CIGA 2020 which received the Royal Assent on 25 June 2020 has introduced several significant changes to UK insolvency legislation. Some of these are temporary measures enacted in response to the Coronavirus pandemic to mitigate the effects of the lockdown. Others, however, are permanent measures that result from a consultation process to amend the Insolvency Act 1986 begun in 2016 and concluded in 2018.
These permanent measures introduce new provisions into the Insolvency Act 1986 to ensure that the supply of essential goods and services is maintained and to restrict a supplier’s ability to terminate a contract where a customer enters a formal rescue or insolvency procedure (which will include CIGA 2020’s new moratorium and restructuring plan).
These changes need to be considered carefully in the context of a supplier’s existing and future contractual relationships.
Termination clauses in supply contracts
Until now it has been the norm for a supplier to include contractual provisions to allow the supplier to suspend provision of goods/services and/or terminate a contract on the basis that the customer is insolvent. The intention is that the supplier’s position is not worsened by being obliged to continue to supply goods or services for which the insolvent company is unlikely to be able to pay.
Such clauses have become known as “ipso facto” clauses (ipso facto being latin for “by the fact itself”; thus if the company is factually insolvent the right to terminate follows automatically). Some clauses have been drafted to extend such rights to be activated where the customer is in a particular financially impaired state.
A supplier that has the benefit of an “ipso facto” clause has been able to threaten to cease supply and/or threaten termination in an effort to pressurise the customer into settling outstanding debts, thus - and depending on the importance to the customer of the goods or services - being preferred for payment to the detriment of (i) the customer’s business as scarce financial resources to keep the business trading are diverted to the supplier and (ii) the other creditors of the customer.
“He who shouts loudest gets paid first” has been the order of the day, reflecting the long-standing principle of English law that parties to a contract should have the freedom to conclude such bargain as they choose.
Restrictions imposed on suppliers: where we were
Even prior to CIGA 2020, when a company entered the insolvency process, it had been the case that a supplier of “essential supplies” (as defined by the Insolvency Act 1986) was prevented from demanding pre-insolvency debts be paid as a condition for continuing their supply (e.g. in an administration or a voluntary arrangement, in order to facilitate the rescue of the company or a better return for the creditors as a whole). Such essential supplies include key utilities to include private suppliers of utilities and IT supplies, which includes computer hardware and software and their support and maintenance, data storage and processing as well as website hosting (under The Insolvency (Protection of Essential Supplies) Order 2015).
However, the law prior to CIGA 2020 did not take account of the specific needs of a particular business in determining what to that business was an essential supply and also allowed a guarantee to be demanded from the Insolvency office-holder in respect of future supplies.
Restrictions imposed on suppliers: where we are now
The measures introduced by CIGA 2020 mean that a supplier of goods and services is no longer able to rely on “ipso facto” clauses where a customer is subject to an insolvency procedure. More specifically, a supplier will not be able to:
- cease the supply of goods or services or terminate the contract where it has an obligation to supply the customer
- make it a condition of any ongoing supply that any outstanding charges incurred prior to the insolvency procedure are paid
- do any other thing as a result of the insolvency procedure e.g. increasing prices or imposing more onerous payment terms
- rely upon any breach of the contract by the customer that took place prior to the insolvency procedure as a reason for terminating the contract or the supply
Limited protection for suppliers
These changes seem to have swung the pendulum in the opposite direction, away from the supplier towards the customer (and the general body of creditors who would benefit from a rescue), transferring the risk from financially struggling companies to their suppliers and small suppliers could suffer disproportionately.
There is a danger that in trying to preserve the supply of goods and services in order to rescue one company, CIGA 2020 may have the unintended consequence of destabilising the financial position of one or more suppliers. Worse, by requiring a supplier to continue supplying to a company in liquidation (i.e. a company with no prospect of survival), it could haver the consequence of triggering a domino effect of financial instability.
However, there are limited situations in which a supplier may still be able to terminate the contract and release itself from its obligation to continue to supply the customer. These are where:
- the insolvent company or an office-holder consents to the termination; or
- the supplier applies to court for relief and the court grants the supplier permission to terminate if the supplier can demonstrate that the continued supply will cause it ‘hardship’.
There is no guidance at this time on what constitutes ‘hardship’ and how practical it will be for a supplier to claim this relief: it is likely to be some time before we see a body of case law develop that defines what is meant by the term.
For now, all we have is Government guidance which gives the example of the supplier itself facing insolvency if it is required to continue supplying. It is not clear whether the courts will interpret ‘facing insolvency’ as the only measure of hardship. The courts have been given discretion in granting the supplier permission to terminate the supply, but it is unclear how that discretion will be exercised: how will the interests of the supplier be balanced against the interests of creditors as a whole? Also, the cost of making an application to the court is likely to cause concern to smaller suppliers.
It does remain permissible for a supplier to terminate the contract on grounds other than the insolvency or restructuring of the customer, provided the contractual right to terminate had not arisen pre-insolvency and simply not been exercised by the supplier. For example, the supplier can terminate for breach of contract or non-payment where this occurs after the commencement of the insolvency or restructuring.
There is a temporary Coronavirus-related exclusion, where the supplier is a small business, that will operate until 30 September 2020. To benefit from this exclusion, a supplier must satisfy two of the following conditions in its most recent financial year:
- its turnover was not more than £10.2 million
- its balance sheet total was not more than £5.1 million
- it had 50 or fewer employees
Exceptions to the Rule
Schedule 12 of CIGA 2020 introduces a Schedule 4ZZA into the Insolvency Act 1986 which provides various carve outs from the new provisions relating to contracts for the supply of goods or services to a customer (“the company”), so excluding where the supplier or company are insurers, banks, electronic money institutions, investment banks and investment firms, payment institutions, recognised investment exchanges, securitisation companies subject to the detailed provisions of the Schedule. As financial contracts are carved out, that means a lender is able to stop the supply of committed financing as a result of an insolvency-related event of default.
Steps a supplier should take to protect its position
To understand the implications and risks for its business a supplier should immediately conduct an audit of all its contractual relationships to understand fully the extent of its contractual rights, and the limits on any protections it has, resulting from the changes introduced by CIGA 2020.
It will want to monitor rigorously the financial performance and ongoing creditworthiness of the customer and be prepared to act quickly when a right to terminate is triggered.
Future contractual relationships may offer the supplier a greater opportunity to protect itself from the impact of the changes, particularly where it has a strong bargaining position. The supplier should consider the following measures to the extent they are appropriate and commercially viable in the context of each deal:
- perform enhanced pre-contractual checks on prospective customers to assess their financial strength and request personal guarantees from directors where there is concern
- revise existing payment terms to require payment in advance of supply and categorise late payment as a termination event without any option to remedy or provision of a grace period
- use a framework structure so that each order constitutes a new contract without a continuing obligation to supply and include the right to reject orders, or use a short term contract to limit exposure to a customer
- update termination rights to ensure compliance with the changes. Identify alternative signs of financial distress (e.g., an adverse change in credit rating or balance sheet insolvency) as termination events. The supplier may also wish include trigger events giving rise to a right to terminate where the customer has taken steps in anticipation of insolvency
- as with existing contracts, monitor customers and be alert to any signs of financial distress then act quickly when a termination right is triggered. Including audit rights within the contract would help to support this process
These changes fundamentally alter the risk profile of the supplier/customer relationship especially in these times of uncertainty and financial turbulence. If you are a supplier of goods and/or services you owe it to your shareholders and other stakeholders to immediately begin an exercise of revisiting your existing contracts starting with the longer term ones and also your existing template contracts/business terms.
The lawyers in Boyes Turner’s commercial & technology team can assist you in carrying out the risk assessment due diligence and in rewriting your contracts, as well as taking action to limit your exposure to failing customers through Boyes Turner’s business support & insolvency team and debt collection services.
Please contact any member of the commercial & technology team or the lawyer with whom you usually deal and they will put you in touch with the right person to assist.
Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.