Tips on How to Manage an Insolvent Party to a Business Contract
Business owners may occasionally face the matter of a contractual party becoming insolvent. Supporting a contractual relationship with an insolvent company may result in financial, legal, contractual and performance consequences.
Whilst many company contracts contain ‘ipso facto’ clauses entitling one party to terminate the contract if the other party becomes insolvent, there are important limitations to their usage. Since 2018, the Corporations Act 2001 (Cth) has restricted the usage on ipso facto clauses in most circumstances. While these laws don’t stop your business from relying on the ipso facto clause, they do operate as a stay of enforcement of the ipso facto clause, and thus have a similiar impact on your business. This means that your business is not able to terminate the contract because the other party became insolvent.
These laws are in place in order to safeguard the ability of the insolvent company to achieve successful restructuring. However, there are some exceptions to this rule, which apply for particular industries. The complete list of exceptions is contained in regulation 5.3A.50 of the Corporations Regulations 2001 (Cth), and include include contracts relating to particular industries such as security, information technology, public health, and certain financial transactions.
Risk Management Practices
If you are already in a contractual relationship with an insolvent party, you may wish to review when the contract naturally expires. You may also consider whether you are able to terminate the contract for other breaches or defaults, such as non-performance. Terminating the contract for reasons other than insolvency may be permitted.
The best time to manage your risk is prior to engaging in a contractual relationship. Undertake ASIC searches to confirm the solvency status of the other party, as well as a Personal Property Securities Register search to view any securities the other party may have against them. You may also search court databases to assess whether the other party has any disputes open against them. A solicitor is posed to assist you with any and all due diligence searches you might require so as to minimise the risk of your business contracting with another party that is at risk of becoming insolvent.
Next Steps
If you become aware that one of your company’s contractual parties may be insolvent, take steps to investigate the matter. Open communication with the party in question, and retain legal support to assist you in managing your exposure to risk. As we explained in this blog, a solicitor will also be able to assist you with recovering debts and payments, engaging any registrations on the Personal Property Securities Register, undertaking due diligence searches, and clarifying and protecting your rights and obligations. If all else fails, you may wish to consider applying to the court to lift the stay of enforcement if your business is likely to face significant hardship.
At Butlers Business Lawyers, we pride ourselves on our practical, commercial focus. Our team of solicitors can provide practitioners with speculative obligation free advice regarding the prospects of recovery or pursuit of a matter in insolvency. Speak with one of our experienced solicitors in Newcastle, the Hunter or Sydney! Call us on (02) 4929 7002, email us or complete an enquiry form.