Senate

Supplementary Explanatory Memorandum

(Circulated by the authority of the Minister for Revenue and Financial Services, the Hon Kelly O'Dwyer MP)

Amendment to the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017

Outline of chapter

1.1 This chapter explains the amendments (the Senate amendments) to the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017 (the Bill).

Detailed explanation of new law

1.2 The Bill provides for a stay on the enforcement of rights against a company that amends or terminates an agreement because of the company's formal restructure. Once a formal restructure has commenced, the stay also applies to rights that are enforceable based on the company's financial position before or during the formal restructure The stay would apply in relation to entities entering into a Part 5.1 compromise or arrangement (where that scheme is for the purpose of avoiding insolvent liquidation), companies that are placed into administration under Part 5.3A of the Act, or where a managing controller is appointed over all or substantially all of the property of the company under Part 5.2 of the Act.

1.3 The Senate amendments amend the application of the stay on the enforcement of applicable rights to:

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strengthen the anti-avoidance mechanisms to ensure that parties cannot contract out of the stay;

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extend the right to consent in writing to the enforcement of a stay so that it is also available to a liquidator who is appointed to a company subsequent to a compromise / arrangement or an administration; and

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clarify that the stay also applies to clauses which automatically terminate or amend existing rights of the restructuring company.

Strengthening the anti-avoidance mechanism

1.4 Amendments 1, 7 and 12 strengthen the anti-avoidance mechanisms relating to the stay on the enforcement of rights that trigger when a company undertakes a formal restructure or on the basis of a company's financial position before or during a formal restructure by:

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introducing a new integrity provision to prevent parties from contracting around the stay; and

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clarifying that the regulations may be used to address potential arrangements that develop to circumvent the operation of the stay.

1.5 The new integrity provisions provide that the stay will apply in relation to arrangements that are in substance contrary to the imposition of the stay. This ensures that contractual arrangements that purport to circumvent the stay by triggering on events that occur prior to a company entering a formal restructure will still be subject to the stay. For example, a contractual clause could specify that the trigger for termination or amendment is the passing of a resolution to appoint an external administration. Such a clause would be caught by the integrity provision and the stay will therefore apply.

1.6 The regulation making powers were included in the Bill as a general anti-avoidance mechanism as explained in the explanatory memorandum to the Bill in paragraphs 2.32, 2.62 and 2.77. The regulation making powers in the Bill are linked to the provisions which impose the stay. This has created uncertainty amongst industry participants about whether the regulations can be used as intended to extend the stay in relation to ipso facto rights that are triggered on events that occur prior to the commencement of an applicable formal restructure.

1.7 The amended regulation making power enables the making of regulations which extend the stay to rights enforceable for reasons which are based on events occurring before the stay period begins (for example before a company enters into or announces the relevant formal restructure). This ensures that the scope of the regulation making powers is sufficiently broad to achieve the intended purpose of capturing all arrangements developed by parties to circumvent the operation of the stay.

1.8 As a result of the amendments to the regulation making powers, if contractual arrangements that trigger on circumstances not captured by the stay or the integrity provision do develop, the Government will be able to use the regulation making powers to ensure that the stay can be extended to cover those types of arrangements. By doing this in the regulations, the Government will be able to respond quickly to ensure there is no widespread circumvention of the stay. As the regulations are subject to disallowance there would still be appropriate Parliamentary scrutiny.

1.9 Amendments 4, 9 and 15 extend the general discretion of the court to the new integrity measures and the amended regulation making powers, enabling them to order that some rights should be enforceable in the interests of justice.

1.10 The Bill provides that rights that are subject to the stay are not enforceable indefinitely to the extent that the reason for enforcing the right relates to a company's financial position prior to or during the stay period or a company's commencement of an applicable formal restructure. Amendments 2, 8 and 13 provide for consequential changes to ensure that the same application period applies where an ipso facto clause is stayed owing to the new integrity measures or amended regulation making powers.

Extending the right to consent to the lifting of the stay on the enforcement of rights under applicable ipso facto clauses to subsequent liquidators

1.11 The Bill provides for an administrator and a person administering a compromise / arrangement to be able to consent in writing to lift the stay on the enforcement of rights under applicable ipso facto clauses.

1.12 Amendments 3 and 14 extend this right so that it is also available to a liquidator who is subsequently appointed to a company after an administration or compromise/arrangement.

Clarifying that the stay also applies to self-executing provisions

1.13 Amendments 5, 10 and 16 make clear that the stay on ipso -facto clauses applies to clauses which are self-executing provisions that purport not to involve the enforcement of a right.

1.14 The stay is generally framed as a stay on the enforcement of contractual rights by the counterparty against the restructuring company. Most relevant ipso facto clauses will fall clearly within the stay as they provide one party to the contract the right to terminate or amend a contract on the occurrence of a certain event, which requires making a positive decision to make use of the right. There are, however, other types of ipso facto clauses that operate automatically on the occurrence of a certain event without requiring a decision by a party to the contract to enforce the right. For example, some clauses may provide that the entire contract automatically terminates if one party enters into external administration. The termination of the entire contract has the effect of terminating all of the rights of the restructuring party, in circumstances where it may not be clear that the counterparty has exercised a right.

1.15 The intention of the Bill was to apply the stay in relation to both ipso facto clauses which must be enforced by a party and those which are triggered automatically (see paragraph 2.17 of the explanatory memorandum to the Bill).

1.16 In order to ensure this intended scope is not frustrated and to allay any concerns that industry may have, the Senate amendments now expressly provide for the application of the stay to self-executing clauses.

Example 1.1

Big Co Ltd (Big Co) has a contract to supply Little Co Pty Ltd (Little Co) with widgets. The contract has a self-executing clause that provides for the automatic termination of the entire agreement if Little Co goes into administration.

As a result of the Senate amendments, it is clear that this clause will not operate. As this application of the clause would be stayed, Big Co will have to continue supplying Little Co with widgets while it is under administration, so long as Little Co continues to perform all of its contractual obligations. Big Co will not, however, have to provide any additional credit to Little Co for the widgets. Big Co will have the right to go to court to obtain an order for relief from the operation of the stay.

Example 1.2

Hingley Samin Ltd (HSL) has leased office space to Connolly Irwin Ltd (CIL). The tenancy agreement includes a clause that provides for the automatic termination of the lease 30 days after CIL's board resolves to enter into administration.

As a result of the Senate amendments, this clause will be stayed and will not have any effect from the time CIL's board decides to enter into administration. The tenancy will still continue to operate (as the clause purporting to terminate the agreement is not able to take effect) so MIL can use its office space to continue trading. If MIL fails to pay the rent or breaches any of the other terms of the lease, HSL may have other causes to terminate the agreement. HSL also has the ability to apply to the court for a relief from the application of the stay.

1.17 As part of the Senate amendments, new regulation making powers have been provided to prescribe requirements relating to the application of the stay provisions in relation to applicable self-executing clauses.

1.18 These regulation making powers have been included to ensure that if contractual arrangements develop to inhibit the application of the existing stay provisions in relation to self-executing clauses, the Government will be able to quickly prescribe special rules to ensure the stay operates effectively and prevent any unintended consequences. As with the other regulation making powers supporting the reforms in the Bill, it is important for the Government to be able to respond quickly to address attempts to frustrate the stay provisions. The regulation making powers are therefore an appropriate mechanism as they allow quick responses by Government and are subject to appropriate parliamentary scrutiny through the disallowance process.

1.19 The Bill preserves the primacy of the Payment Systems and Netting Act 1998 and the International Interests in Mobile Equipment (Cape Town Convention) Act 2013 to the extent that there are any inconsistencies with the stay provisions. Amendments 6, 11 and 17 to 20 provide for the primacy of those Acts in relation to the new provisions applying the stay in relation to applicable ipso facto clauses.