Termination for insolvency: how can suppliers protect their position?

Suppliers can no longer rely on contractual terms entitling them to terminate a contract on the grounds of a corporate customer’s insolvency (ipso facto clauses) in most cases. This prohibition was introduced by the Corporate Insolvency and Governance Act which came into force on 26 June 2020 (the Act). This briefing looks at the changes suppliers may need to make to their contracts, as well as to their credit and enforcement strategies, in light of this prohibition.

What does the new law do?

Insolvency legislation already contains limited protections to ensure that companies in financial difficulty are able to continue to access essential supplies (namely utilities, communications and IT supplies). The new Act has extended protection to almost all supplies of goods and services to companies in almost all insolvency proceedings (subject to certain exclusions).

Suppliers of goods and services that do not fall within one of the exclusions are now prevented from terminating a contract or “doing any other thing” on the grounds of the customer’s insolvency. Suppliers are also prevented from terminating the contract on the grounds of a pre-insolvency breach if that right is not exercised before the customer enters insolvency proceedings.

The intention behind this new prohibition is to ensure continuity of supply and thereby encourage and allow companies the opportunity to continue to trade with a view to achieving a rescue, if at all possible. These provisions extend and apply to England, Wales, Scotland and Northern Ireland.

Which contracts are affected?

The prohibition applies to contracts for the supply of goods and services where the customer enters a “relevant insolvency procedure” in the UK. Please note that the Act does not affect customers who are looking to terminate an agreement with an insolvent supplier.
The Government has indicated that leases, licences and sale agreements for land or property are not generally considered to fall within the prohibition. If there is an element of provision for the supply of goods and/or services within such an agreement, that element would be subject to the prohibition, but the remainder of the agreement is likely to be unaffected.

Small suppliers are temporarily exempt from the prohibition until 30 March 2021 if they meet at least two of the following criteria in their most recent financial year: (i) turnover no more than £10.2m; (ii) balance sheet no more than £5.1m; and/or (iii) average number of employees no more than 50. The criteria are slightly different if the supplier is in its first year of trading.

There is a permanent exemption where either the customer or the supplier is involved in financial services. This includes, amongst others, insurers, banks, investment firms, payment institutions and operators of payment systems. There is also an exemption for certain financial services contracts.

How can suppliers protect their position?

Pre-insolvency

We consider that it is still advisable for suppliers to include rights to terminate on a customer's insolvency in contracts where possible. This will allow them the potential option of applying to the court or asking the office holder (or the company where there is a moratorium, CVA or restructuring plan in place) for permission to terminate the contract if the customer does subsequently enter an insolvency procedure. However, suppliers should be aware that it is highly unlikely that they will be able to rely on such termination provisions.

Suppliers should also consider what further contractual provisions would provide them with protection in the event that the customer begins to experience financial difficulties. These might include:

• reducing the contract term
• reducing the payment periods
• looking for security from third parties
• requiring part payment in advance
• provision of financial information on request or at regular intervals (including notice of withdrawal of a customer's credit insurance or downgrading of credit rating)

It will become more important than ever to keep a close eye on the customer’s financial condition and to ensure that there are a variety of routes open for terminating the contract pre-insolvency. The key will be tight monitoring and short payment terms. Suppliers will no longer be able to terminate a contract for a pre-insolvency breach after a company has entered insolvency proceedings, and will need to act quickly to identify breaches and
exercise termination rights in relation to a customer that is struggling.

Post-insolvency

Even where the prohibition applies, suppliers may be able to terminate the contract with the consent of the office holder (or company, if applicable) or the court. The court will only grant permission where it is satisfied that continuation of the contract would cause the supplier “hardship”.
It is currently unclear how the courts will interpret the "hardship" test, and the approach may vary depending on the type of contract in question and whether, for example, suppliers have adhered to the recent Cabinet Office guidance on responsible contractual behaviour in exercising their remedies in response to performance of contracts impacted by Covid-19.

Suppliers will still be entitled to terminate a contact on the grounds of a right arising after the insolvency proceeding began but not triggered by the proceeding, for example, non-payment for debts arising during the insolvency period. They may also have other contractual or common law rights, including set-off or netting rights and specific advice should be sought in each case. An open dialogue with the insolvency office holders (or company, where appropriate) will be important. It may still be possible to negotiate terms or even agree to terminate the contract.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at September 2020. Specific advice should be sought for specific cases. For more information see our terms & conditions.