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Update contracts and register assets to protect against insolvency events

Posted by Nicholas Achurch | 04 December 2018 | Construction & Infrastructure

It’s time to review and update your insolvent trading clauses and practices! Historically common law came to the aid of an asset owner needing to protect materials, plant and equipment delivered to a buyer which had not yet paid in full. Recent changes to the Corporations Act 2001 (Cth) assist such buyers in receipt of unpaid assets even though the buyers are potentially insolvent.

The changes have a broader impact, the narrow focus here is for contract drafters, especially in the construction industry.

How the law restricts owner and contract rights

For contracts entered from 1 July 2018 the Corporations Act changes introduce new law restricting the right to a remedy affecting owners against buyers when the buyer or other type of acquirer is affected by an insolvency event.

The changes are known colloquially as safe harbour and ipso facto reforms. That Latin reference partly references insolvency event clauses, which we’ll get to.

Very specifically, the new law comes to the aid of a company director who may otherwise be personally liable for insolvent trading provision (ie under section 588G(2) of the Corporations Act) if:

The director will be protected against insolvent trading liability if there is “a course of action” which is reasonably likely to lead to a better outcome for the company (eg its survival) than administration or liquidation.

There are exceptions. If the cumulative total of a project exceeds A$1 billion, then the restrictions on contract rights do not apply. The restrictions also do not apply to some contracts for government works.

Review of template standard insolvency event and related clauses is timely given that the restriction of rights affects a very wide range of contract provisions, such as:

  • termination of contract;
  • acceleration rights;
  • self-executing provisions;
  • set-off rights; and
  • indemnification rights.

Review insolvency event clauses

To protect ownership of assets, contract drafters draft a definition of “insolvency event” when they are keen to have a fishing net to capture many circumstances of threatened insolvency. The Corporations Act changes make it timely to review the wording of those clauses.

Simply stated insolvency event clauses are usually drafted to be a very large fishing net. Events can include a company arrangement, appointment of a controller or receiver; or a company going into administration.

How personal property securities registration helps owners

The Corporations Law changes were drafted so as to not interfere with the operation of the Personal Property and Securities Act 2009 (Cth) (‘PPSA’). Registration of personal property interests (over tools, materials, leasing interests and the like) perfects the interest held by the entity first registering the interest and ensures a superior legal claim.

Compare PPSA protection to retention of title clauses.

  • In the event of insolvency retention of title clauses may be useful in claiming priority to ownership but they do not provide a supplier or builder with security as a creditor or owner.
  • For example, say a subcontractor has supplied materials for construction of a building or part of it, and the head contractor experiences an insolvency event. If there is a retention of title clause the issue would likely arise that the subcontractor and the administrators of the head contractor would be in dispute over which party has the stronger entitlement to the materials, regardless of whether the subcontractor had been paid.
  • In contrast, if the subcontractor registered its interest in the materials, the superiority of its interest would be clear-cut and it could effectively attend the site and re-possess and re-use any unused materials that have not been fully paid.
  • It is much more practical and risk-averse for a contracting party to register interests in building materials to reduce exposure to increased costs as a result of another party’s insolvency event.

Use step-in clauses.

  • While there is no definitive authority on the affect of the law changes to step-in rights, including a step-in clause can allow the insolvent party to engage a third party as agent to complete the works.
  • This agency relationship may create a complex overlap of security interests. Therefore, the PPSR has become a more powerful mechanism to protect interests where other avenues are otherwise restricted.
  • When a third party is engaged, an interest over plant, equipment, materials and goods is created in favour of that third party under section 588FM of the Corporations Act and section 267 of the PPSA. Whilst this interest may provide standing for a claim, that interest may not be enough to protect the third party from loss in the event of a dispute. Therefore, it is prudent to register the interest on the Personal Property Securities Register. It can protect against that third party suffering loss resulting from administrators, liquidators and/or disputes with other contractors.

Get onto it!

Since the changes to the Corporations Act contracting in the construction industry has become more complex given the restrictions on traditional solutions in the event of an insolvency breach.

Almost all conventional remedies for dealing with another party’s insolvency have become unavailable for new contracts.

Therefore:

  • contracting parties should ensure PPSA registration of all materials, plant and equipment capable of being registered; and
  • third parties stepping in should ensure that the contract allows for step-in, and the contract of agency is drafted so that any registerable interest acquired is registered and perfected in favour of the third party.

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Photo credits: Cranes photo by Jack Dylag on Upsplash. Other images, Bathurst Street construction in Sydney by Noric Dilanchian.

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