Termination Rights In The Event Of Insolvency: Where Are We Now With Ipso Facto Clauses; Are They Still A Potent Weapon In A Creditor's Armoury

• Published date: 27 November 2020
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Insolvency/Bankruptcy, Contracts and Commercial Law
• Law Firm: Quadrant Chambers
• Author: Mr Nigel Cooper

Introduction

Long term contracts frequently contain clauses which either terminate the contract automatically or entitle a party to terminate the contract in the event of the other party becoming insolvent; so-called 'ipso facto' clauses. The use of such clauses is controversial and in many jurisdictions such clauses are unenforceable because they are seen as allowing one creditor to take priority over other creditors in relation to property that should otherwise form part of the bankruptcy estate. English law did not share this approach but viewed the operation of such clauses as being essentially a matter of contractual construction. That position has now changed with the coming into force of amendments to the Insolvency Act 1986 ('IA 1986') introduced by the Corporate Insolvency & Governance Act 2020 ('CIGA 2020'), which make ipso facto clauses in contracts for the supply of goods and services unenforceable against an insolvent party. The purpose of this article is to examine some of the issues which arise in relation to the construction of ipso facto clauses and to explain the effect of the amendments to the IA 1986.

Ipso facto clauses are generally considered valid under English law. They do not, without more, offend against the public policy that prevents a party contracting out of the pari passu distribution of an insolvent's assets. Nor do they offend against the anti-deprivation rule, which prevents a party from withdrawing assets on bankruptcy, liquidation or administration so as to reduce the value of the insolvent estate to the detriment of creditors. As to the last, the Supreme Court held in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd [2012] 1 AC 383 that the rule would not invalidate clauses which did not amount to an illegitimate intent to evade bankruptcy or insolvency law and had a legitimate commercial basis.

Construction of the contract

The starting point for considering the applicability and effectiveness of an ipso facto clause will therefore be, as is so often the case, the construction of the contract. In this regard, clauses inevitably vary in their complexity, whether it be in the definition of what constitutes a triggering event or as to the procedures, such as the giving of notice, which have to be followed in order for termination to be valid. There are no special rules of construction applicable to ipso facto clauses. The general principles laid down in cases such as Arnold v Britton [2015] AC 1619 and Wood v Capita [2017] AC 1173 apply. In summary, one is looking to ascertain the objective meaning of the language used by the parties to express their agreement. This means looking at the contract as a whole and, depending on the nature, formality and quality of the drafting, giving more or less weight to the wider context of the agreement. However, the consequences of triggering an ipso facto provision are inevitably severe. In addition, the courts have emphasised in a series of recent judgments that the principles which apply to the construction of exclusion clauses and indemnity provisions do not represent special rules applicable only to certain types of clauses but represent principles of construction which are to be used alongside the general principles of construction for the purposes of determining the intention of the parties; cf. Fujitsu Services Ltd. v IBM United Kingdom Ltd [2014] EWHC 752 (TCC) at [24] - [26] and CNM Estates v VeCref I Sarl [2020] EWHC 1605 (Comm) at [14] - [18]. As such, when questions arise as to the construction of an ipso facto clause, a court should be guided by the principle that clear words are necessary to define the circumstances in which the parties intended that the right of termination would accrue.

The first question with any ipso facto clause is whether there has been a triggering event, which gives rise to the right to terminate. Clauses may define when a party is deemed to be insolvent...