Ipso Facto Clauses and Insolvency
1.0 Introduction
Ipso Facto clauses are already established phrases that provide the strategy to be adhered to when terminating an agreement with a company because of insolvency, bankruptcy or financial constraints. The clauses are also known as bankruptcy clauses because they identify the consequences of the company’s bankruptcy. The clauses allow the termination of a lease, contract or agreement without prior notice if one of the parties becomes bankrupt or files for bankruptcy protection. In case one of the parties is facing insolvency or liquidation, the clauses allow the termination of the contract. In a situation where the financial status of one of the parties becomes weak, the other party has the right to terminate the contract. The standards of the Ipso facto clauses are considered non-negotiable unless the contracted had the provision of reservation of intellectual property in case of insolvency or bankruptcy.
Ipso Facto Clauses in Australia and the U.S
The clauses have been an essential part of insolvency and bankruptcy laws across the globe. In various countries, the enforcement of IFC takes different forms through the application of the available laws. In Australia, Bankruptcy laws and laws on insolvency do not explicitly indicate the application of ipso facto clauses.[1] However, reforms have been proposed on the bankruptcy laws to guide the enforcement of ipso facto laws in the country subject to various conditions. According to the committee on the reform to ipso facto clause enforcement laws, the application of such clauses to the insolvency context should be limited in order to protect the interests of the debtors rather than reducing the chances of survival.[2] As opposed to the U.S and English laws, the insolvency in Australia is carried out in a manner that does not facilitate or initiate corporate turn e for the better. As such, the application of ipso facto clauses only function to reduce the possibility of corporate revival in Australia as opposed to the U.S where the enforcement of such clauses is subject to various laws which give debtors the opportunity to advance their economic interests while also paying off their debts.[3]
In the U.S, Chapter 11 of the constitution on Bankruptcy Laws gives an opportunity for the invalidation of the IFC in executor contracts subject to certain conditions. The law provides that ipso facto clauses can be exempted from enforcement in cases where the debtor is facing insolvency, has a case that is due for commencement on insolvency and/ or when the debtor has their estates in the hands of an appointed trustee. The objective of imposing such enforcement conditions are to enhance the capacity of the debtor to continue expanding their estates either through personal or entrusted management. While this is a positive direction for debtors to take in takes of salvaging estates bound for insolvency, it only increases the risks associated with later insolvency and/ or adds to the difficulty involved in persuading the sources of funding for more funding.[4]
Although there are currently no general restrictions on the enforcement of ipso facto clauses in Australia, the provisions available for handling insolvency are insufficient in offering incentives for continued investment and to restructure.[5] This especially applies because of the precedence of at third party which takes control of the insolvent estates during such cases. As a form of change towards improved enforcement capabilities, the committee on ipso facto clauses has continued to provide recommendations for the unenforceability of ipso facto clauses especially where the company facing insolvency does so voluntarily. The key concern of organizations and legal bodies in the enforceability of ipso facto clauses is the increase in the risks associated with estate insolvency. According to the proposed reforms, any intended changes should aim at achieving a balance between the risk taking in credit provision and the protection of creditors from the possible impacts of insolvency in organizations.[6]
While carrying out reforms on the enforcement of ipso facto clauses in Australia, the government intends to make every form of these clauses void in cases that are explicitly explained in the reform documents such as financial contracts that are prescribed by the law, and particular suppliers who file under the court procedures that they have faced significant hardships in the execution of contracts held with the insolvent estates.[7] The enforcement of the IFC will also be subject to various other proposed conditions such as the need for explicit legal clarification of the factors under which the clauses are enforceable. The need for clarity in legal wordings concerning IFC is founded on the premise that the enforcement of such clauses requires uniform basis to be applied for all contracts. The reforms in the bankruptcy laws are to consider the question as to whether the ipso facto clauses should be void or not. Moreover, there is also need to address the concern on whether restrictions to the application of these clauses would be limited to the right for termination of contracts or will expand to other factors as well as whether creditors will be cushioned from the potential effects of the enforcement of ipso facto clauses.
Based on the need for achieving balance between risk taking and the protection of creditors, it has been argued that the exercise of the rights to terminate contracts based on insolvency of one of the contract parties can result increase the economic benefits of the creditors through the involvement of those creditors in unfair dealing terms with the debtors. According to,[8] ipso facto clauses can drive the estates facing insolvency to seek for informal methods of restructuring such as accelerated payment of debts in order to avoid insolvency as well as avoid the possible termination of contracts with other counterparties. It is suggested that a restrictions on the enforcement of ipso facto clauses should be subject to conditions which require creditors to operate without the counterfeiting of executory contracts or without modification of their interests in the contract.
Subject to the avoidance of forfeiting and making dubious claims bordering on the advancement of selfish interests, the broadening of the scope of ipso facto clauses over and above the right to terminate contracts upon the insolvency of one party can result in the increase of the incidences of corporate rescue in Australia.[9] It is on this same basis that the U.S Chapter 11 on bankruptcy and ipso facto clauses aids in the recovery and restructuring of companies facing insolvency.[10] However, the question about ipso facto clauses still remains on whether creditors actually need extra protection from potential risks after broadening of the components of the ipso facto clause enforcement restrictions. As a matter of fact, several advantages have been associated with ipso facto clauses both in their unlimited forms as well as in their broadened enforcement forms. Some of the advantages associated with these clauses include the ability to enhance social welfare and the capacity to prevent estate administrators from cherry picking contracts. On the other hand, opponents of ipso facto clause enforcement assert that these clauses increase the powers held by suppliers and customers over estate operations.[11]
Based on the given theoretical background and comparison of the various pros and cons for the enforcement of ipso facto clauses, this paper advances the belief that ipso facto clauses are more beneficial to the estate sector than they are detrimental. As such, their invalidation in the Australian context poses greater significant challenges compared to their enforcement in this context. However, the enforcement of such clauses should be subject to certain conditions as proposed by the intended reforms. The present paper discusses the applicability of the ipso fact clauses in the Australian insolvency laws including the pros and cons of the clauses and how these pros and cons can be leveraged in the estate context to advance social welfare as well as economic capabilities. Various case laws are exemplified to show the relevance of the ipso facto clauses in the insolvency cases of recent times.
1.1 The Existence of IFC
Ipso Facto Clauses exist to offer one of the parties a costless exit from a contract. The clauses protect the other party from the liability that comes along with terminating a contract. The clauses give the lawmakers the right to draft bankruptcy laws. They also allow the involved parties to invoke the termination if the case has not been dismissed after a particular period. The clauses assist in the definition of various terms such as the assignee, trustee, receiver, and custodian to prevent any form of misunderstanding. Ipso Facto Clauses also exist to determine the bills that have to remain unpaid and the duration that the involved party has to take before it is declared that it has failed to pay its debts. The clauses also assist in distinguishing the inability of the debtor to pay the bills from borrowers deliberately refusing to pay. When referring to the debtor’s failure to pay the arrears, the clauses indicate that the situation can either be unhelpfully under-inclusive and over-inclusive. The clauses also show the action that should be taken when the debtor seeks to resolve the debts by requesting for an informal financial assistance from the creditors instead of filing for bankruptcy or solve the issue through a formal procedure provided by the law to solve debts issues. The clauses allow the termination of the contract if the debtor arranges, takes measures to organize a walkout or restructures the debt. The clauses exist to guide the two parties on what to do if one of them does not comply with the financial agreements.
1.2 The implementation of IFC
The clauses are enforceable because of the force of habit. Over the years, lawyers and estate owners have learned to include the Ipso facto clauses in their contracts and have continued to apply them in many other agreements. Lawyers do not prefer scrapping off the clauses because they assume that the bankruptcy code can be changed to restore the old rule. They are enforceable if there is an actual bankruptcy that can be filed. In a scenario where a termination is made based on insolvency, before filing bankruptcy, the clauses might not be enforced. When this happens, the debtor has an opportunity to retain the contract rights and might even assume executor contract when the bankruptcy case is in progress. There are enforceable when there is a limited exception in bankruptcy. Such exception occurs when an executor contracts intellectual property licenses. In a situation where the trustee or the debtor is not allowed by law to assign or assume the executory contract, the clauses are enforceable. For instance, if a trustee or a debtor cannot assume an executory contract, then the borrower making the contract with another party can reject the license based on the ipso facto clauses. Not all the ipso Facto clauses are enforceable. For instance, if a bankrupt state owns the property interests of the debtor, no provision is provided requiring forfeiture of the interest because of the financial status of the debtor or insolvency. The bankruptcy code nullifies the Ipso Facto clauses rendering them unenforceable if they lead to the forfeiture of an expired lease or an executor contract. The Australian government aims at introducing two more changes that will ensure that IFC is not enforceable. This will be achieved through drafting of clauses that will allow the contract to be terminated only because of an insolvency event, and it will be unenforceable if such a company is carrying out a restructure. It will also be unenforceable if the directors hire a restructure adviser to form a turnaround plan for the company. A case in question is the one regarding the Kodak Company whereby the directors of the company sought to be given the necessary tools to avert the liquidation process. The corporate insolvency law was re-written to include the voluntary administration to ensure that Kodak Company was restructured.
1.3 Obstacles to IFC
1.3.1 In General
Ipso facto clauses face various obstacles while being implemented. For instance, the courts have been reluctant to enforce the clauses, thus propelling creditors to devise strategies to evade bankruptcy proceedings. Such entities are known as bankruptcy remote entities because of their remoteness from any form of a bankruptcy filing. Boards of Directors formulate a bankruptcy remote entity to restrain the ability of the other party to file a bankruptcy petition. The creditor might also demand the debtor to adjust the structure of the current entity. Other legislative measures have been enacted to restrict the enforcement of the Ipso Facto clauses are no longer permitted to operate in insolvency. It is extremely hard for the debtor to file for bankruptcy because of the need for unanimous consent, which the creditor-controlled director cannot accept to vote.
1.3.2 In Insolvency Law
In the insolvency law, the Ipso Facto clauses face obstacles because the former has been adjusted to protect the vulnerable shareholders and the investors. The directors of the company are held accountable by the solvent to ensure that they do everything in the best interest of the estate. Instead of implementing the Ipso Facto clauses, the insolvency law requires the company directors to appoint qualified advisers to ensure a turnaround of the estate through appropriate restructuring. When this is taking place, the Ipso Facto clauses are unenforceable according to the insolvency law. When restructuring estates facing insolvency, the key challenge faced by the debtors, is the possibility of increased costs of debts payable for contracts in cases where the restructuring is carried out under the management of authorities other than the estate owners. In such cases, the appointed trustees in most cases pay off debts and require the estate owners to pay them off once the estate has achieved a turn around. This poses a challenge through the increase in the amount of debts payable due to the absence of ipso facto clauses. In cases where the clauses exist, it is possible for contractors to simply walk out of unexecuted contracts and hence avoid incurring any losses to the insolvent parties. The insolvency law provisions currently do not offer explicit restrictions to the application of ipso facto clauses but clearly outline the need for contract parties to continue in contracts that have been partially executed by either party.[12]
1.4 The Relation between Ipso Facto Clauses and Insolvency Process
Both Insolvency and Ipso Facto Clauses are aimed at protecting the company and the creditors. Ipso Facto clauses and insolvency process makes it difficult for the administrators to trade their way out while, on the other hand, the creditors are given the right to terminate their agreement with a company in case it is declared bankrupt. Debtors should retain the crucial contracts such as leases for various equipment and intellectual property licenses. The two ensure that a company’s administrator should be given the opportunity to reject or adopt unexpired executor contracts within a specified period. The liquidation or insolvency of a company is allowed by the clauses and during the insolvency process. The courts are reluctant to intervene and expressly forbid the use of Ipso Facto clauses in insolvency cases.
In any case, the application of Ipso Facto Clauses in insolvency cases should aim at the maximization of the value of the said estates. For instance, while addressing the need for applying the ipso facto clauses in insolvency, it is desirable to consider the potential outcomes of the process on the creditors as well as the debtors. The need to maximize the profits attainable from the debtor’s estates often drives debtors facing insolvency to seek for informal ways to protect their estates from the detrimental effects of insolvency. Consequently, it has been argued that ipso facto clauses reduce the potential of estates to recover their finances due to the loss of key contract parties to their estate growth. In a similar note, estates facing insolvency have greater drive to profitability hence the need to retain the important counterparties in the contract. Ipso facto clauses therefore cause negative implications to estate owners in such contexts where there implementation would result in the loss of potential estate by debtors.
2.0 Pros and Cons of Ipso Facto Clauses
2.1 Pros of Ipso Facto Clauses
In spite of the numerous claims against the suitability of Ipso Factor Clauses in the event of Insolvency, there are also various advantages and benefits that can be linked to the enforcement of these clause in insolvency contexts. In the present study, some of the benefits associated with Ipso Facto Clauses are discussed explicitly to provide a view into the entire aspect of ipso facto clauses and to enable potential readers to make informed decisions on whether to support this subject or not. In the Australian Insolvency Law, the enforcement of Ipso Facto Clauses is still limited based on various arguments about the increased risks it poses to creditors.
2.1.1 Benefits to the Counterparties
Proponents of Ipso Facto Clauses claim that the enforcement of such clauses prevents counterparties from writing off debts as well as outstanding invoices.[13] This implies that through the enforcement of ipso facto clauses, it is possible for such counterparties to protect themselves from incurring losses in terms of invoices as well as bad debts issued to the insolvent parties. In case the company to which goods and services are offered after the proposal for insolvency is indeed declared bankrupt, the creditors may lose any unsecured debt whether incurred through contract terms or not. The case of Fibria Celulose S/A v Pan Ocean provides a typical example of the application of Ipso Facto clauses.[14] In this case, the Fibria Celulose filed a case in an English court against Pan Ocean with claims that since Pan Ocean had filed for insolvency, the plaintiff had the alternative to terminate the contract between the two companies based on the Ipso Facto Clause. The court ruled in favor of the plaintiff.[15]
Ipso Facto clauses therefore help to avoid such situations which make the reduction of risks possible for the creditors. The counterparties can therefore offer their goods and/ or services to other more potentially profitable companies by forfeiting the contracts which they consider probably detrimental to their estate finances. Although this may be profitable to the creditors in the long run, it may also affect the debtors negatively to a certain degree. The effect to debtors may not be financial or even social in the short run but when the long term effects are considered, the damage to the estates is immense. In Australia, there are currently no legislative obligations for the enforcement of Ipso Facto Clauses in Insolvency.[16]
Another factor that is considered positive in relation to the enforcement of ipso facto clauses is the prevention of contract breach on various premises.[17] In the presence of ipso facto clauses, parties to a contract can continue to execute their contract obligations until there is proof of potential insolvency on one party and the actual insolvency of that party. This gives the solvent party and opportunity to consider various contract implications while still executing. At the same time, it also gives the party facing insolvency an opportunity to rectify operations towards greater advantages in the financial segment of the estate. The party facing insolvency may even seek for an opportunity to address the potential insolvency through fast payment of debts and/ or other informal financial agreements. The availability of laws that help solvent parties to avoid lose through the enforcement of ipso facto clauses therefore increase the confidence of such parties through the awareness that whatever comes will be dealt with without incurring any additional loses. On the other hand, where ipso facto clauses are not enforceable, the solvent parties may opt to terminate their contracts with parties facing insolvency earlier, prior to decisive confirmation of facts by advancing claims of potential breach of contracts based on insolvency. This may be detrimental to both the potential insolvent and the solvent parties in terms of losses to estate.
Furthermore, Ipso Facto Clauses also prevent administrators from selectively picking contracts in a manner that can be described as cherry picking.[18] Through an understanding that any counter party could potentially cause loses through the termination of contracts at will may encourage estate administrators to seek contract agreements with companies which are considered to have lower loss implications than others. In cases of insolvency, ipso facto clause enforcement makes it possible for counterparties to withdraw from contracts resulting in financial difficulties for the parties facing insolvency, particularly where those parties are suppliers for the company undergoing insolvency. The key foundation of this argument is that in cases where the potential risks are high, balancing between potential losses and perceived profits is mandatory for every estate. As such, although creditors desire profitability, it would be more reasonable for them to provide credit to potentially less profitable companies than to those deemed more profitable and incur losses when the latter face insolvency. This also ties to the concept of sustainability in profits in comparison to one shot high profit values and prolonged loss.[19]
2.1.2 Benefits to both Contract Parties
Besides these advantages, Ipso Facto Clauses also help to reduce the systematic risks associated with insolvency through the coalescence of the parties’ obligations in order to minimize the net obligations associated with contracts.[20] With minimized net obligations, contract parties can also reduce the potential losses in collaboration rather than through independent execution of contract obligations. In the presence of enforceable ipso facto clauses, contract parties are bound to consider the potential for reducing the net obligations rather than avoiding contracts with every potentially insolvent company. In the absence of Ipso Facto Clauses, each of the contract parties may act independently resulting in increased obligations and subsequently increased potential loses. In this case, optimization of the debtor’s estate is not achieved through any other means. The obligations of each party can only be achieved partially when many and the degree of execution also reduces with increase in the scope of obligations associated with contracts. The availability of ipso facto clauses that can be enforced makes it possible for organizations to consider potential losses and thus agree to coalescence of obligations in order to reduce the degree of negative impacts in case of insolvency. Countries with enforceable ipso facto clauses such as England have the capacity to protect the interests of both debtor and creditor in situations where insolvency is anticipated through the aggregation of contract obligations.[21]
In addition to this, insolvency may subject creditors to unexpected estate terms through expectations to continue estate with unplanned legal bodies. In the cases of enforceable Ipso facto Clauses, such unplanned estate practices can be avoided.[22] Ipso Facto Clauses enable the solvent partner to terminate the contract at will on the insolvency of the other contract partner. This implies that the solvent party will not be forced to enter into estate with the party appointed to be in charge of the estate of the insolvent contract party. Subsequently, in case the solvent party desires to continue his/ her obligations under the previously entered contract under the management of the trustee, the choice made would be purely on the basis of the counterparty’s choice rather than as an obligation. This gives the solvent party a higher leverage than the insolvent partner since engagement in any contract with the new appointee would probably result in higher profitability due to the review of terms.
2.1.3 Benefits to the Debtors
Although the enforcement of Ipso Facto Clauses has not been significantly attached to economic benefits in terms of increased profits for the participating parties, it is reported that Ipso Facto Clauses have the potential of increasing incentives for investment for both the debtor and the counterparty in the contract.[23] The key incentives for investment are through the increase of the debtor’s commitment to the estate through the availability of greater opportunities for increased debt capacities. Moreover, debtors are also driven to invest more through the provision of lower costs of debts by the creditors. This is particularly of essence in countries such as America where Ipso Facto Clauses operate subject to the requirements for business recovery. Efforts made through the support of the law by allowing the owners of the insolvent estates to take control of their affairs while reinstituting the businesses for debt payment allows the business owners to practice commitment towards the achievement of business objectives and subsequent payment of business debts. Such clauses that ensure business owners of continued management of their properties after insolvency do not prevail in the Australian insolvency laws hence the argument that insolvency in Australia does not provide insolvent businesses with sufficient incentives to restructure.[24]
An understanding of how insolvency works can drive the creditors towards provision of lower interest rates for debt payment. In cases where this happens, the party undergoing insolvency has the probability of increasing the debt capacity while also increasing opportunities for gaining funding for future projects through debts. As such, parties that are potentially insolvent can access funding for off-setting their debts and subsequently reduce the possibility of facing insolvency.[25] As companies address the issues relating to insolvency, Ipso Facto Clauses can be invoked to help debtors in formulating debt payment plans through termination of contracts too. This can be achieved where continued execution of contract obligations can yield greater values of debt than initially accrued. While this may not be 100 percent beneficial to the debtor, it may also reduce the financial risks associated with the counterparty in the contract. Accomplishing this role by Ipso Facto Clauses also leads to a realization of greater social welfare.
Ipso Facto Clauses also increase the welfare of debtors in various ways.[26] In determining the value of an estate, consideration is made, not only of the present status but also of the future status of the estate. Contracting parties subject to Ipso facto Clauses have the potential of increasing value for the debtor. This can be achieved through the maximization of the estate in terms of both input and output. While the input in terms of commitment of objectives comes in from the owner, the results bound to be received include increased profitability, better access to estate funding and increased ex post value of the estate. During insolvency, the estate of the insolvent party is taken control of by a third party. The third party is in most cases interested in the payment of the estate’s debts. This implies that both the creditors and the trustee have to push for the estate to yield maximum profits. Offers of estate funding also arise through other potential investors whose objective is to see the payment of the estate’s debts and/ or acquire the assets of the estate. As counterparty to a contract with the insolvent estate, the enforcement of the Ipso Facto Clause exempts one from the implications of any further actions in lieu of the estate. This means that the debtor will only pay off debts but will not cater for extra contract costs hence the increase in funding availability. Moreover, the change of management in itself is a sure way of gaining greater profitability due to increased accountability of the estate’s management.[27] Increase in the business profit margins yields even greater ex post values for the estate.
Another aspect of welfare improvement by Ipso Facto Clauses comes in through improving collectivization capacities of an insolvent estate.[28] In cases where there are no enforceable ipso facto clauses, creditors tend to be involved in property rushes to offset their debts after the liquidation of the estate assets. This brings about losses to the debtor through excessive gains for the creditors. Moreover, an absence of Ipso Facto Clauses leads to a reduction in the estates value through bans that may be imposed on the estate based on the level of disintegration of creditor payment efforts. As the estate scrambles to obtain funding to offset certain debts, the creditors tend to operate independently, in a rush of assets, each aiming at maximizing their own self benefits without regard for the other creditors. Where Ipso Facto Clauses are enforceable, creditors tend to come together in collectivity to observe the continued sale of the estates properties and thus to gain access to their debts. Courts therefore enforce Ipso Facto Clauses with regards to the particular impacts of the clauses on the estate of the debtor as well as on the creditors’ estates. The objective is then to avoid undue loss to either team and thus enhance just actions with regards to debt payments and the conduct of creditors and debtors.
Another great benefit of Ipso Facto Clauses is that they reassign initial property rights especially in cases where their enforcement is subject to certain restrictions such as in America.[29] In the U.S, Ipso Facto Clauses are extremely beneficial in this regard since their enforcement is subject to conditions which ensure that the solvent party can access their assets and manage them as a form of corporate recovery. Instead of appointing a trustee as is done in Australia, Chapter 11 of the U.S constitution on Insolvency and Ipso Facto Clauses indicate the need to preserve the interests of both the creditors and the debtors through the assignment of initial property rights by Ipso Facto Clauses.[30] This increases the potential for reduced performance rates as demanded by the creditors from the debtor. The upside of this form of reduced performance expectation and rates is an improvement of the debt settlement opportunities by the debtor. This achieves the objectives of Chapter 11 which is to facilitate recovery of corporate bodies ahead of their burial.[31] Based on the presented benefits of Ipso Facto clauses in their application in the Insolvency laws, the proponents of Ipso Facto for Australia therefore have a strong point to present. However, there can never be any idea complete without challenges and/ or disadvantages.
2.2 Cons of Ipso Facto Clauses
2.2.1 Disadvantages to the Debtors
Apart from the brighter side of Ipso Facto Clauses in any Insolvency laws, certain challenges also present with respect to the concept. The key concern raised by opponents of Ipso Facto Clauses is that the enforcement of these clauses enables suppliers and/ or customers to walk away from their business contracts. This is the main basis from which Chapter 11 of the U.S constitution provides guidelines for the enforcement of Ipso Facto Clauses. Similarly, English laws enforce Ipso Facto Clauses sparingly, while Australian laws have no explicit regulations for the enforcement of Ipso Facto Clauses.[32] The rationale behind this argument is that at the time a company faces insolvency, the estate of the company requires intensive operations and increase in profitability in order to pay its debts as well as advance its business strategic objectives. However, Ipso Facto Clauses allow suppliers and customers to terminate their contracts with a solvent company at will hence reducing the possibility of recovery from the insolvency situation. This has the potential of impacting the company negatively through the reduction of its good will capacity held in its work in progress.
Another concern frequently raised by the opponents of Ipso Facto Clauses is based on the argument that Ipso Facto Clauses give business suppliers the leverage against business administrators in insolvent companies.[33] This is explained to be due to the need that insolvent companies have for suppliers at the moments when they have to face insolvency. This implies that while companies strive to recover from the insolvency status, the suppliers may also take advantage of the situations faced by the company by insisting on payment before performance or before the payment of other debtors prior to delivering on their contract terms. Understanding the terms of ipso Facto Clauses makes the suppliers to be considered more essential to business operations compared to other contract partners. The presence of those clauses therefore disrupts the administrative processes in the organization. Moreover, the Ipso Facto Clauses also increase the possibility of abuse by suppliers in business contracts.[34]
In situations where the supply is essential as in cases of insolvency, suppliers may understand their positions in the recovery of the business and subsequently use ransom measures against the insolvent company.[35] The ransom measures frequently employed by the suppliers include increase of contract values at the time of most need. This is because in desperate situations, organizations are bound to make some investment and expense decisions which are out of line with their financial objectives. In the end, the insolvent business undergoes loses through unplanned expenditures based on the incremental budget imposed by suppliers. This also tends to disrupt the administrative process through the disorganization of company finances. The disadvantages of Ipso Facto Clauses with respect to supplier misbehavior are more or less in regard to possibility of issuing threats. Where the suppliers tend to give their contract performance conditions failure to which they terminate their contracts. Since it is their supplies that the insolvent companies intend to use for business recovery, the insolvent companies tend to adhere to their demands based on the fear that the retraction of suppliers may result in business burial rather than recovery. In America, Ipso Facto Clauses can be invalidated based on three conditions which include when the debtor faces insolvency, or when there insolvency case that is intended to commence. The satisfaction of any of these conditions makes Ipso Facto clauses unenforceable within the U.S Law. With regards to controlling supplier behavior, the invalidation of Ipso Facto Clauses under these conditions ensures that suppliers do not take advantage of companies facing insolvency. Issues such as ransom contracting and disruption of administrative functions through financial disorganizations therefore have no place where Ipso Facto Clauses are restricted.[36]
An example case in which ipso Facto Clauses were deemed unenforceable based on the premise that the clauses were condition after the commencement of an insolvency case involved the Lehman brothers and BNY Corporate Trustee services.[37] In this case, the plaintiff claimed that the defendant had imposed undue demands based on a preemptory note prepared for a contract explaining Ipso Facto conditions in case of insolvency. The debtor in this case, Lehman brothers held that the Ipso facto clauses referred to by the defendant were unenforceable based on their conditioning after the commencement of the case. The court held that the Ipso Facto Clauses alluded to were unenforceable due to various reasons which included: that the enforceability of Ipso Facto Clauses were not only subject to consideration of whether they were conditioned after the commencement of the bankruptcy case by the debtor but also after commencement of bankruptcy case by any other entity that is related to the debtor in some way. Moreover, the Ipso Facto clauses referred to did not provide safe harbor conditions for the defendant. The case was thus ruled in favor of the plaintiff who was acting on behalf of its relative company, Lehman Brothers Holdings Inc.[38]
2.2.2 Disadvantages to the Counterparties
Ipso Facto Clauses also initiate the desire to employ self help measures by potentially insolvent companies.[39] Any companies entering into contracts with others especially for the supply of goods and/ or raw materials have formulated self help measures in order to cushion themselves from the detrimental effects of supplier misbehavior in the organizational context. One of the key self help measures taken by organizations in the contemporary times is through the incorporation of certain supplier control agreements into contract agreements. Such clauses incorporated by potentially insolvent companies include the requisition of the potentially insolvent companies that supply agree to terms requiring them not to terminate the contract unless under obligation to do so either through completion of the contract obligations or through breach conditions that force the contract to be terminated.[40]
Direct agreements aimed at ensuring that suppliers do not neglect the company in times of need have been instituted through the inclusion of such terms in the contract documents. As a form of cushioning against the negative effects of direct agreements which bound suppliers to financially detrimental contracts, laws provided for restrictions of Ipso Facto Clause enforcement have been increasingly debated to increase the benefits associated with this clause.[41] In cases where Ipso Facto Clauses are enforceable, it is probable to find such direct agreements taking centre place in the organizational set up. For instance, as opposed to England and America where the enforceability of Ipso Facto Clauses is subject to various restrictions, the enforceability of the same in Australia is more bent on the accomplishment of law demands.[42] This makes it difficult for business owners to achieve cushioning hence the need to include direct agreements in the contract conditions. Such direct agreements are rarely met in the U.K and U.S contexts.[43]
A further disadvantage of Ipso facto clauses is that they reduce credit in businesses through liquidation and settlement of debts.[44] Contracts with suppliers and customers are terminated under the Ipso Facto Clause conditions resulting in reduced income through sale of products as well as reduced production rates in case of manufacturing companies. Consequently, payment of debts has to be managed from organizational financial reserves which lead to reduction in the organization’s credit. Moreover, the liquidation of organizational assets after the enforcement of Ipso Facto Clauses results in incremental losses due to the inability to access supplies and/ or maintains other contract conditions. If businesses are allowed to continue operations under the management of the debtors who are also the business owners, the profitability of those businesses may increase as is required by chapter 11 of the U.S constitution.[45]
Conclusion
The debate surrounding the relevance of Ipso Facto Clauses in insolvency goes beyond the borders of Australia. While some countries such as the U.K and the U.s have found ways to effectively manage the enforcement of these clauses without increasing the debtor or creditor risks, Australia is still grappling with a lack of clarity in its law provisions concerning the enforceability of these clauses. This lack of clarity has continued to draw debates with proposals for reform taking the core of these debates.[46] As a form of optimizing on the potential for business recovery through the application of Ipso Facto clauses, various camps have proposed the consideration of the U.S chapter 11 as a guideline for a functional law for Ipso facto enforcement. Several cases have also been decided which alluded to the applicability and enforceability of Ipso Facto clauses in the contract environment.
Various reasons have been provided by pro- Ipso facto clause teams as to the benefits associated with the enforcement of the Ipso Facto Clauses in insolvency. Some of the highlighted benefits include the protection of creditors from incurring bad debts, reducing the possibility of claims about anticipatory contract breach, cherry picking of potentially profitable contracts by administrators among others. In a similar light, the cons against Ipso Facto Clause enforcement have been identified as the possibility of retraction by suppliers and customers among other factors. The comparison of the weight of advantages of Ipso Facto clauses versus the disadvantages of the same clearly show that contrary to the conventional belief that Ipso Facto clauses have no significant benefits to business contracts, the clauses have greater benefits than perceived.[47] With slight restrictions, Ipso facto clauses can be used to initiate business recovery post insolvency rather than business burial.[48]
Recommendations
Following the findings of the present study, the following recommendations are made especially for the Australian government concerning the enforceability of Ipso Facto Clauses in Insolvency cases.
- The enforceability of the Ipso Facto Clauses should be made clear enough in the constitution, particularly on their relevance to insolvency. While doing this, an explanation should be made so that the drafting of contracts should be made with awareness of the enforceability of these clauses in mind.
- Secondly, despite making the clauses enforceable, this should be done within the confines of moral law through restriction of enforcement in situations where the enforcement could be disadvantageous to either of the contract parties. For instance, the clauses could be made enforceable only when the contracts entered into did not involve the supply of certain means of existence e.g. raw materials for organizational operation.
- Ipso Facto Clauses should also be broadened to include not only the ability to terminate contracts at will upon insolvency, but other clauses that can be able to help recovery before burial of insolvent organizations.
Bibliography
Adams, Kenneth. A Manual of Style for Contract Drafting. (ABA Web Store, 3rd Ed., 2013)
Apathy, Paul, Rowena White and James Myint. ‘Australia’s Insolvency and Bankruptcy Law Reforms Ipso Facto Clauses.’ (2016) Herbert Smith Freehills.
Buterick, Brett. ‘Terminable- at –Will Clauses and Executory Contracts in Bankruptcy: An Examination of Third Circuit Treatment and Practitioner Guidance,’ (2015) Rutgers Journal of Law and Public Policy.
Cheetham, Cameron. Ipso Facto Clauses and Insolvency (2012). Clayton Utz Ltd.
Ellenberg, Mark. ‘The Dante Decision: A legal Analysis,’ (2010) Institutional Investor News.
Eisenson, Joshua. ‘Pre-petition Hindrance Mechanisms,’ (2014) 22 ABI Law review 247. Fibria Celulose S/A v. Pan Ocean [2014] EWCH 2124.
Higgins, Katie, Roger Dobson and Kal Luck. Corporate and Business Rescue in Australia: Insolvency Law Reform Process Continues as Government Releases Proposals Paper (2016) Jones Day.
Lawton, David and Andrew C. Gold. ‘Ipso Facto Clauses: Not Always unenforceable in Bankruptcy’ (2013) Strafford University Publications.
Lehman Brothers Special Financing Inc. v. BNY Corporate Trustee Services Limited [2010] 422 B.R. 407.
Kaufmann, Sebastian & Arthur J. Steinberg, ‘New Decision Offers Lessons on Bad Boy Guarantees,’ (2012) 1 New York Law Journal.
Kennedy, George and Chloe Townley. ‘Court upholds English Contract Termination Clause that is Invalid under Foreign Insolvency Law,’ (2014) Knowledge Bank Sector Insights.
Papadakis, Marianna. ‘Ban ‘Ipso Facto’ Clauses say Insolvency Experts,’ (2015) The Australian Financial Review.
Poole, Nick and Peter Bowden. ‘Chapter 11 Again Mooted as an Option for Australia’s Insolvency Regime,’ (2014) Clayton Utz Ltd.
O’Flynn, Karen. ‘Safe Harbors and unforeseeable Ipso Facto Clauses on the Way for Australian Insolvency Law.’ (2015)Clayton Utz Ltd.
Sachak, Ravi. ‘Corporate Rescue Proceedings and Enforcement of Ipso Facto Clauses: A Comparison of the English and U.S Approaches,’ (2011) International Corporate Rescue (Chase Cambria Company Ltd, U.K)
[1] Nick Poole and Peter Bowden. ‘Chapter 11 Again Mooted as an Option for Australia’s Insolvency Regime,’ (2014) Clayton Utz Ltd.
[2] Ibid.
[3] Ibid.
[4] Ibid.
[5] Katie Higgins, Roger Dobson and Kal Luck. Corporate and Business Rescue in Australia: Insolvency Law Reform Process Continues as Government Releases Proposals Paper (2016) Jones Day.
[6] Ibid.
[7] Ravi Sachak. ‘Corporate Rescue Proceedings and Enforcement of Ipso Facto Clauses: A Comparison of the English and U.S Approaches,’ (2011) International Corporate Rescue (Chase Cambria Company Ltd, U.K)
[8] Katie, above n 5.
[9] Ibid.
[10] Poole and Bowden, above n 1
[11] Ibid.
[12] Cameron Cheetham. ‘Ipso Facto Clauses and Insolvency’ (2012). Clayton Utz Ltd.
[13] Ibid.
[14] Fibria Celulose S/A v. Pan Ocean [2014] EWCH 2124.
[15] See, George Kennedy and Chloe Townley. ‘Court upholds English Contract Termination Clause that is Invalid under Foreign Insolvency Law,’ (2014) Knowledge Bank Sector Insights.
[16] Cameron, above n 12.
[17] Ibid.
[18] Brett Buterick. ‘Terminable- at –Will Clauses and Executory Contracts in Bankruptcy: An Examination of Third Circuit Treatment and Practitioner Guidance,’ (2015) Rutgers Journal of Law and Public Policy.
[19] Ravi, above n 7
[20] Brett, above n 18.
[21] Karen O’Flynn. ‘Safe Harbors and unforeseeable Ipso Facto Clauses on the Way for Australian Insolvency Law.’ (2015)Clayton Utz Ltd.
[22] Ravi, above n 7.
[23] Karen, above n 21.
[24] Brett, above n 18.
[25] Ibid.
[26] Kenneth A. Adams. A Manual of Style for Contract Drafting. (ABA Web Store, 3rd Ed., 2013)
[27] Brett, above n 18
[28] Ibid.
[29] Poole and Bowden, above n 1.
[30] Ibid.
[31] Ibid..
[32] Ravi, above n 7.
[33] Ibid.
[34] Paul Apathy, Rowena White and James Myint. ‘Australia’s Insolvency and Bankruptcy Law Reforms Ipso Facto Clauses.’ (2016) Herbert Smith Freehills.
[35] Ibid.
[36] Brett, above n 18.
[37] Lehman Brothers Special Financing Inc. v. BNY Corporate Trustee Services Limited [2010] 422 B.R. 407.
[38] See, Mark Ellenberg. ‘The Dante Decision: A legal Analysis,’ (2010) Institutional Investor News.
[39] Joshua L. Eisenson. ‘Pre-petition Hindrance Mechanisms,’ (2014) 22 ABI Law review 247.
[40]Ibid.
[41] Ibid.
[42] Nick and Bowden, above n 1.
[43] Sebastian F.C. Kaufmann & Arthur J. Steinberg, ‘New Decision Offers Lessons on Bad Boy Guarantees,’ (2012) 1 New York Law Journal.
[44] Brett, above n 18.
[45] Karen, above n 21.
[46] Marianna Papadakis. ‘Ban ‘Ipso Facto’ Clauses say Insolvency Experts,’ (2015) The Australian Financial Review.
[47] David L. Lawton and Andrew C. Gold. ‘Ipso Facto Clauses: Not Always unenforceable in Bankruptcy’ (2013) Strafford University Publications.
[48] Joshua, above n 39.