Letter from America – Kathryn Sutherland-Smith takes TMA Australia members on a tour of the American ipso facto landscape

Event debrief by Paul Apathy (Herbert Smith Freehills), Vice Chairperson of TMA New South Wales Committee

In July 2019, TMA New South Wales held a lunchtime event in which Kathryn Sutherland-Smith of White & Case (New York) gave a comparative presentation on ipso facto laws in the United States (US) and Australia.

The new ipso facto provisions in Australia’s Corporations Act take significant inspiration from the US Bankruptcy Code, and therefore US law provides an important source of reference when grappling with Australia’s regime.

In her presentation, Kathryn guided TMA members through the key similarities and differences between the US and Australian regimes. From this, she indicated areas where the US experience may be instructive to the operation of the regime in Australia.

In doing so, she drew upon her master’s thesis and recent article ‘A Trans-Pacific Tale of Carrots and Sticks: Lessons for Australia from the United States’ Experience of the Ipso Facto Stay’.[1]

The ‘anti-discrimination’ principle

Kathryn explained that the ‘anti-discrimination’ principle underpins the US ipso facto regime. This provides that a debtor should not lose the benefit of its contractual bargain simply because it has entered a formal insolvency process (or, in other words, counterparties should not be able to use insolvency as a justification to renege on their deals).

Avoidance of the stay

However, it is important to note that the exceptions to the US ipso stay are somewhat narrower than the exceptions in Australia. The US has no exception for secured creditor enforcement and, with the exception of similar safe harbours for securities and financial contracts, does not have a detailed list of exceptions in the legislation that is analogous to the one set forth in the Australian regulations.

Instead, the ipso facto stay is restricted to ‘executory contracts’, a broad concept that the US court

s have moulded over the years, in some cases to address the needs of bankruptcy policy.

Treatment of substantive defaults – cure and assumption

The Bankruptcy Code also goes beyond ipso facto protection, and also provides a mechanic to address substantive contractual defaults by the debtor. A US debtor in bankruptcy can cure past defaults under executory contracts, if it compensates the relevant creditors and assumes responsibility for future performance. The Australian regime, as yet, does not contain this type of mechanism.

Critical vendors

Another key issue arising in both the US and Australian ipso facto regimes is the ‘critical vendor gap’. This refers to fact that, under both regimes, the ipso facto law does not oblige suppliers to continue supply where there is no pre-existing contractual commitment to do so (which is a common situation).

In such circumstances, US courts regularly allow debtors to make payments of pre-insolvency claims to key suppliers, through ‘critical vendor orders’, which require the supplier to continue trade post insolvency on customary terms in exchange for the up-front payment of its claim. There is no specific Australian statutory provision addressing such payments, although it is certainly not unknown for ‘ransom creditors’ to be paid in an Australian administration to keep the business running.

Final thoughts

The TMA would like to extend their sincere thanks to Kathryn Sutherland-Smith for an engaging presentation and for taking time to speak to our members and guests in both Sydney and Melbourne on 9 and 10 July. We also thank White & Case for generously hosting at their offices in both States.

[1] (2018) 26 Insolv LJ 134.