The End of The End? New UK Legislation Will Prevent Suppliers from Terminating Contracts Due to A Customer Becoming Insolvent
The ability of suppliers to terminate contracts when a customer becomes insolvent is to be curtailed by the Government under plans published in the Corporate Insolvency and Governance Bill (the “Bill”).
The Bill contains a suite of measures designed to help businesses both during and after the COVID-19 pandemic, several of which have been under consultation for some time. This blog will focus on the measures affecting termination clauses and how they apply. A broader overview of the measures introduced by the Bill can be found here.
Most contracts for the supply of goods and services contain a termination clause (also known as an ipso facto clause) which, on the occurrence of an insolvency related event, either: –
automatically terminates the contract, or
entitles the supplier to terminate the contract.
However, the successful turnaround of a distressed business often requires continued co-operation from its suppliers, just as much as it requires the support of its customers. As a result, the Government is seeking to prevent these termination clauses from taking effect in order to “help companies trade through a restructuring or insolvency procedure, maximising the opportunities for rescue of the company or the sale of its business as a going concern.”
Similar provisions preventing what are deemed “essential suppliers” (such as utility companies) from terminating contracts upon a company’s insolvency have been in place for some time. These new proposals effectively seek to expand upon these existing measures to mirror similar principles in restructuring laws in other European countries and in the US.
Which contracts does the new legislation apply to?
The new proposals apply to contracts for the supply of goods and services. This is a wide definition which is likely to affect the vast majority of supplier contracts. However, it should be noted that the following specific suppliers and contracts are exempt:-
Suppliers classed as “essential suppliers” (which will be dealt with under the existing essential supplier regime);
Certain persons involved in financial services;
Contracts involving certain financial services; and
Suppliers classed as “small suppliers” – but only for a limited period.
Whilst the definition of a “small supplier” is fairly straightforward, the provisions detailing what amounts to a person involved in financial services and contracts involving financial services are highly technical. Providers of financial services should carefully review the Bill to ensure that they are able to operate outside of this regime and consider amending contractual terms to avoid falling foul of this new legislation.
When does the new legislation apply?
These measures will apply when a company becomes subject to a “relevant insolvency procedure”. administration, administrative receivership, company voluntary arrangements (“CVA”), liquidation and provisional liquidation all fall within this definition, as do the two insolvency procedures intended to be established by the Bill, the statutory moratorium and the restructuring plan.
How does the new legislation work?
The provisions apply to any clause in a contract for goods and services, which either automatically terminates the contract or entitles the supplier to terminate the contract upon a company becoming subject to a relevant insolvency procedure.
The Bill also seeks to prevent suppliers from doing “any other thing” upon a company becoming subject to relevant insolvency procedure and the explanatory notes to the Bill indicate that this is aimed at preventing suppliers from changing payment terms. For example, this will prevent suppliers with termination rights effectively holding distressed companies to ransom by placing onerous conditions on trade or applying increased pricing on the continuation of supply. However, the generality of this wording may have wider ramifications.
Other key points to note are that there is an express provision preventing the supplier from making the payment of pre-insolvency debt arrears a condition of continuing supply and that there is no mechanism to make an office holder personally guarantee the payment of ongoing charges. This latter point is in contrast to the provisions that relate to “essential suppliers”, which enable a supplier to hold an office holder personally liable for the payment of ongoing charges.
When can a supplier terminate the contract?
The supplier is able to terminate the contract in the following scenarios:-
The office holder consents (in an administration, administrative receivership, liquidation and provisional liquidation);
The company consents (in a CVA, statutory moratorium or a restructuring plan); or
The court is satisfied that the continuation of the contract would cause the supplier hardship and grants permission.
It should, however, be noted that the prohibition only affects the termination provisions of the contract that apply upon a company becoming subject to a relevant insolvency procedure. The supplier still has the right to terminate the contract on other grounds, unless these grounds arose before the company became subject to a relevant insolvency procedure.
A fair balance?
These proposals are not a knee jerk reaction to the COVID-19 pandemic. Proposals preventing supplier contracts from becoming terminable upon an insolvency related event were first published by the UK Government in August 2018 as part of its response to a 2016 Insolvency Service review.
The Bill seems to strike a balanced approach between the interests of the suppliers, distressed companies and creditors. These measures, if properly implemented, should aid the Government in meeting their aim of maximising the opportunities for the rescue of a company or the sale of its business as a going concern.
However, there are a number of gaps in the Bill that would benefit from further consideration. For example, the ambiguous nature of what financial hardship constitutes and what is meant when suppliers are prevented from doing “any other thing”. Also, whilst the definitions relating to “persons involved in financial services” and “contracts involving financial services” are expansive, it is unclear whether hire purchase arrangements are exempt from this new legislation and whether suppliers are able to pursue guarantors once a company becomes subject to a relevant insolvency procedure. The Bill is due to be considered by MPs next Wednesday and this is a welcome opportunity to fine tune these provisions to avoid any legal ambiguity once the Bill becomes law.
A broader overview of the measures introduced by the Bill can be found here, our blog outlining the temporary suspension of wrongful trading can be found here, our quick guide on directors’ duties here and our first blog in a series of blogs considering the new statutory moratorium can be found here.