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Limits introduced on suppliers’ right to terminate for insolvency

29 June 2020

Clauses which allow termination when your counterparty enters into insolvency are commonplace, and are often inserted into commercial agreements routinely, without too much thought. It may come as a surprise, therefore, that these will now largely be unenforceable by suppliers of goods and services against their customers.

These so called “ipso facto” clauses are invalidated by the Corporate Insolvency and Governance Act 2020, which received Royal Assent on 25 June and took effect on 26 June.

The aim of invalidating ipso facto clauses is to protect companies in financial difficulty from suppliers who terminate their agreements and thereby withhold supplies which are vital to the survival of the business. Although the coronavirus pandemic is a clear impetus for the Act, the new provisions on ipso facto clauses are not time restricted and are long term.

If you’re a lawyer who is drafting/negotiating supply contracts it’s worth understanding the provisions and considering the consequences of them.

Summary of the provisions

Section 14 of the Act is the key provision which amends the Insolvency Act 1986:

  • it applies to all contracts for the supply of goods or services (excluding the supply of certain financial services);
  • it applies to termination clauses which are triggered when the customer/client enters into “relevant” insolvency proceedings (such as liquidation, administration or the new statutory moratorium)
  • the effect of the provisions is that, when the customer/client enters into relevant insolvency proceedings, any “ipso facto” clauses cease to have effect. This is the case whether they:
  • automatically trigger termination, or
  • give the supplier the right to terminate the agreement;
  • once the customer/client enters into relevant insolvency proceedings, the supplier cannot rely on another right to terminate (eg for non-payment or material breach) if that right arose before the customer/client entered into relevant insolvency proceedings.

There is however some comfort for suppliers:

  • a supplier can still terminate for grounds other than insolvency, as long as the contractual right to terminate did not arise pre-insolvency and was simply not exercised. For example, it remains possible to terminate for breach of contract or non-payment occurring after the insolvency proceedings have commenced;
  • a supplier may apply to the court for relief, entitling it to terminate the agreement, if continuing to supply the goods or services would cause ‘hardship’; and
  • the agreement may, of course, always be terminated with the customer/client’s consent (or that of the relevant officeholder, eg an administrator).

There is also a temporary exclusion for "small suppliers" (as defined in the Act). This exclusion is available until 30 September 2020, extendable in six-month increments by the government.

Other points worth noting include that:

  • the new provisions only apply to contracts for the supply of goods or services, so do not apply to commercial contacts generally;
  • it only applies to a supplier’s right to terminate, so a customer/client can still rely on ipso facto clauses to terminate if their supplier enters into insolvency;
  • as financial contracts are excluded from the new regime, a lender would still be able to stop the supply of committed financing due to an insolvency event of default.

What do you need to do about this?

Given that suppliers may apply to court to enforce ipso facto clauses in the event of hardship, it seems that they should continue be included in your contracts.

Clauses which allow termination for non-payment will be more important than ever, and should be reviewed to check they are robust enough. For example, if they allow for a time period for payment to be made following notice of non-payment, perhaps you want to reduce that period to ensure it can be triggered before the customer enters into relevant insolvency proceedings.

Perhaps most importantly, keep a close eye on non-paying customers. If you think they are going to enter into insolvency and you want to exercise a right of termination (eg for non-payment), act quickly (making sure, of course, that you’ve followed the termination procedure so it cannot be challenged). If you don’t, you may well lose that right to terminate, have to continue to supply and just hope that the customer will survive and be able to pay, eventually…

Further information

The government has provided guidance on the ipso facto termination provisions which includes a short case study.

(This article was updated on 29 June to reflect the Act receiving Royal Assent and coming into force).

 

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