First decision on Australia’s ipso facto stay in voluntary administration

The Federal Court of Australia (Court) has handed down the first reported decision on the ipso facto stay provisions contained in the Corporations Act 2001 (Cth) (Act). In Rathner, in the matter of Citius Property Pty Ltd (Administrator Appointed) [2023] FCA 26 the Court examined the operation of the voluntary administration ipso facto stay contained in s 451E(1) of the Act, and the extent to which that stay would continue during any liquidation that followed the administration.

Justice O’Bryan confirmed that:

• the s 451E(1) stay operates to restrain a counterparty from exercising its contractual rights by reason of: (i) a company’s entry into administration; or (ii) its financial position during the period of administration;
• if the administration ends in the liquidation of the company, the s 451E(1) stay will continue to operate until the liquidation of the company is complete; and
• the s 451E(1) stay does not operate to restrain a counterparty from enforcing:
  • any contractual rights arising by reason of a company’s entry into liquidation (even if the liquidation follows on from the administration); or
  • any substantive performance obligations of the company under a contract, or any right of the counterparty to terminate the contract on the basis of the company’s failure to perform those obligations.

This broadly reflects the market understanding as to how the administration stay under s 451E operates, but nonetheless provides some very welcome additional certainty. However, as we discuss, a number of important issues relating to the operation of the ipso facto regime remain to be addressed.

The decision also highlights that commercial parties will normally want to ensure that their contractual default or termination rights arising upon a counterparty’s ‘insolvency event’ are drafted so as to apply not only on administration, but also where the counterparty enters liquidation or a deed of company arrangement.

Factual background

Citius Property Pty Ltd (Citius) provided consultancy and project management services in connection with the development of industrial properties.

Citius’s principal asset was an agreement for the provision of project management services by Citius to the ‘Dexus Parties’ in connection with a commercial property development project (Dexus Agreement). That agreement contained an ipso facto clause (clause 16.1(d)) which permitted the Dexus Parties to terminate the agreement upon the occurrence of an ‘Insolvency Event’ in respect of Citius. ‘Insolvency Event’ was defined to include Citius “tak[ing] any step to obtain protection or is granted protection from its creditors, under any applicable legislation or an administrator is appointed”.

Following the appointment of an administrator, Citius continued to perform its obligations under the Dexus Agreement so as to earn further payments thereunder. At the time of the case, the Dexus Parties had not sought to terminate the Dexus Agreement as a result of the occurrence of the Insolvency Event (and they had not indicated any intention to do so).

The application by the administrator

The case involved an application by the administrator of Citius for:

• extension of convening period: an order extending the convening period for the second meeting of creditors by a period of 12 months (pursuant to s 439A(6) of the Act). The purpose of this extension was to extend the period of the administration and thereby allow Citius to continue performing the Dexus Agreement for its remaining term (and therefore earn the remaining payments thereunder, maximising the funds available for distribution to creditors); and
• ipso facto: several orders seeking ‘certainty’ in respect of the continuation of the ipso facto stay in any liquidation following the administration. These were orders to the effect that, if the administration of Citius ended because of a resolution or order for Citius’s winding up:
  • • the administrator was justified and acting reasonably in proceeding on that basis that the ipso facto stay period ended at the completion of the winding up of Citius (pursuant to s 90-15 of the Insolvency Practice Schedule (Corporations) (IPSC)); and
    • the ipso facto stay period was ‘extended’ to the completion of the winding up of Citius (pursuant to s 451E(3)(a) of the Act),

  (together, the Ipso Facto Orders).

The basis for the administrator’s application for the Ipso Facto Orders

The administrator was concerned that there could be some uncertainty about the operation of the administration ipso facto stay under s 451E(1) of the Act where a liquidation follows an administration.

Section 451E(1) provides that a right cannot be enforced during the stay period against a company for:

1. the reason that the company has come or is under administration;
2. the company's financial position, if the company is under administration;
3. a reason, prescribed by the regulations for the purposes of s 451E(1) (none have been so prescribed to date) that relates to the foregoing reasons; or
4. a reason that is, in substance, contrary to s451E(1),

if the right arises for that reason by express provision (however described) of a contract, agreement or arrangement.

Under s 451E(2), the ‘stay period’ starts when the company comes under administration and ends at the latest of the following:

1. when the administration ends;
2. if one or more orders are made extending the time period that would otherwise apply following an application made under s 451E(3) before the administration ends – when the last of those orders ceases to be in force; or
3. if the administration ends because of a resolution or order for the company to be wound up - when the company's affairs have been fully wound up.

The administrator considered that it was “clear on its face” that the s 451E(1) stay continued until the end of any liquidation immediately following an administration. However, he noted that the s 451E(1) stay would not apply where a liquidation occurred without an immediately preceding administration. The administrator suggested that this was a potentially “anomalous outcome”.

In the absence of any judicial consideration of s 451E, the administrator submitted that it would be appropriate for the Court to make the Ipso Facto Orders in order to provide the administrator with certainty as to the ongoing operation of the stay in any liquidation of Citius (should Citius move from administration to liquidation).

Rejection of the ipso facto stay application

The Court rejected the administrator’s application for the Ipso Facto Orders on the basis that the administrator had misconstrued the way in which the s 451E(1) stay operates.

Properly understood, the Court considered there was no anomaly as to the operation of s 451E in the liquidation context. This was because the s 451E(1) stay only applies to rights arising by reason of a company entering administration or its financial position during the administration period. Importantly, however, the s 451E(1) stay does not apply to rights arising by reason of the company entering liquidation. Accordingly, there would be nothing for the s 451E(1) stay to do in a case where there was no administration preceding the liquidation.

It was therefore clear that the s 451E(1) stay would continue on until the end of the liquidation should Citius move from administration to liquidation.

This also meant that whether the s 451E stay was effective in practice to prevent the Dexus Parties from terminating the Dexus Agreement during a subsequent liquidation would depend on whether the Dexus Agreement gave the Dexus Parties separate termination rights that would be triggered on (i.e. “arise by reason of”) Citius entering liquidation (the Dexus Parties would not be restrained from exercising such separate termination rights).^[1].

As put by O’Bryan J:^[2]

In my view, the Administrator’s apprehensions with respect to the meaning and effect of s 451E are unwarranted. The language and purpose of s 451E(1) of the Act is clear on its terms. Section 451E(1) operates to restrain a counterparty from exercising rights arising in a contract, agreement or other arrangement by reason of the fact of a company’s entry into administration or its financial position during the period of administration. The stay operates for the length of the administration and, if the administration concludes because of a resolution or order for the company to be wound up, until the winding up is complete.

The supposed anomaly referred to by the Administrator does not arise. The stay under s 451E does not apply to contractual rights that may arise by reason of the winding up. If the counterparty has a right to terminate a contract by reason of the company’s entry into liquidation, s 451E does not operate to stay that right. The stay only applies to a right that arises by reason of the company entering administration or the company’s financial position during administration. It is the stay of such a right that continues during a subsequent liquidation. The section does not stay the exercise of a right that arises by reason of liquidation.

In the present case, it is clear that s 451E(1) operates with respect to Citius and that it serves to restrain the Dexus Parties from exercising their right to terminate under cl 16.1(d) of the Dexus Agreement by reason of Citius’s entry into administration for the duration of the administration and, if the administration ends by resolution or order to wind up Citius, for the duration of the winding up.

His Honour therefore held there was no legal issue or question requiring determination with respect to the proper operation of s 451E(1) and therefore considered it unnecessary to make the order under s 90-15 of the IPSC.^[3]

With respect to the requested order under s 451E(3)(a), O’Bryan J noted that this section allowed a court to make an order extending the period of the s 451E(1) stay otherwise applying. However, in this case, the administrator was seeking an order that the stay applied until the end of a subsequent liquidation, which was merely restating what section 451E already provided (given the analysis above). He therefore considered it was not an appropriate order to make.

Extension to the convening period

Justice O’Bryan did consider that it was appropriate and consistent with the object of Part 5.3A to make the order sought by the administrator extending the convening period for the second meeting of creditors in the administration for 12 months (and thereby extending the period of the administration).

In so deciding, his Honour noted that the practical effect of extending the administration in this way was to continue the operation of the s 451E(1) stay, meaning that the Dexus Parties would remain subject to their obligations under the Dexus Agreement, potentially for an additional 12 month period.

Notwithstanding this, O’Bryan J was satisfied that the ongoing operation of the s 451E(1) stay ought not preclude the grant of the administration extension because:

• the Dexus Parties were on notice of, but did not oppose, the application;
• the scope of the s 451E(1) stay was limited to the specific ipso facto provision contained in clause 16.1(d) of the Dexus Agreement. No other rights of the Dexus Parties would be affected. O’Bryan J emphasised (at [52]):

Importantly, the Dexus Parties retain their rights to require the proper performance of the Dexus Agreement, and to terminate the Dexus Agreement if it is not properly performed by Citius.

• the Dexus Parties were entitled to apply to the Court to address any prejudice that arises from the extension.^[4]

Comments

Although the case is the first reported decision on the ipso facto provisions of the Act, as O’Bryan J noted, the language and purpose of s 451E(1), in this regard at least, is clear on its terms and the judgment therefore does not come as a great surprise.^[5]

Termination on liquidation

Most commercial contracts will contain termination rights that arise on a number of insolvency related events, and typically these will include a contractual party entering administration or liquidation. In such cases, the decision illustrates that even if a counterparty is stayed during an administration from exercising its termination rights by virtue of the ipso facto stay contained in s 451E(1), once the company enters liquidation the counterparty will no longer be restrained as it can then rely on its liquidation termination right.

The case demonstrates that one possible option for addressing this issue is for an administrator to seek an extension of the administration, so to preserve the effective operation of the administration stay. However, the willingness of courts to grant such extensions where the application is contested by the relevant counterparty (who might also be seeking an order lifting the stay under s 451F) remains to be seen.

Deeds of company arrangement

A similar issue appears to arise in respect of the entry by the company into a deed of company arrangement following an administration. Where the contract contains a termination right based on the party entering into such an arrangement, this would also appear to provide the counterparty a separate termination right that is not restrained by s 451E(1). Unlike liquidation, where a business will usually cease operating, a deed of company arrangement will typically seek to preserve the ongoing business. The apparent lack of an ipso facto stay applicable where a company enters into a deed of company arrangement is therefore problematic.^[6]

Non-performance of substantive contractual obligations

Justice O’Bryan’s comments regarding the ability of a counterparty to exercise its contractual performance rights (including any termination rights arising from such non-performance) during the ipso facto stay period are also noteworthy. Again, this reflects the general market understanding of the ipso facto provisions but is critically important to counterparties. This aspect of the decision is also applicable to the operation of the similar ipso facto stay provisions applying in respect of receivers and other controllers (appointed over the whole or substantially the whole of the company’s property) under s 434J, in respect of schemes of arrangement (for the purpose of avoiding insolvent liquidation) under s 415D or because a company has come or is under small business restructuring under s 454N of the Act.

Remaining issues

A number of important issues remain to be addressed by the courts in respect of the ipso facto stay regime. These include, for example:

• the extent of the ‘anti-avoidance’ limb of the ipso facto stay which stays enforcement of rights arising “for a reason that is in substance contrary to this sub-section” (s 451E(1)(d));
• the breadth of a stay on enforcing rights for the reason of “the company’s financial position” (s 451E(1)(c)(ii));
• whether a counterparty may enforce rights against company A by reason of (for example) the administration of company B;
• the approach of the court to applications for stay orders under s 451E(3), or where counterparties seek to lift the ipso facto stay under s 451F; and
• uncertainties regarding the ambit of a number of the exceptions to the stay.

Drafting ‘insolvency event’ default or termination triggers

For anyone involved in drafting ipso facto clauses, the message from the Rathner case is clear: in order to obtain the greatest optionality to terminate or modify the operation of the contract upon the occurrence of a specified insolvency related event, the ‘insolvency related event’ should include (among other things) specific limbs relating to the entry by the counterparty into any of administration, liquidation or a deed of company arrangement.

Our discussion of the ipso facto regime can be found here.

[1] Justice O’Bryan did not address whether the definition of ‘Insolvency Event’ in cl 1.1, para (i) of the Dexus Agreement would include the liquidation of Citius. It appears, however, that his Honour assumed that cl 16.1 of the Dexus Agreement conferred on the Dexus Parties a contractual right of termination upon Citius entering administration only, and did not confer on the Dexus Parties a separate right of termination in the event Citius entered into liquidation (as to this, see [61]).

[2] Rathner, in the matter of Citius Property Pty Ltd (Administrator Appointed) [2023] FCA 26, [59]-[61].

[3] Ibid, [62].

[4] Ibid, [49]-[53].

[5] In this regard, it is worth noting that the precise relationship and distinction between s 451E(2)(c), which provides for the administration stay period to continue on and end at the end of any subsequent liquidation, and s 451E(4), which provides for the indefinite continuation of the stay in respect of matters prior to the end of the stay period, is not easy to discern, particularly in light of this decision which indicates the s 451E stay only applies to the administration or the company’s condition during the administration period. The explanatory memorandum suggested that the purpose of s 451E(4) was “to prevent the perverse outcome of a clause in an agreement that is stayed during an external administration being used against a company once its administration has ended on the basis that it was under administration.” This issue was not addressed in the decision.

[6] It is also notable that there is no equivalent to s 451E(2)(c) specifically extending the period of the administration stay throughout the period of a deed of company arrangement where this follows on from an administration process.