurst
rehana.box@ashurst.com
