How ipso facto provisions (and exemptions) affect project finance - both good and bad news

In brief

The new ipso facto regime applies to contracts entered into on or after 1 July 2018. It imposes a stay on the exercise of certain contractual rights in some insolvency regimes (administration and some receiverships and schemes of arrangement, but not liquidation). There are many exemptions from the regime, some of which will be relevant to project finance. Partner Scott McCoy, Senior Finance Counsel Diccon Loxton and Senior Associate Isabel Cropley discuss some of the issues.

How does it affect you?

• Many of the rights held by project financiers will be exempt and free from the stay (but not all of them).
• At the same time for many projects, if the project financiers enforce their security by appointing a receiver over all assets of the project vehicle (or it goes into administration), rights of builders, suppliers, off-takers and other contractors will be stayed. So, the vehicle (and its financiers) may still be able to rely on those contracts.
• But not all contracts with project vehicles will be stayed, in particular:
  • contracts in some very large projects
  • some government contracts
  • some PPP contracts
  • hedging contracts and other derivatives
• It is important for financiers to ensure they have security over the whole or substantially the whole of the assets of the project vehicle.

The new regime

In July 2018, new laws came into effect under which the ability of a party to enforce its rights under a contract, agreement or arrangement following various insolvency-related trigger events relating to the counterparty are stayed.¹ These triggers include where:

• the counterparty has applied for or adopted a scheme of arrangement (expressly to avoid the company being wound up in insolvency);
• a managing controller (including a receiver) is appointed to the whole or substantially the whole of a counterparty's property; and
• an administrator is appointed to the counterparty.

The stay does not apply as a result of a liquidation.

If one of those insolvency-related trigger events occurs, a right that arises because of the financial condition of the counterparty is also stayed. The stay covers 'self-executing' clauses that would otherwise operate to automatically enforce rights under a contract – such as automatic termination of contract or automatic acceleration of a loan. There are anti-avoidance provisions.

The reform is, in essence, to protect the value of the company by restricting the ability of the company's creditors to terminate a contract solely due to the insolvency or financial position of the company.

But importantly, if there is a breach of contract such as a payment default or non-performance, a party can enforce its rights arising from the breach. 

Where are the exemptions?

There is a wide variety of contracts and rights that are exempted from the ipso facto regime. These exemptions are contained in:

• The provisions themselves:
• Amendments to the Corporations Regulations 2001² (Regulations); and
• A ministerial declaration³ (Declaration).

It is important to check the wording of these exemptions. They are not always intuitive or clear and it is easy to make a wrong assumption.

What is exempted?

The good news for financiers is that there are a number of exemptions allowing enforcement of rights under a financing agreement despite the statutory stay. This may be due either to the nature of the financing, or be subject to the particular right to be enforced. Some key exemptions are listed below.

Types of financing

• Financiers can exercise their usual rights if a breach of contract has occurred that is not related to the insolvency trigger event or the financial position of the company. For example, financiers can enforce on a payment default.
• Financiers under an agreement that is or governs 'syndicated loans' can exercise any rights contained in that agreement.
• Financiers who have provided hedging can exercise their rights under derivative contracts.
• Rights under finance documents entered into before 1 July 2018 are protected.
• New contracts arising from amendments, assignments or novations of finance documents entered into before 1 July 2018 are protected if they are entered into before 1 July 2023.
• Rights of financiers under contracts that involve special purpose vehicles (SPVs, although that term is not defined in the legislation) and that provide for project finance arrangements are protected from the stay. To be eligible, the finance under the arrangement is to be repaid primarily from the project's cash flows and all or substantially all project assets must be held as security.
• Rights of parties under contracts that involve SPVs and that provide for a public-private partnership (PPP) are protected from the stay. It is not clear on the face of the legislation what 'provides for' means in this context and whether this extends to all finance documents and other project documents that support a public-private partnership. 

Security rights

• Financiers with security over the whole, or substantially the whole, of a company's property can still appoint a receiver.
• Secured financiers can appoint a receiver over any asset of a company if a receiver has already been appointed over any asset of the company (eg following the appointment by a different financier), even if the receivers are being appointed over different assets.
• Financiers can exercise any step-in rights they may have.
• Also, even if a financier's rights are stayed as against a borrower, a financier may still enforce against guarantors and third party security providers.

Inter-creditor issues – a potential mess

The ipso facto regime, and the limited exceptions to it, may lead to perverse results where some creditors are entitled to exercise rights on an insolvency, and others are not.

Stayed financiers may not be entitled to rely on cross-default provisions where other financiers (exempted from the stay) are able to enforce because of insolvency or the financial position of the company. And it is not certain whether the stayed financiers can rely on the cross-default when the other financiers actually enforce in those circumstances.

Given the potential inter-creditor issues that arise due to the ipso facto regime, where there are multiple creditors on a transaction, the intercreditor arrangements between the parties will become more important.

Stay on enforcement under project documents

More good news for financiers (and the borrower) due to the new ipso facto regime is that, unless a relevant exemption exists, project counterparties may be stayed from enforcing their rights under project documents, so the day-to-day business of the borrower can be maintained despite an insolvency.

However, certain project documents will be exempt from this stay as well, including the following:

• contracts entered into before 1 July 2018;
• government licences, permits and approvals – it will be prudent for financiers in the due diligence stage to identify what conditions are exercisable by the relevant government authority on an insolvency of the company, particularly for critical authorisations which the project is reliant on;
• certain 'critical' government contracts, such as contracts relating to Australia's national security, border protection or defence capability, goods or services to a public hospital or public health, or other contracts for the supply of essential or critical goods or services, or carrying out essential or critical government works. These expressly include public transport services, public security or safety services, and works affecting essential public infrastructure;
• certain high-value construction contracts entered into before July 2023 are excluded where the total payments for all contracts, agreements or arrangements for the project for work, goods or service of those kinds is at least $1 billion;
• step-in rights are excluded regardless of the type of contract they are contained in;
• derivatives are excluded so hedge agreements for the project may be able to be terminated (including any power purchase agreements or other offtake agreements structured as contracts for difference); and
• as mentioned above, rights of parties under contracts that involve SPVs and that 'provide for a public-private partnership' are protected from the stay.

Practical lessons

• Consider each transaction – Be aware of the new reforms and consider ipso facto at the outset of a transaction. Financiers will be smart not to assume they are protected without careful analysis of the relevant legislation for each transaction. The exceptions are not clearly defined and their scope is untested. Projects can contain their own nuances that could bring them in or outside of an exception.
• Intercreditor issues – When structuring a transaction, think hard about intercreditor issues. If perverse results would arise from the ipso facto provisions applying differently to different creditors, consider how these can be avoided.
• Tripartite Agreements and Step in Rights – A financier would be prudent to continue to insist on tripartite agreements in respect of material contracts.  A counterparty will be stayed in some circumstances unless an exception exists but there will be other circumstances in which they will not be stayed – in particular, liquidation – and the scope of these exceptions is still untested. The counterparty may always apply to a court to seek relief. A tripartite agreement will also offer the financier step-in rights, which will not be stayed.
• Importance of all asset security – Financiers should ensure they have security over the whole or substantially the whole of the assets of the project vehicle in order to take advantage of the exemption to the stay to appoint a receiver. This makes it important to ensure the security covers all material contracts. Note that the exempted right to appoint a receiver does not, under the terms of the legislation, extend to the right to accelerate all amounts owing even where security has been granted over all assets. This appears to be an unintended and odd result of the legislation.
• Contracts at the borrower level – Remember that the borrower may also be subject to the ipso facto stay in relation to its contracts with other counterparties if they are subject to an insolvency trigger event. Financiers should focus in due diligence on any key contracts where a stay on enforcement may materially affect the project vehicle. However, importantly, the borrower will still be able to exercise its rights if a breach of contract has occurred such as non-payment or non-performance of obligations.
• Government licences and government contracts – If government licences and contracts with government are important to the project vehicle, consider during the due diligence stage the rights that the government will be able to exercise that will not be subject to the stay.
• Drafting considerations:
  • Given the protection for amendments up to 1 July 2023, we expect that where possible, financiers will be keen to document variations and extensions as amendments rather than 'amendments and restatements' or fresh facilities.
  • If financiers are relying on exemptions that are specific to certain types of contracts, it is important to consider which contract contains the relevant enforcement rights.
  • Broad discretions of the financiers and additional triggers that are not related to the financial position of the borrower are helpful for financiers but may not be possible in the commercial context of a transaction.
  • Consider confirmatory language if an initial single lender is intending to syndicate after signing and wants to rely on the syndicated loan exemption.
  • Guarantees should be drafted so that the guarantor can be required to repay the loan where the lenders are stayed from accelerating against the borrower.

  The APLMA documentation committee is making suggestions to cover the last two bullet points.

Please get in contact to discuss with a member of our team.