A Comparative Look at the Ipso Facto Regime

By Meiyen Tan and Keith Han (Oon & Bazul)

The new Insolvency, Restructuring and Dissolution Act 2018 (“IRDA”) came into effect on 30 July 2020 and introduces several key updates to the existing legislation, most notably the introduction of section 440 which restricts the operation of certain ipso facto clauses while a company undergoes restructuring proceedings. In particular, this article seeks to examine section 440 and how it is likely to be applied and developed in Singapore. It also undertakes a comparative analysis of the exemptions to the ipso facto regime in other jurisdictions and how similar exceptions might be applicable in Singapore.

Background

Ipso facto clauses are clauses which allows the contracting party to terminate, amend, accelerate payment or forfeit the term under any agreement or to terminate or modify any right or obligation under any agreement, solely based on the contracting party’s insolvency or commencement of an insolvency-related proceeding. Such proceedings include but are not limited to judicial management, administration procedures, schemes of arrangement, and applications for a moratorium.

Prior to the IRDA, there were no such restrictions and parties could freely rely on such clauses to terminate or accelerate a contract. However, such ipso facto clauses pose great difficulties for companies attempting to restructure their debs since the termination of key contracts can severely hamper the company’s operations, plunging the company into further distress and undermining any restructuring efforts.

Section 440

Section 440 adopts the wording of section 34 of the Canadian Companies’ Creditors Arrangement Act (“CCAA"), making equivalent legislation and case law from that jurisdiction, along with Australia, valuable to the examination of the operation of section 440 in Singapore.

1. First, examining the wording of section 440 itself sheds light on the scope of its application.
2. Section 440(1) aims to preserve the status quo of the distressed company’s contracts while it undergoes restructuring, by preventing the termination, acceleration of a payment, or forfeiture of the term of a contract. However, it is suspensory in nature and does not seek to terminate or extinguish the counterparty’s contractual rights. Nevertheless, counterparties can still terminate the contract on grounds other than insolvency.
3. Section 440(2) states that the rights of counterparties to require payments for payables accrued after the commencement of the specified proceedings are not affected and counterparties are in no way obliged to advance further credit to the distressed company.
4. Section 440(3) provides that parties may not contract out of the ipso facto regime.
5. Section 440(4) provides an exemption to the ipso facto restrictions, allowing for a counterparty to apply to Court for relief on the grounds of significant financial hardship.
6. Section 440(5) carves out certain specified classes of contracts such as ‘financial contracts’, ship charters and government contracts from the ipso facto regime. ‘Financial contracts’ are defined in the Insolvency, Restructuring and Dissolution (Prescribed Contracts under Section 440) Regulations 2020.
7. Section 440(6) sets out the proceedings to which the restrictions on ipso facto clauses under section 440 apply. It must be noted that the restrictions do not apply if the distressed company undergoes insolvency proceedings which are not concerned with the rehabilitation of the distressed company, such as winding up and receivership.

Safeguards for the Counterparties

The ipso facto regime is not without its unintended consequences which were summarized in the 2013 report of the Insolvency Law Review Committee (the “ILRC”). These included unfairness to the contractual counterparty; the risk of small suppliers and customers becoming insolvent; and lack of contractual freedom. Notwithstanding the consequences, the restrictions on ipso facto clauses were eventually introduced.

Under the regime, counterparties might be forced to carry out their contractual obligations with no prospects of receiving payment. The injustice might be more acute in situations where contracts contain exclusivity provisions which restrict the counterparty from sourcing alternative supplies or which require the counterparty to continue making periodic payments to the distressed company. However, this is ameliorated in part by way of Section 440(1), which allows parties to effectively enforce ipso facto clauses so long as they are triggered by grounds other than the company’s insolvency or commencement of restructuring.

Significant Financial Hardship

1. Additionally, Section 440(4) also allows a counterparty to seek relief from the Courts if the restrictions under Section 440 causes “significant financial hardship”. We now turn to Canadian and Australian jurisdictions to understand the likely definition of “significant financial hardship”.
2. The Canadian Court in Toronto-Dominion Bank v Ty (Canada) Inc [2003] CanLII 43355 ("Toronto-Dominion Bank"), held that the interests of all affected parties should be considered in determining significant financial hardship.
3. While the Australian position makes no reference to “significant financial hardship”, the Court has the power to grant an applicant relief from the ipso facto regime if it is “appropriate in the interests of justice” (see Australian Corporations Act 2001 (Cth), sections 415D, 415E, 434J, 434K, 451E and 451F). Given this wide discretion conferred upon the Australian Courts, it is arguable that the Australian Courts would be allowed to consider the interests of third parties whose rights might be affected as well.
4. Based on the statutory wording of Section 440(4), it is likely that the Singapore Parliament had intended only for the interests of that one counterparty to be considered in its application for relief; it is unlikely that the interests of third parties will be considered under “significant financial hardship” in Singapore.
5. The Canadian Court in Toronto-Dominion Bank also adopted an objective test in determining “significant financial hardship”. The Court held that the “objective prejudice… refers to the degree of prejudice suffered by the creditor in relation to the indebtedness and the security held by the creditor and not to the extent that such prejudice may affect the creditor as a person, organization or entity… the creditor must be able to show quantitatively the prejudice is will suffer”.
6. It remains to be seen whether Singapore will adopt a similar objective test in assessing “significant financial hardship” or determine each case on its facts. Notably, in the second reading of the Insolvency, Restructuring and Dissolution Bill, it was stated that Section 440(4) was a safeguard to “bring in a degree of flexibility, depending on the impact it may have in a particular situation… this can be determined by the Court on the basis of facts… on a case-by-case basis.”

Exempted Contracts under the IRDA

Section 440(5) of the IRDA states that certain types of contracts are exempted from the ipso facto regime. Such contracts are defined as “eligible financial contracts” and include, amongst others, derivatives agreements, agreements to borrow and lend securities or commodities, repurchase agreements, buy-sell back agreements with respect to securities or commodities, and margin loans (see Rule 3(f) and 3(g) of the Insolvency, Restructuring and Dissolution (Prescribed Contracts under Section 440) Regulations 2020).

Significantly, the Singapore definition of “eligible financial contracts” closely mirrors the Canadian position as defined in Rule 2 of the Canadian Eligible Financial Contract General Rules (Bankruptcy and Insolvency Act). This suggests that the Singapore Parliament has recognized and imported the best practices of the Canadian regime and is adopting a wait-and-see approach regarding other kinds of exempted contracts.

Some guidance can be gleaned from Australia’s experience with the restrictions on ipso facto clauses, and the corresponding exemptions. The exempted contracts to the Australian ipso facto regime are set out in Sections 415D(6) to 415D(7), 434(J) and 451E of the Corporations Act 2001 (Cth). These were supplemented with a further 60 exclusions and carve-outs in the Corporations Regulations 2001 (Cth) in 2018. This would mean that in practice, a sizeable number of commercial arrangements will be exempted from the Australian ipso facto regime. For example, any agreement relating to Australia’s national security, border protection or defence capability and any agreement for the supply of goods and services to a public hospital or public health service will exempted from the ipso facto regime (reg 5.3A.50 of the Corporations Regulations 2001 (Cth)).

While the Singapore Parliament has the ability to prescribe the exclusion of contracts likely to affect the national or economic interests of Singapore, it is difficult to see Singapore adopting such a broad exclusion approach like Australia. The Singapore Parliament clarified that the underlying principle behind exempting certain contracts from the ipso facto regime is that restricting ipso facto clauses in such contracts would likely lead to uncertainty in the market. Prima facie, this entails a market analysis which, in the end result, will lead to greater specificity in the categories of contracts that are excluded from the ipso facto regime.

Conclusion

The new ipso facto regime in Singapore was tailored to benefit businesses experiencing financial hardship in the wake of the COVID-19 pandemic. To that end, section 440 will likely play a critical role in the toolkit for companies seeking to restructure their debts, especially in the current and anticipated wave of corporate insolvencies.

In interpreting section 440, the ability of the Singapore Courts to grapple with various interests of stakeholders in a commercially equitable manner will go a long way towards setting Singapore on its path to becoming the forum of choice for international debt restructuring.

(*) This post summarises an article published by the authors in the Singapore Academy of Law Practitioner. The full article can be found here. For their contributions to the article, the authors would like to thank Angela Phoon and Zephan Chua.