Beware the self-executing clause

Contracts, which includes leases, entered into after 1 July 2018 with self-executing (also called ipso facto) clauses are now subject to the Corporations Act.

What are they?

Self-executing clauses typically provide a right for the termination of a contract (lease) or amendment of the contractual terms, if the other party to the contract (lease) enters into an insolvency event.

What happens if there is an insolvency event?

If a right pursuant to a self-executing clause (eg to terminate or amend the contractual terms) arises by an express self-executing clause in a contract (lease), agreement or arrangement, that right is stayed/cannot be enforced against the company (eg lessee) for the reason that:

1. the company (eg lessee) enters into voluntary administration;

2. a managing controller (which includes a receiver and manager) is appointed over the whole or substantially the whole of the company's (eg lessee's) property; or

3. the company (eg lessee) publicly announces that it will be making an application to enter into a scheme of arrangement for the purpose of avoiding being wound up in insolvency.

How long are your rights delayed/is the stay effective?

The length of the "stay" will turn on whether the company is undergoing an administration, appointment of managing controller or receiver or scheme of arrangement, and will be subject to any court orders that may be in force. In general terms:

1. for a voluntary administration - the stay will begin when the company enters administration and end when the administration ends or when the company is wound up;

2. for a receivership - the stay will begin when the managing controller or receiver is appointed and end when the managing controller or receiver's control ends;

3. for a scheme of arrangement - the stay will begin when a public announcement or scheme application is made, and end three months after the announcement when the application is unsuccessful or dismissed, or when the company is wound up.

What contracts (leases) are affected?

The changes to the Corporations Act:

1. will only apply to self-executing clause rights under contracts (leases) entered into after 1 July 2018;

2. do not have retrospective application.

Practical considerations for lessors and lessees

1. The Corporations Act amendments do not alter any existing rights and entitlements relating to leases. The self-executing clause provisions introduced into the Corporations Act will simply add an extra layer of protection for lessees experiencing an insolvency event, but will cause lessors to proceed in exercising their rights with caution.

2. Lessors will be able to continue to terminate a lease for a breach of non-monetary and non-self-executing clauses which are clear and enforceable.

3. The amendments restricting enforcement of self-executing clauses are against the company (eg lessee) which goes into administration. That is, the lessor is still able to exercise rights against third parties, eg banks, who have provided bank guarantees.

4. If leases entered into after 1 July 2018 haven't been updated and continue to contain self-executing clauses, a lessor needs to be careful not to issue a notice of termination on the basis of the self‑executing clause, as it may be open for the lessee to accept such a notice of termination as repudiation of the lease and sue for damages.

5. Lessors need to consider as to whether the lessee should have a right pursuant to a lease to grant a mortgage of the lease, or a security interest over personal property on the premises the subject of the lease.