Changes to Suppliers’ ability to terminate contracts and other remedies for Customer insolvency
In the wake of the Coronavirus pandemic, the Government has fast-tracked its long-trailed changes to the corporate insolvency regime. The Corporate Governance and Insolvency Act 2020 hurtled through Parliament, coming into force on 26 June, just 36 days after it was introduced into the House of Commons.
Suppliers of utilities and communications services, which for these purposes include most IT and data processing services (together known as “essential services”), are already used to restrictions on their ability to terminate for insolvency if a customer enters administration or a voluntary arrangement, but these restrictions have been significantly extended.
The changes to the remedies for customer insolvency (and the introduction of a new stand-alone moratorium procedure and a new restructuring plan process) are permanent changes, though the suspension of wrongful trading liability and winding up petitions by the same Act are only temporary.
Who do the new rules apply to?
The new rules apply to almost all suppliers of goods and services, not just suppliers of utilities, communications services, IT supply and data processing. There are some exceptions:
- Small suppliers are exempt until 1 October 2020. A supplier is a small supplier if it satisfies 2 of the following 3 requirements: turnover not exceeding £10.2m (or £850,000 per month if the business is in its first financial year), balance sheet total not exceeding £5.1m, and not more than 50 employees. This exemption may be extended in increments of up to 6 months, if necessary to mitigate an effect of coronavirus;
- Certain regulated financial services firms and financial contracts – so, for example, a lender cannot be forced to continue to provide finance. This is to i) ensure that the existing special insolvency schemes, which give financial regulators power to intervene in relation to insolvency of certain financial services firms in order to mitigate the risks to financial stability and ensure consumers are protected if these firms are at risk of failing, are unaffected and ii) give financial market participants the legal certainty needed to facilitate the efficient functioning of the financial market.
- Contracts for essential services made on or after 1 October 2015 (including those made after the new rules came into force on 26 June 2020) remain subject to the old regime but will also be subject to the new regime where this goes beyond the old regime, and any contracts for “essential services” made before 1 October 2015 and still in force will now be subject to the new regime in its entirety.
Although the wording of the Act does not make this entirely clear, it is likely that the new rules will apply to contracts for the licensing of intellectual property and equipment hire agreements, as well as to agency and franchise agreements.
When do the new rules apply?
The new rules also apply to a much wider range of insolvency procedures. They apply as before if the customer:
- enters administration; or
- puts a voluntary arrangement (“CVA”) in place;
and now also if the customer:
- enters a stand-alone moratorium of the type introduced by the Corporate Governance and Insolvency Act;
- has an administrative receiver appointed;
- goes into liquidation or provisional liquidation, or
- is subject to a court order for the new type of restructuring introduced by the Corporate Governance and Insolvency Act.
The new rules apply to companies which become subject to a relevant insolvency procedure on or after 26 June 2020, in relation to contracts made before, on or after that date.
What do the new rules prevent?
The new rules are very similar to the existing ones for essential services. As before, the rules prevent a supplier:
- terminating the contract or its supply because the customer has entered a relevant insolvency procedure; or
- exercising any other right triggered by the customer entering the relevant insolvency procedure – so for example the supplier cannot increase its charges or default interest rate, shorten the payment period or otherwise alter credit terms, or require additional security from the customer, if the right to do so is triggered by the insolvency procedure.
The restrictions apply whether termination is automatic or at the supplier’s discretion.
In addition, as before:
- any right to terminate the contract or supply arising for any reason before the customer enters the relevant insolvency procedure (for example, for a pre-insolvency material breach of contract or change of customer control) cannot be exercised during the insolvency period; and
- the supplier cannot make payment of outstanding pre-insolvency charges a pre-condition of its continued supply during insolvency.
What protection is available for the supplier who is forced to continue to supply a customer in financial difficulty?
Protection is more limited than under essential services regime:
- Unlike the essential services regime, there is no right to require the insolvency office holder to give a personal guarantee as a condition of continued supply.
- Unlike the essential services regime, there is no express right to terminate if another event occurs during the insolvency period which would entitle the supplier to terminate, or if charges for supplies during the insolvency period are not paid within 28 day of the due date. However, it should still be possible for a supplier to terminate in these circumstances if the contract includes such a right and the trigger is not the customer becoming subject to a relevant insolvency procedure.
- Suppliers who have continued supplies during any new-style moratorium will have priority for their charges during the insolvency period in any liquidation or administration which begins within 12 weeks of the end of the moratorium – but this may not be much consolation if the customer has no assets left after meeting its tax liabilities.
- The supplier can terminate the contract with the consent of the customer or the insolvency office holder – but there is no ability for the customer or insolvency office-holder to consent to the supplier exercising any other right which was triggered by the customer entering the insolvency procedure.
- The supplier can also terminate if it satisfies a court that continued supply would cause the supplier hardship. The Act gives no guidance as to what constitutes hardship, but the briefing paper for the House of Commons debate made clear this is a high hurdle: a supplier will be entitled to terminate on this ground only if continued supply threatens its own solvency. The prospects of rescue of the debtor customer are relevant but there was no reference to the potential impact on the supplier’s own suppliers, although vital help for one link in a supply chain may have a deleterious impact at one or more stages higher up that supply chain. This is just one of many occasions when the courts may become involved in the application of the new insolvency procedures; concerns have been raised as to whether the courts currently have the necessary resources, with relevant insolvency experience, to deal with all the potential applications.
- The House of Lords suggested that amendment should be made to the suppliers’ ability to obtain trade credit insurance where it is forced to continue supply, but this proposal was not pursued so the supplier may find such insurance is increasingly expensive or unavailable.
Right to terminate
Triggered by insolvency procedure
Other trigger, before insolvency period but exercised during insolvency period
Other trigger during insolvency period
How can suppliers improve their position?
The new provisions (like the old rules) do not apply where the supplier’s right to terminate or take other action arises at an earlier stage in the customer’s financial difficulties for example when an application is made to appoint an administrative receiver, administrator or provisional liquidator, or a meeting is convened to consider a resolution for winding up or the customer is deemed unable to pay its debts. The supplier will still be able to exercise these rights – provided it does so before the customer’s financial situation worsens and it enters one of the relevant insolvency procedures.
There is also no restriction on a supplier taking action short of termination, the trigger for which is something other than the customer entering an insolvency procedure.
Suppliers may therefore want to:
- review their standard terms and bespoke contracts, for existing and new arrangements, and include a right to terminate or take other protective action at an earlier stage in the customer’s financial difficulties; the supplier will probably also want an obligation on the customer to notify it if the relevant early stage occurs;
- consider more often whether to require guarantees, up-front payment or payments on account;
- consider offering less generous credit terms from the start;
- consider whether to include remedies other than termination, for example rights to vary pricing, default interest rates and other credit terms, which are triggered by events other than the customer entering an insolvency procedure, so that these rights remain available (see summary table above);
- include specific remedies (including termination) for (material) failure to pay an undisputed invoice for any reason, so these rights can be exercised during any insolvency period for non-payment during that period;
- shorten the periods of payment default and notice warning of termination for non-payment in existing rights to terminate for non-payment;
- shorten the duration of supply contracts, or structure these as a series of separate supply contracts under a master agreement; and
- monitor customer compliance with payment obligations, and check customer solvency frequently, and then act quickly if anything indicates there may be a problem.
Nothing in the Act compels suppliers to agree to the transfer of a supply contract, for example to a buyer of the distressed customer’s assets via a pre-pack administration or restructuring. Suppliers will therefore be able to cut their losses at this point (provided they have not already agreed to such a transfer as part of the underlying contract or otherwise – so suppliers should take care that any prior approval of transfer does not apply in circumstances of customer insolvency).
What should customers think about?
The new rules do not apply if a customer enters a Part 26 scheme of arrangement. Customers in financial difficulties who wish to take advantage of the new rules on termination for insolvency may therefore prefer to opt for the new restructuring plan process introduced by the Corporate Governance and Insolvency Act, which the Government describes as closely resembling the existing restructuring schemes with the addition of “cross-class cramdown” provisions allowing the court to sanction the plan even if certain classes of shareholder would have voted against it.
Eligible companies might also want to consider the new free-standing moratorium based on the US Chapter 11 procedure. This option will only be available if the company is not a financial or overseas company, is not subject to a winding up petition, and has not been the subject of an insolvency procedure in the previous 12 months.
Customers will also want to be alert to suppliers seeking to include:
- rights to terminate triggered at an early stage of customer financial difficulties; or
- rights to increase prices or default interest, or otherwise vary credit terms, triggered by something other than the customer entering an insolvency procedure.
Customers may also need to accept shorter term contracts, less favourable credit terms, and more frequent requests that they provide a guarantor.
Please get in touch with your usual Kemp Little contact if you would like to consider changes to your terms of business in the light of these new rules, or to discuss any of the other issues in this.
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