How are existing contracts treated in restructuring and insolvency processes? Are the parties obliged to continue to perform their obligations? Will termination, retention of title and set-off provisions in these contracts remain enforceable? Is there any an ability for either party to disclaim the contract?
Restructuring & Insolvency
None of the formal insolvency processes in Australia result in the automatic termination of contracts between the debtor and third parties. Often, however, contracts will contain ipso facto clauses which allow counterparties to terminate or renegotiate on the occurrence of an insolvency event.
Part 5.6, division 7A of the Corporations Act gives liquidators the specific ability to disclaim certain property or uncommercial contracts in certain circumstances. A liquidator will usually require the Court’s leave to do so (except in the case of unprofitable contracts or a lease of land) as this is likely to adversely affect third-party interests. There are no specific provisions for disclaimers in a voluntary liquidation, although the court has wide powers to control these reorganisations and application can be made to the court.
Although receivers and administrators are not given specific powers to disclaim contracts, they may look to ignore contracts with any resulting damages claim being unsecured against the company (and not the receiver or administrator personally). However, any contract a receiver continues with may result in the receiver being held personally liable under the Corporations Act.
Section 553C of the Corporations Act provides statutory set-off is available in a liquidation scenario where there have been mutual dealings between the distressed company and the relevant creditor. In such circumstances an automatic account is taken of the sum due from one party to the other in respect of those mutual dealings, and the sum due from one is to be set-off against any sum due from the other. Administrations and DOCAs will likely also recognise this statutory set-off as to not to do so would entitle an aggrieved creditor to recourse on the grounds of unfair prejudice.
The Corporations Act allows a broad range of claims capable of set-off. The rule entitles creditors who are also debtors to have preference over the general body of creditors. Only unsecured creditors and secured creditors who choose not to rely on their security can take advantage of the rule. A creditor is, however, unable to claim the benefit of set-off if he or she had, at the time of the relevant transaction, notice of the insolvency of the company. Further, a creditor cannot off-set any existing claim or debt of the company against new claims or debts that may arise during any period of administration.
As described above, retention of title provisions will remain enforceable so long as the creditor’s security interest in the property has been perfected and registered on the PPSA register.
A liquidator has no right to disclaim either onerous property or unprofitable contracts, which will therefore continue to bind a company in liquidation, although the commencement of insolvency proceedings may constitute an event of default allowing a counter-party to terminate an existing contract.
Under common law, a winding-up order serves to terminate all employment contracts of the company in official liquidation.
Employees' rights will only be affected by a scheme of arrangement in the event that the scheme purports to compromise their rights as creditors under their employment agreement. Similarly, the impact of a scheme on existing contracts and the parties ongoing obligations under those contracts will depend on the terms of the scheme (in particular, the extent to which the scheme purports to compromise rights under the contracts) and the terms of the contracts.
The commencement of a voluntary or provisional liquidation will have no legal effect on employees' rights, except as for provided for in the relevant employment agreement.
Termination, retention of title and set-off provisions contained in the contracts to which the company was party prior to its winding up will remain enforceable by the contracting counter-party on any winding-up. In the absence of any set-off provision, account must be taken of what is due from each party to the other in respect of their mutual dealings, and a set-off is applied in relation to those amounts.
In case of bankruptcy proceedings, there are certain types of contracts that are terminated automatically under applicable substantive contract law (e.g. mandates governed by Swiss law). For other types of agreements, the applicable substantive contract law or the specific contract may provide for a termination right in case of bankruptcy. Automatic termination or termination rights are generally upheld in a Swiss bankruptcy. A contract which has not been terminated continues to exist as a matter of Swiss bankruptcy laws. If so, the receiver in bankruptcy may choose to perform the bankrupt's obligations under a so-called synallagmatic agreement (so called cherry-picking right). If the receiver in bankruptcy decides to perform the bankrupt party's obligations to secure performance by the other party, these obligations qualify as so-called estate obligations which are satisfied in advance and in full prior to all other creditors. Special rules apply to long-term contracts. In case no cherry-picking right has been exercised by the receiver in bankruptcy, even if they are not terminated upon the opening of bankruptcy procedures, future claims arising under such long-term contracts will only be admitted to the schedule of claims if they cover the period until the next possible termination date (calculated from the opening of bankruptcy) or until the end of the fixed duration of a contract. In addition, the cherry-picking right can be exercised for future obligations only. It is heavily debated under Swiss law whether an obligation of the non-affected party to perform agreements which have not been terminated and where no cherry-picking right has been exercised continues to exist.
In composition proceedings, contractual relationships between the debtor and its counterparties generally continue to be effective during the moratorium unless terminated ex lege or based on a contractual termination right (which, again, would generally be upheld). For contracts which have not been terminated, the administrator has the authority to order conversion of a performance owed by the debtor into a monetary claim of corresponding value which will then become subject to the terms of the composition agreement. Furthermore, the debtor may terminate long-term contracts without respecting the contractual notice periods during the moratorium against full indemnification of the counterparty (but only as an unsecured and non-privileged insolvency claim) if the continuing existence of these contracts would jeopardise the restructuring as a whole. The administrator's consent is required for such a termination.
Set-off rights generally continue to be available in insolvency proceedings, subject, however, to certain restrictions which may, in particular, prohibit set-off of pre-insolvency with post-insolvency claims. Retention of title arrangements are not typically effective in an insolvency scenario of a Swiss debtor unless the very strict rules, including registration requirements for retention of title arrangements under Swiss law have been properly followed (which is the exception rather than the rule).
As from the opening of insolvency proceedings, creditors are prevented from enforcing their contractual claims.
In respect of a mutual contract which is not or not completely performed by the debtor and its counterparty when the insolvency proceedings are opened, the insolvency administrator has the option to perform such contract and claim the counterparty's performance (Sec. 103 Insolvency Act). If the administrator refuses to perform such contract, the counterparty is entitled to claims for non-performance only as an insolvency creditor. The counterparty may request the administrator to opt for performance or non-performance, in which case the administrator must make this decision without undue delay; otherwise, performance may no longer be requested.
While provisions entitling the debtor’s counterparty to terminate a mutual contract which has not yet been fully performed by both parties or providing for automatic termination because of the insolvency or the insolvency petition are void, termination provisions for reasons other than the insolvency and the insolvency petition remain valid.
By retaining title, the creditor generally ensures the right to separate his property from the estate without paying any fees to the insolvency administrator. The insolvency administrator or debtor in self-administration are also entitled to pay the contract price and obtain title to the goods.
Only those debts which were legally established prior to the opening of insolvency proceedings are capable of set-off, which, thus, is not available if the creditor has
- become an obligor to the insolvency estate only after the opening of the insolvency proceedings or
- obtained its claim against the debtor from a third party after the commencement of the insolvency proceedings or pursuant to a transaction which is avoidable.
There are specific, less restrictive set-off rules applying in certain cases of the insolvency of financial institutions.