Suppliers’ termination clauses rendered toothless

Supplying goods and services is something every organisation is involved in, to some degree. In this, the final instalment of our plain English updates on the new Corporate Insolvency and Governance Act, we examine how the new legislation affects supplier relationships with distressed businesses.

Termination clauses in supply contracts

The new bill prohibits suppliers from relying on termination clauses in their contracts that are triggered when their client or customer enters into a formal insolvency process or event.

These ‘insolvency events’ include a company going into administration; appointing administrative receivers; approving a company voluntary arrangement; liquidation; provisional liquidation; the new stand-alone statutory moratorium; and the new restructuring plan.

Like many other measures introduced by the bill, the provisions are debtor-friendly to aid economic recovery. The aim is to allow a distressed company to continue to trade and benefit from supplies and ensure that suppliers cannot insist on payment of outstanding charges as a condition of future supplies.

New restrictions on suppliers

If any insolvency events are in play, suppliers are forbidden from doing a number of things.

1. Suppliers can’t activate clauses that terminate/change contracts or impose fines – automatically activated clauses are also restricted.
2. Suppliers can no longer terminate a contract for breaches or events that occurred before the insolvency event.
3. Making payment of pre-insolvency arrears a condition of continuing supply is not allowed. Pre-insolvency debts rank alongside other unsecured claims and will only be paid if there are sufficient assets to pay a dividend to unsecured creditors after the costs of the insolvency and secured creditor claims.

Are there any exceptions?

Certain suppliers and contracts are exempt from the restrictions. Namely those classed as “essential” (dealt with under the existing essential supplier regime). Certain suppliers and contracts involved in financial services are also exempt, while “small suppliers” are temporarily exempt until 30 September 2020.

Small suppliers are suppliers who meet at least two of the following criteria:

• employ less than 50 people;
• have a balance sheet with assets not exceeding £5.1m; and
• have a turnover of £10.2m or less.

When the temporary period expires, small suppliers will also be caught by the restrictions.

Can suppliers challenge the restrictions?

A supplier can apply to court seeking an order to disapply the restriction on the grounds that they will suffer hardship as a consequence of continuing to supply. However, there is no definition or guidance in terms of what constitutes “hardship”.

It is suggested that it may include where the supplier’s own insolvency is likely, but it is not clear and it will likely be challenging to demonstrate. Non-payment of arrears may not be sufficient given the protections afforded to suppliers i.e. that the supplier is entitled to be paid for any goods or services supplied post-insolvency.

It remains to be seen how the courts will balance the individual supplier’s financial position as against the interest of creditors as a whole. The application itself may also be cost prohibitive for the supplier since it must, by the nature of the application, have financial difficulties itself.

Can termination be achieved at all?

 A supplier can exercise its rights to terminate on insolvency if:

• the office holder (e.g. administrator, liquidator etc.) consents;
• the company consents (in a CVA, moratorium or restructuring plan); or
• the court is satisfied that continuing supply would cause hardship and grants permission.

Insolvency expert advice to suppliers

Kelly Jordan, partner and head of restructuring & insolvency, has a number of suggestions to help suppliers mitigate the impact of the changes.

1. Keep on top of payment terms, consider reducing payment periods, keep the situation under regular review and tighten credit control procedures.
2. Review terms and conditions to ensure they are up to date and fit for purpose.
3. Check what rights and remedies you have under your terms and conditions, particularly in terms of events of default and remedy periods.
4. Monitor changes to your customers’ financial position and, where possible, terminate on other grounds and/or before an insolvency event occurs e.g. where a notice of intention to appoint administrators has been filed but the administrators have not yet been appointed or where a CVA has been proposed but not yet approved.
5. Consider whether to incorporate alternative termination rights into your contracts such as additional termination rights that are triggered prior to an insolvency event and exercise those rights before an insolvency event occurs.
6. Framework agreements, where individual call off contracts are entered into for each ‘order’, may provide an answer rather than long running supply contracts.

We hope you've found this commentary on the new Corporate Insolvency and Governance Act helpful. Click here to view the rest of the updates.

For more help and specialist insolvency and restructuring advice, contact Kelly Jordan on 0191 211 7899 or email [email protected] for a free consultation.