The Promise and Perils of Regulating Ipso Facto Clauses
It is common for contracts to include a clause which provides that on an event of default, the counterparty has an unconditional right to terminate the contract or accelerate payment (an ipso facto clause). The regulation of ipso facto clauses has become a topic of debate in recent years with a number of jurisdictions introducing constraints on enforcement of such clauses as part of broader restructuring reform packages. These jurisdictions include Germany in 2021 (as part of its implementation of the EU Restructuring Directive) and the UK in 2020. For jurisdictions introducing such constraints for the first time, there is much to learn from those jurisdictions, such as Canada, that have had constraints on ipso facto clauses in place for much longer.
In a recent paper, we examine the experience in Canada alongside the constraints introduced in the UK, the EU Restructuring Directive, and Germany. Our analysis reveals that largely divergent regimes have developed based on the discussion of a similar set of principles and arguments. We argue that when revising their regime on ipso facto clauses, often in connection with a general insolvency or restructuring law reform, policymakers should follow a sequence of steps in their decision-making.
The first step is to establish clarity regarding the rationale for interfering with parties’ freedom of contract. We identify a number of different rationales that can be utilised, and observe that some jurisdictions leave these policy debates unfinished, leading to a lack of coherence and uncertainty for debtors and creditors. Once the policy rationale has been identified, the second step is to clarify the scope of the rules limiting the enforceability of ipso facto clauses. This decision has a number of facets including identifying the kind of proceedings that can trigger an ipso facto ban, for example whether it will only encompass restructuring procedures, and the kinds of contracts that will be affected by the ban. Should all executory contracts be included or a subset, and if so which contracts are to be excluded? These decisions need to be grounded in the underlying policy rationale identified in step 1.
Step 3 requires policymakers to clearly identify the existence and availability of safeguards for affected counterparties. A common remedy for creditors is the ability to apply to court for a determination that the constraints do not apply, or should be limited in some way, but jurisdictions then need to determine the extent of such safeguards, for example whether they should be available to individual creditors. If they are, such requests are likely to involve weighing the interests of the individual creditor against the interests of the debtor/creditors as a whole, against the backdrop of the policy goals of imposing the constraints in the first place. Step 4 requires that these policy choices be clearly articulated so that contractual counterparties understand the rationale for setting aside their negotiated arrangements at the point of insolvency proceedings. These policy choices can also be relevant to creditors’ ability to challenge the imposition of ipso facto constraints.
Step 5 is a question of timing the introduction of any constraints. One question that arises is whether the introduction of any such constraints should operate retrospectively. Arguably such changes might be fairer to prospective creditors, who can bargain with these changes to the law in mind as compared to existing creditors who bargained under one regime but now find themselves in another. The final step is for policymakers to consider how their constraints on enforceability of ipso facto clauses may interact and/or impact cross-border comity and cooperation. Any comprehensive ipso facto insolvency or restructuring law reform should consider the issue of cross-border effects, parallel proceedings and forum choice.
Examining the ipso facto rules in the UK, EU, Canada, and Germany makes it clear that different jurisdictions often make quite distinct policy choices regarding the rationale for any constraints on ipso facto clauses as well as on the specific nature and scope of the provisions. Different jurisdictions find different points of balance between the interests of individual creditors in upholding their freedom of contract and the rights of the debtor and creditors as a whole in preserving the business as a going concern. The range of choices is not per se problematic as long as they are implemented with clarity and transparency, so that debtors and creditors can bargain ex ante in the light of any legislative provisions.
Janis Sarra is a Professor of Law at the Peter A. Allard School of Law, University of British Columbia.
Jennifer Payne is the Linklaters Professor of Corporate Finance Law at the University of Oxford.
Stephan Madaus is a Professor of Law at the Martin Luther University Halle-Wittenberg, Germany.