How do the ipso facto rules apply to SMSFs?

“While the law relating to ipso facto clauses is not specifically targeted at SMSFs, it is relevant since many SMSFs enter into contracts on a regular basis. In particular, there is an increasing number of SMSFs, especially SMSFs with corporate trustees, that enter into contracts that contain ipso facto clauses,” he says.

Rendering contracts unenforceable

The law makes certain ipso facto clauses that amend or terminate a contract unenforceable if the ipso facto clause is triggered under three scenarios:

• The first is if the company is entering administration.
• The second is when a managing controller has been appointed over all, or substantially all, of a corporation’s property.
• The third is when the company is applying for, or undertaking a compromise or arrangement, for the purpose of avoiding being wound up in insolvency.

“Generally, where a triggering event under any of the three categories occurs, there is a ‘stay on enforcing rights’, and the effect is that a party cannot seek to enforce rights to amend or terminate a contract that were triggered by such events. There also exists exceptions to a ‘stay on enforcing rights’,” Cheung explains.

Scenarios for SMSFs

Here are some common scenarios where the ipso facto laws affects SMSFs.

“One example is when an SMSF owns business real property and leases it to an unrelated

third-party tenant or a related party tenant. In this example, a lease agreement is executed by the SMSF as lessor.”

In this scenario, the lease may contain provisions stating the lease agreement is terminated if the tenant enters into administration or fails to make a lease payment within a prescribed time period.

In another example, an SMSF invests by providing a loan to an unrelated third-party borrower. A loan agreement is executed by the SMSF as the lender. “In this scenario, the loan agreement may contain provisions stating the loan agreement is terminated if the borrower enters into administration or the borrower fails to make a loan repayment within a prescribed time period.”

In these examples, the SMSF trustee may seek to rely on these provisions to terminate the agreement with the other party when a triggering event happens. However, some of these provisions may be considered ipso facto clauses.

What do trustees need to do to ensure they comply?

In light of the new rules, SMSF trustees and advisers should review all contracts entered into on or after 1 July 2018.

“When reviewing contracts, SMSF trustees should consider a number of questions,” says Cheung.

Here are three questions to ask when reviewing contracts:

1. Is a certain clause in the contract an ipso facto clause? For example, a clause stating the contract is amended or terminated if the borrower enters into administration is most likely an ipso facto.
2. If the clause in the contract is an ipso facto clause, does an exception apply? If an exception applies, there is no ‘stay on enforcing rights’, and the relevant party can seek to rely on the ipso facto clause to amend or terminate the contract.
3. If no exception applies and there is a ‘stay on enforcing rights’, can another clause be relied on for the amendment or termination of the contract? For example, if the borrower has entered into administration and has also failed to make a loan repayment on time, the lender, that is, the SMSF trustee, may seek to amend or terminate the loan agreement via another clause that deals with the failure to make a loan repayment within a prescribed time period. Such a clause could protect the SMSF trustee in its capacity as a lender.

“The parties should review each contract entered into after 1 July 2018 to determine whether any documents need to be updated in light of the law relating to ipso facto clauses,” Cheung recommends.

“SMSF trustees should also obtain documentation such as LRBA documentation from a quality supplier, preferably a law firm that is expert in the area and that has reviewed its documentation to ensure that it is up-to-date in light of this law in relation to ipso facto clauses,” he adds.

Avoiding mistakes

There are a number of mistakes SMSF trustees should ensure they avoid around the new ipso facto laws.

For instance, says Cheung, SMSF trustees in their capacity as lessor or lender could mistakenly think they can rely on an ipso facto clause to terminate the contract with the other party when a triggering event happens.

“If the clause in the contract is an ipso facto clause and no exception applies, there will be a ‘stay on enforcing rights’ and the SMSF trustee cannot seek to rely on the ipso facto clause to amend or terminate the contract,” he explains, adding, “mistakes can also be minimised by obtaining legal advice wherever there is any doubt.”

Additionally, contracts may include other clauses that are not ipso facto clauses that deal with the consequence of the termination. Says Cheung: “It is important for SMSF trustees and advisers to know whether such clauses can be relied on if certain triggering events occur.”

Finally, he says despite the operation of a ‘stay on enforcing rights’ in relation to ipso facto clauses, this law does not prohibit parties from exercising other rights. For example, where there is a breach involving non-payment or non-performance by one party, the counter party can pursue its legal rights.

As this shows, the new ipso facto provisions are complex. Trustees must seek legal advice if they are at all unsure about whether these new provisions relate to them.