Is an ipso facto contract termination “unfair” on a small insolvent business?

New laws have commenced under the ASIC Act and Australian Consumer Law extending unfair contract term protections to small businesses.  The law allows “unfair” and “standard form” contract terms to be declared void and allows for the contract to continue to bind a supplier, for example, if the contract can operate without the unfair term. 

An argument may be made by a liquidator or administrator appointed to an insolvent business that a termination clause in the company’s supply contract is unfair if it gives the supplier of the goods or services to the business the immediate right to terminate the contract, and the supply, on the basis only – ipso facto – of the business going into liquidation or administration. 

When a liquidator, more so an administrator, is appointed under Part 5.3A of the Corporations Act to an insolvent business, they will often try to at least sell the business intact, as a going concern. To keep the business going, the administrator may need the continued supply of goods and services, on the basis that there are funds to pay for these, and for which the administrator is personally liable in any event.  The sudden stopping of those services, by the supplier relying upon the termination clause, can in effect close the business down.

In other words, it may be “unfair” for the supplier to terminate supply under what is usually a standard form “ipso facto” termination clause in its contract if the administrator can assure the supplier that it will continue to be paid for the supplies. The ulterior motive of the supplier to simply end what may be an inconvenient and unwanted contact may not be allowed to prevail.

The government has agreed that such termination rights in a contract with a company entering insolvency should be removed or restricted and new law is awaited. That restriction does apply under personal insolvency law.

Although this is probably not within the contemplation of these new laws, the determination of what is unfair is a matter for a court. Existing consumer and financial protection laws do provide a number of criteria. But then there are also the objectives in Part 5.3A to try to preserve and resurrect an insolvent business, or realise more for it than a straight asset sale. The courts have been ready to compromise the rights of other parties in order to achieve those objectives, if not on the basis of unfairness, then on similar grounds.  

It should be noted however that the new law is limited to businesses of fewer than 20 employees where the contract does not exceed $300,000, or $1 million for contracts longer than 12 months.

Franchising

On a related issue, there is an ipso facto right of a franchisor to terminate a franchise agreement on the insolvency of the franchisee, but not, it appears, for the reverse situation.  Clauses 27 and 28 of the Franchising Code of Conduct explain the general rights to terminate franchise agreements for both sides.  Clause 29  – Termination—special circumstances provides that a franchisor may terminate a franchise agreement without complying with either clause 27 or 28 if the agreement gives the franchisor the right to terminate the agreement because the franchisee becomes a “bankrupt, insolvent under administration or an externally‑administered body corporate”.  The Code notes that this clause does not itself give rise to a right of termination – such a right must be in the franchise agreement itself. In other words, such terms of agreements are not unlawful and can override clauses 27 and 28. See the Franchising Code of Conduct (Competition and Consumer (Industry Codes—Franchising) Regulation 2014).  This may now be subject to the new small business protection laws.

None of this is fully researched but is raised for discussion.  Readers should rely on their own advice.

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