Impact on Termination Clauses in the Event of Insolvency

The Government has now published the Corporate Insolvency and Governance Bill (the “Bill”), which will make changes to existing insolvency laws in response to COVID-19 and will significantly impact supplies of goods and services to companies in financial distress. The provisions in the Bill will apply to all the creditors and companies and suppliers may need to act urgently in order to mitigate or address the likely impact of the Bill.

Reliance on an ‘ipso facto’ termination clause

It is now not possible for UK suppliers to rely on an ‘ipso facto’ termination clause to stop supplies to their customers (usually corporate clients) by reason of that company’s insolvency. Suppliers were previously able to exercise their right to terminate a contract in the event of an insolvency or if the customer enters into restructuring, however, the Bill is now render this option void.

Existing insolvency law already prevents certain key suppliers, such as utility companies, from stopping supplies in the event of an insolvency. The new provisions of the Bill can apply to all suppliers. Perhaps, the changes recognise that the key suppliers are vital for a business to achieve continued trading in this uncertain climate and ultimately business rescue will vary depending on the nature of its business and are not just limited to utility companies.

How does the Bill impact supply contracts?

These measures will likely have a significant impact on the position of creditors and their existing rights to seek repayment of overdue indebtedness. The Corporate Insolvency and Governance Bill weakens and even removes two of the most effective options available to unpaid suppliers, i.e. threat of termination of the contractual agreement and commencement of insolvency proceedings (which is a relatively cost and time effective procedure if the debt is not disputed).

If a company enters a formal insolvency process, the new pre-insolvency moratorium procedure outlined above prohibits termination of contracts on the grounds of enforcement of termination clauses in contracts which trigger upon the financial condition or formal insolvency of a debtor company. The counterparties will, therefore, have to continue to fulfil their contractual obligations.

It should be noted that this prohibition will not prevent termination for reasons of non-payment or the exercise of any other right to terminate that might exist under the relevant contract. Perhaps inevitably, that balance is likely to favour debtor companies more than creditors and that is bound to be of concern to creditors whose businesses are in need of a cash injection.

In addition to this, if the customer enters into an insolvency procedure, it may be that the unpaid supplier is obliged to continue supplying the customer, without payment of prior invoices and on existing terms.

What should suppliers do?

During these unprecedented times, suppliers may want to review their existing contractual arrangements with customers who are likely to become financially distressed.  Supplies may utilise their termination rights to negotiate new beneficial terms, such as:

  • seeking payments on account rather than payment upon receipt of the supplies;
  • arranging short term contracts with fixed termination dates which will prevent suppliers from being locked in to supply for a considerable period;
  • including an express right in the contract to withhold supply of goods and services in the event of any non-payment;
  • seeking personal guarantees from the customer’s directors or persons in-charge.

Download the Corporate Insolvency and Governance Bill

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