Overview
When a company enters financial distress, contractual enforcement rights are often among the first to be affected. The ipso facto stay under the Corporations Act 2001 (Cth) restricts the enforcement of certain rights that arise because of an insolvency event. These events include voluntary administration, the appointment of a managing controller over the whole or substantially the whole of a company’s property, and proposals for schemes of arrangement.
These laws are designed to prevent counterparties from terminating contracts solely because of insolvency and to give distressed companies an opportunity to maximise returns for creditors and stakeholders.
For secured creditors, the immediate question is practical. Can security still be enforced once the insolvency process begins?
The stay is not absolute. The Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (Cth) (the Declaration) sets out a number of important exclusions. Several of these exclusions directly affect parties holding security interests.
For secured creditors, these exclusions are commercially significant. This is because the statutory carve-outs preserve certain enforcement mechanisms that would otherwise be suspended during the stay period.
This paper discusses the security-related exclusions contained in the Declaration, how they operate in practice, and what they mean for secured creditors in insolvency scenarios.
Crystallisation of Security Interests
Conversion of Circulating to Non-Circulating Security Interests
The Declaration preserves a secured party’s right to convert a circulating security interest into a non-circulating security interest. In practical terms, this allows a creditor to move assets from a category that the grantor can deal with in the ordinary course of business, such as inventory or receivables, into a category that is subject to tighter control.
This change usually occurs when a default or insolvency-related event arises. Once the conversion takes effect, the debtor’s ability to dispose of secured assets becomes restricted. The result is greater stability in the asset pool available to the secured creditor.
For insolvency practitioners, the consequences can be immediate. Assets that might previously have been available to support ongoing trading can become subject to the secured creditor’s control once the security interest converts.
Transfer of Accounts and Chattel Paper
The exclusion also extends to rights permitting the transfer of accounts or chattel paper to the secured party by way of security. This is particularly relevant in receivables financing arrangements, where the secured creditor may, upon the occurrence of a trigger event, assume direct control over income streams.
In practice, this may involve redirecting payments from account debtors to the secured creditor, effectively redirecting payments away from the insolvent entity and mitigating the risk of dissipation or misapplication of funds. For practitioners, this can significantly affect cash flow assumptions during voluntary administration or restructuring processes.
Restrictions on Dealings with Secured Property
The Declaration also preserves rights that restrict the grantor from dealing with secured property. These rights allow a secured creditor to prevent the sale, transfer or other disposal of assets that are subject to the security interest.
This limb functions as a practical safeguard, ensuring that even where specific crystallisation mechanisms are not invoked, the secured creditor retains the ability to freeze the asset base and prevent value erosion.
Rights of Set-Off, Netting and Related Enforcement
Set-off and netting rights remain enforceable
The Declaration preserves contractual rights that allow financial exposures to be reduced through set-off and netting. These exclusions apply broadly but are particularly significant in secured financing arrangements.
Three categories of rights fall outside the ipso facto stay. First, where a creditor has a contractual right to set off amounts owed to and by the debtor, or to combine multiple accounts held by the debtor, that right can still be exercised despite the stay. Second, where a creditor has a contractual right to net balances or other amounts across multiple obligations or transactions, the creditor may calculate a single net figure and enforce accordingly. Third, the steps required to give effect to those set-off or netting rights are also preserved.
This includes the ability to accelerate payment obligations so amounts become immediately due, convert or exchange amounts denominated in different currencies into a single currency, and crystallise a security interest as part of the enforcement process.
Acceleration rights are limited to supporting set-off and netting
The exclusion for acceleration rights is not unlimited. Under the Declaration, acceleration is listed as a step that may be taken to give effect to a set-off or netting right, rather than as an independent exclusion. Accordingly, acceleration is not a separate or standalone exclusion. It operates only to the extent necessary to give full effect to a protected set-off or netting right.
A creditor therefore cannot rely on the exclusion to accelerate a debt as an independent enforcement step. The acceleration must support the exercise of a set-off or netting entitlement. For example, if part of the debt that the creditor wishes to set off has not yet fallen due, the creditor may accelerate that amount so it can be included in the set-off calculation. Acceleration used for other purposes remains subject to the stay.
Creditors can complete the steps needed to give effect to set-off
In practical terms, a creditor exercising set-off or netting rights can take the steps needed to give those rights commercial effect without being restrained by the ipso facto stay.
For banks and financial institutions, this exclusion is particularly important. Lenders commonly maintain several facilities or accounts with the same debtor. A debtor may have an operating account that holds a credit balance while also owing money under a loan facility. When the debtor enters administration or receivership, the lender can combine those accounts, apply the credit balance against the loan exposure, and immediately net out the mutual obligations.
The lender is not required to leave cash available to the debtor while being prevented from reducing its own exposure.
Right to Appoint a Controller
It is common for a company to have several secured creditors, each holding security over the same property and each with the contractual right to appoint a controller. The ipso facto stay does not prevent the first of those creditors from exercising its right to appoint a controller.
The Explanatory Statement confirmed that the right to enforce the right to appoint a controller is only excluded from the stay once a controller has already been appointed by another creditor, or where another creditor has exercised its right to appoint and the appointment process is underway.
The practical effect is straightforward. If one secured creditor appoints a controller, another secured creditor with security over the same property can still exercise its own appointment right. The ipso facto stay does not prevent that step. This allows secured creditors to protect their positions in a coordinated or sequential way.
The policy behind the exclusion is to avoid a race between creditors. Secured creditors should be able to assess the situation and decide whether enforcement is appropriate without being required to act pre-emptively solely to preserve their rights. The contractual arrangements between parties as to the priority of secured creditors in insolvency events are therefore left undisturbed.
Step-In Rights and the Continuation of Contractual Performance
The Declaration also preserves certain rights that allow contractual performance to continue when a counterparty enters insolvency. It excludes from the stay a right to perform obligations, to engage another person to perform obligations, to enforce rights, or to appoint another person to enforce rights under a contract, agreement or arrangement.
Where step in rights commonly arise
Step-in rights frequently appear in construction contracts and long-term services arrangements. In these transactions it is common for the contract to allow another party, usually the principal or a project financier, to assume the role of a contractor or service provider if that party enters insolvency.
Once the right is exercised, the stepping-in party may continue performing the relevant obligations or enforce the relevant contractual rights. This allows the project or service arrangement to continue despite the contractor’s financial distress.
Can a principal or financier step in and perform the obligations?
In practical terms, the exclusion preserves the ability of a secured creditor or principal to step in and perform the obligations of the distressed party. It also allows that party to engage a replacement contractor or service provider to perform those obligations.
This is particularly important in construction and infrastructure contracts, where continuity of works is essential. If performance stops, delays may give rise to consequential losses across the project.
Default interest and indemnities in financing arrangements
The Declaration excludes two categories of rights that frequently appear in financing documents. These are the right to charge a higher rate of interest following an insolvency event and the right to enforce an indemnity for costs, expenses, losses and liabilities incurred by the lender because the borrower has entered formal insolvency.
What counts as a financing arrangement?
The term financing arrangement is defined broadly. It captures any contract, agreement or arrangement under which a person provides financial accommodation to a company. Financial accommodation is not limited to traditional loan facilities. It also includes arrangements under which bonds, notes, debentures and other debt securities are issued. The exclusion therefore applies across the full range of debt financing structures used in commercial practice.
Default interest following insolvency
Financing documents commonly provide that once a formal insolvency occurs, the lender may charge interest at a higher rate. These provisions are often described as default interest or uplift clauses. Depending on the terms of the facility agreement, default interest may operate automatically upon the occurrence of the relevant insolvency event, or may require the lender to issue a notice or make an election before it accrues. Practitioners should review the specific drafting of the default interest clause to determine whether any further step by the lender is required.
Indemnities for insolvency related costs
Financing arrangements also frequently contain indemnity provisions. These require the borrower to reimburse the lender for costs that arise because of the borrower’s insolvency. The costs may include legal advice obtained by the lender to assess its enforcement options, together with professional fees, administrative costs and other expenses that arise once the borrower entered a formal insolvency process.
For secured creditors, the exclusion provides important certainty. Default interest provisions and insolvency-triggered indemnities continue to operate according to their terms. Lenders are not required to maintain pricing that no longer reflects the risk they bear, nor to absorb the additional costs that arise when a borrower enters formal insolvency.
Assignment, Transfer and Novation of Security Interests
The Declaration preserves the ability to assign, transfer or novate rights and obligations under a contract to which the stay would otherwise apply, including secured debt instruments and related financing arrangements. This exclusion is particularly relevant to the secondary market in secured debt.
In practice, secured creditors often transfer their interests to third parties. This may occur through debt trading transactions, portfolio sales or as part of a restructuring of the creditor’s own balance sheet. If the ipso facto stay applied to these transfers, a secured creditor could be prevented from managing its exposure by disposing of its interest in the secured debt.
The policy rationale for the exclusion is straightforward. Restricting the assignment or novation of secured debt would not advance the purpose of the ipso facto reforms. Instead, it would disrupt the operation of debt trading markets.
It would also affect rollover arrangements in which maturing facilities are replaced or extended through the assignment or novation of the underlying obligations. These transactions are a routine feature of commercial lending markets.
What the exclusions mean for secured creditors
For secured creditors, the exclusions confirm that certain enforcement mechanisms remain available despite the ipso facto stay.
A central implication is that control over secured assets can still be strengthened at the point of distress. Through crystallisation mechanisms and restrictions on dealings, secured creditors are able to stabilise the asset pool and prevent dissipation or diminution of asset value. This helps ensure that the onset of insolvency does not disturb the commercial allocation of risk agreed when the transaction was first structured.
The preservation of set-off and netting rights reinforces that position. Secured creditors are not required to remain exposed to a gross position that does not reflect their true net liability. Instead, they can reduce mutual obligations to a single net balance and act on that position immediately. In practice, this can materially reduce credit risk at the point when a formal insolvency event occurs.
The ability to appoint a controller and to exercise step-in rights also reflects a broader policy balance. Secured creditors retain the capacity to intervene where necessary to protect collateral or maintain the performance of critical contracts. At the same time, the regime avoids forcing premature enforcement by allowing creditors to act in an orderly and considered manner, without losing the ability to enforce or being placed at a strategic disadvantage. Priority between security interests continues to be determined under the PPSA and general law principles.
Economic protections within financing arrangements also remain intact. Default interest and indemnities ensure that pricing and cost recovery mechanisms continue to reflect the heightened risk and expense associated with insolvency. This preserves the commercial bargain and avoids shifting insolvency-related costs onto lenders in a way that could distort credit markets.
Overall, the ipso facto regime contains important statutory carve-outs that protect and preserve the position of secured creditors when enforcing their rights. When a debtor enters financial distress, it should not be assumed that enforcement rights are automatically suspended by the statutory stay. Secured creditors should carefully consider whether their rights fall within the exclusions set out in the Corporations (Stay on Enforcing Certain Rights) Declaration 2018 (Cth), as many key mechanisms remain available in practice.
If you require advice on how to enforce your rights as a secured creditor in an insolvency scenario, please contact Ironbridge Legal. Our team can provide clear, commercially focused guidance tailored to your position.
Why Engage Ironbridge Legal?
Ironbridge Legal advises secured creditors, lenders and other stakeholders on the practical operation of the ipso facto regime under the Corporations Act 2001 (Cth). We assist with analysing security documents, assessing whether particular rights fall within the relevant exclusions, and developing enforcement strategies that protect commercial position in distressed scenarios.
If you are considering enforcement action against an insolvent counterparty or need advice on whether your security rights remain exercisable despite the statutory stay, we can help you act on an informed basis.
Further Information
For further information about ipso facto stays, security enforcement, and secured creditor rights in insolvency, please contact the author of this article:
