Ipso Facto Clauses and Leases

A lot has been written in the recent past about the new laws affecting ipso facto provisions in contracts.

A useful starting point with any new legislation is the explanatory memorandum which accompanies the Bill that goes through Parliament to explain what the new law is all about.

Broadly, the new law is designed to create a safe harbour for company directors from insolvent trading while they attempt to restructure the company.

The explanatory memorandum defines an “ipso facto” clause as follows:

“An ‘ipso facto’ clause is a provision that allows one party to terminate or modify the operation of a contract upon the occurrence of some specific event, regardless of otherwise continued performance of the counterparty.” A counterparty is the other or opposite party in a contract.

The concern is that the operation of ipso facto clauses “can reduce the scope for a successful restructure or prevent the sale of the business as a going concern” and defeat the purpose of the new law which is, essentially, to give company directors some breathing space while they restructure their beleaguered companies and attempt financial recovery to avoid being wound up.

A common ipso facto clause in a commercial lease that is affected by the new law is one which gives the landlord the right to terminate a lease on the occurrence of an insolvency event if the Lessee appoints a receiver, manager or other controller of the lessee’s property, what is commonly defined the lease as an “insolvency event”.

Under the new law, the landlord may not be able to enforce the right to terminate the lease simply because of an insolvency event. That right is stayed from the time the company appoints the receiver, manager or controller and ends when the appointment ends or until such further time as allowed by an order of court.

Therefore, if the tenant appoints a receiver, manager or controller to sort out its financial situation and continues to pay the rent and observe its covenants under the lease, the landlord will not be able to terminate the lease.

This stay, however, does not extend to the right to terminate if the tenant is in breach of a payment obligation or any other obligation under the lease that gives the landlord a right to terminate the lease. Therefore, if the tenant stops paying the rent, the landlord is not prevented by the new law from enforcing its right to terminate the lease in accordance with the provisions of the lease and any other law that applies to the lease.

As with every new law there are exceptions, rules and criteria that apply and it would also be a good idea to contact Narinder Jessy at Jessy Legal for a chat about your position whether as a landlord or a tenant and how it may be affected by this new law.

Narinder is the principal of Jessy Legal, which is a property and commercial practice with emphasis on property transactional and commercial leasing advice and representation. For more information on Jessy Legal, visit the website www.jessylegal.com.au.