Hello ipso facto…Are you prepared for the new ipso facto regime?

The ipso facto regime came into effect on 1 July 2018. However many franchisors are yet to consider how it may impact on their systems and what steps they should be taking to mitigate potential risks.

What is the ipso facto regime?

The “ipso facto regime” is the name used to describe a number of changes to the Corporations Act 2001 (Cth) that took effect on 1 July 2018. The object of the reform is to facilitate a company to continue trading during a formal restructure without the sanction of counter parties terminating contracts during the formal restructure.

The key change that franchisors need to be aware of is the change which provides for a stay on the enforcement of rights which arise in favour of a party due to the insolvency of its franchisees or counterparty. Using the franchisor as an example, this means that the franchisor cannot enforce a right against a second party, the franchisee, that arises:

• Because the franchisee  becomes subject to a specified insolvency event (eg voluntary administration); and
• Pursuant to an express provision of a contract, arrangement or understanding. (Note that if a right is, for example, a statutory right, then the stay will not apply to that right – the stay only applies where the right arises due to an express provision of a contract).

The amendments will not apply if a company enters liquidation given the purpose of the moratorium.

How long does the stay last for?

The period of the stay depends on the type of insolvency event and how the circumstances surrounding the insolvency event transpire. However, generally speaking, it will last until:

• The insolvency event ends;
• The expiry of any Court orders extending the period;
• If liquidation follows a voluntary administration (or scheme of arrangement), when the liquidation ends; or
• The consent of the appointee is given, or relief from the Court is ordered.

What contracts does the regime apply to?

The regime applies to all contracts entered into on or after 1 July 2018 unless the contract is exempted under declaration/regulation. Therefore, the regime will apply to all contracts that you enter into now (including all franchise agreements), unless such contracts or rights are specifically excluded by declaration/in the regulations.

Grandfathering

The grandfathering of contracts entered into before 1 July 2018 may result in situations where some counterparties are entitled to enforce their rights under ipso facto clauses in ‘pre-1 July 2018 contracts’ against the insolvent company, while other counterparties will not be in a position to exercise such rights contained in contracts entered into after 1 July 2018. This will likely lead to contracting parties considering whether to amend their contracts, rather than entering into new ones after 1 July 2018, in order to preserve the grandfathered status of their contractual rights under pre-1 July 2018 contracts.

Are there any exemptions?

As previously mentioned there are certain circumstances where the regime will not apply – for instance where the initial appointment is of a liquidator.

Treasury released the Corporations Amendment (Stay on Enforcing Certain Rights) Regulations 2018 on 24 June 2018. These regulations and declarations seek to exclude certain contracts and contractual rights from the new amendments. However the listed exemptions are quite limited. While it had been hoped that there would be an exemption for franchising (or at least the right to terminate in the case of insolvency, as contemplated by clause 29 of the Franchising Code of Conduct (Code)), no such exemptions were included. As such, most franchise agreements (and other agreements used in franchise networks) will be caught by the new regime.

How does the regime impact on franchising?

The regime will impact on various aspects of the franchise relationship.

Clause 29 of the Code specifically allows a franchisor to terminate a franchise agreement immediately if a franchisee becomes “bankrupt, insolvent under administration or a Chapter 5 body corporate”. However, this right is not a statutory right – rather, in order to rely on this procedure to terminate an agreement, there needs to be a contractual right to terminate included in the relevant franchise agreement.

Noting the above, most franchise agreements will provide the franchisor with an express contractual right to terminate in the circumstances of a franchisee’s insolvency. However, in light of the ipso facto regime, this right will be stayed – ie a franchisor cannot rely on this right to terminate for the period of the stay. This means that the franchisor will, during the period of the stay, have to liaise and co-operate with, most likely, insolvency practitioners who may not have the same level of experience with the brand.

The right to terminate on insolvency is the most obvious right of franchisors to be impacted by this regime. However there are likely to be a range of other rights arising on insolvency which will be impacted by this regime. For instance, franchisors may have rights on insolvency to vary supply terms under supply agreements, step in to property documents and/or set-off rights under franchise agreements and/or supply agreements.

Likewise, franchisors may need to consider how the regime will impact their ability not to renew an agreement (eg when the franchisee is in insolvency).

Can I terminate a franchise agreement for another reason during the period of the stay?

The stay contemplated by the ipso facto regime only relates to the exercise of rights arising due to a specified insolvency event. If a franchisee becomes subject to an insolvency event a franchisor cannot terminate for this reason during the period of the stay. However, if another event occurs, then the franchisor may still be permitted to terminate for that reason.

However, franchisors will need to tread carefully and consider whether, in substance, the reason for the termination is the insolvency event (or the financial condition of the counterparty during the insolvency event) or is legitimately another event.

What do I need to do?

If you have not yet considered the regime, you should do so now. Specifically we recommend:

• Reviewing agreements to consider what rights arise (or might arise) as a consequence of an insolvency event;
• Considering if there are any changes you want to make to your template contracts/processes in light of the new regime. For instance, you might want to consider taking more security or double checking that your performance management/KPI clauses are sufficiently robust;
• Considering what you will do if an insolvency event occurs to a franchisee and a third party (eg an administrator) is appointed to operate the franchised business. For instance, you might want to prepare a template management agreement so you can offer to manage the location on behalf of the administrator; and
• That you manage contracts (including renewals) and exercise termination rights as promptly as possible (giving clear reasons in writing for doing so). Alternatively, take care to properly reserve rights of termination for non-performance.

The new regime provides for a significant shift in the way franchisors will need to deal with an insolvent franchisee. If you have not already done so, you should immediately review your agreements to consider how you may be exposed and how to manage any potential risks. Please contact any member of our franchising team to assist with this process.

This article was written by Allison McLeod, Partner and Jonathan Kramersh, Partner.