Step-in Rights: are you protected?

Where the supply of particular goods or services (or both) are critical to your project or business, it's a really good idea to consider including step-in rights in the applicable supply contract.

But - what are step-in rights?

Basically, if the contractor is in default under the contract or fails to maintain a certain level of supply, a step in clause allows for the principal to "step in" to the contractor's operations and take over control of providing that supply (by taking control of relevant equipment and other contractor assets) until the levels are appropriately restored.

Step-in rights are also usually regarded as a ‘Security InterestWA’s under the Personal Property Securities Act 2009 (Cth). This is because, in substance, they allow the principal to take control of contractor assets if the contractor fails to perform certain obligations. Therefore, the step-in rights should be perfected by registration against the contractor on the Personal Property Securities Register, so that the rights do not vest (i.e. dissolve) on the insolvency of the contractor.

Importantly, however, these rights do not usually, of themselves, give the principal security over 'the whole or substantially the whole' of the assets of the contractor. If an administrator were appointed to the contractor, the principal would be unable to exercise its step-in rights during the administration unless it does so as a secured party with a security interest over the whole all or substantially the whole of the assets of the contractor.

For this reason, it's recommended that the principal's rights be supported with an 'all asset' security (or, at the very least, featherweight security), so that the step rights are enforceable if an administrator is appointed to the contractor.

It's also important to note that step in rights were recently preserved as an exception to the recent 'ipso facto' law reforms, which disapply contractual rights that enliven on insolvency-related trigger events.

Bearing this all in mind, the principal should broadly ensure that at least the following protections are addressed when contracting with a supplier:

1. Assets critical to the relevant supply cannot be removed by any person unless the contractor has terminated (by expiry or by termination rights);
2. The step-in rights survive insolvency of the contractor; and
3. The principal's step in rights bind a secured financier of the contractor (and the principal's rights take priority over any rights of that financier).

These key points can be addressed by appropriate wording in the contract and, in the case of point 3 above, a deed executed by the contractor's secured financier. The form of deed can be agreed up front in the contract.

Other points will be relevant depending on particular circumstances.

Please feel free to contact Dom McGreal or Trish Chapman to discuss your particular requirements. We have recent experience in all 3 items above.

Wright Legal is WA’s only law firm specifically dedicated to banking and finance. In the project financing context, as experienced banking lawyers we regularly work alongside our clients' commercial lawyers to oversee important financing issues such as these in key commercial project contracts. Our clients benefit from our legal perspective and the commercial experience we bring to the table.