Out-Law / Your Daily Need-To-Know

Termination clauses now void on insolvency events

Out-Law Analysis | 06 Jul 2020 | 8:41 am | 3 min. read

UK suppliers can now no longer rely on an 'ipso facto' termination clause to stop supplies to a corporate customer by reason of that company's insolvency.

The prohibition is contained in the 2020 Corporate Insolvency and Governance Act (the Act). The Act came into force on 26 June and makes major changes to insolvency procedures.

Suppliers now need to continue to supply insolvent corporate clients on an ongoing basis, as the right to terminate on an insolvency event is effectively void. This will have a major impact on commercial contracts and supply chains. In the current economic environment, this will have a particularly significant impact on sectors such as manufacturing and aerospace where supply chains are often critical to the ongoing operations of a business.

Why have changes been introduced?

Suppliers will often stop supplying, or threaten to stop supplying, a company that has entered into an insolvency process or a restructuring procedure. They do this in order to gain leverage to get previous debts paid, and can sometimes effectively evade the statutory 'waterfall' of payments in an insolvency as a result.

There are already measures in existing insolvency law preventing certain key suppliers, such as utility companies, from stopping supplies. The new provisions can apply to all suppliers. The changes recognise that the key suppliers vital for a business to achieve continued trading and ultimately business rescue will vary depending on the nature of its business, and are not just limited to utility companies.

The new provisions also take effect across all insolvency procedures, including the new moratorium and new restructuring plan that have been introduced by the Act.

What are the changes?

Supply contracts often include a contractual right for a supplier to terminate the contract if the customer enters into some form of insolvency process. This termination right is effectively void and overridden by the Act.

Suppliers are unable to use termination rights which arose prior to the insolvency process and which were not exercised before that time. Therefore, the only opportunity to terminate would be a breach arises subsequent to the insolvency process starting - for example, if the supplier is not paid for ongoing supplies after the insolvency process has begun.

The Act also prevents suppliers from making other changes connected to the insolvency, for example to change payment terms or increase prices.

The Act has retrospective effect, so applies to contracts already entered into. There are some exemptions. In the short term, there is a temporary exemption for 'small' companies. These are companies which meet at least two of three criteria during the Covid period, which is stated as lasting until 30 September 2020: turnover less than £10.2 million; balance sheet less than £5.1m; and fewer than 50 employees.

Suppliers can be relived of the obligation to continue supplies if they agree this with the office holder or company, or if it causes hardship to the supplier's business. A court application would need to be made before the latter of these can be relied upon, so this is not a quick - or very cost effective - route.

What should suppliers do now?

Suppliers should review their contract terms in order to update precedents and, where applicable, existing contracts, in order to take account of these changes. This will include updates to the insolvency clause to reference the new procedures under the Act.

Although the clause may now be void on an insolvency event, these clauses should be retained in updated contracts in order to ensure that they provide a termination right if the supplier wishes to make an application to the court for relief, or otherwise agree a termination with the company under one of the exemptions.

Suppliers should also consider what other clauses they wish to seek to change in their templates and contracts in order to provide greater protection. For example, shortening payment terms so any breach subsequent to the insolvency event can be actioned without an extended period passing. Suppliers should also consider how they can factor potential early warning signs of any difficulties into contracts, so that preventative action can be taken where appropriate.

There are also practical considerations for suppliers. Due diligence into the financial position of customers before entering into contracts, and ensuring well managed documentation and contract management, will also be critical to ensuring that the potential risks are managed on an ongoing basis.

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