Ipso facto provision introduced to UK insolvency landscape by the Corporate Insolvency and Governance Act 2020 (“the 2020 Act”).
On 26 June 2020 the Corporate Insolvency and Governance Act 2020 (“the 2020 Act”) finally entered into force. Now it is in its final form, Simon Newman and Christopher Pask of 1 Chancery Lane’s Commercial, Chancery and Property team will be providing their views on its provisions and their impact over a series of updates.
In this update, Christopher Pask addresses the permanent change introduced by section 12 of the 2020 Act in respect of contracts for the supply of goods and services. The previous update looks at the introduction of new rescue mechanisms for companies in the form of a moratorium and restructuring process. The next update will look at the suspension of the wrongful trading rules.
Contractual Termination Clauses (Ipso Facto provision)
Contracts for the supply of goods and services normally contain clauses which either automatically terminate, or entitle the supplier to terminate, the contract if their customer enters insolvency. Suppliers will often be left with arrears owed to them if their customer becomes insolvent and consequently will wish to stop the supply of goods, or provision of services, as soon as possible to limit losses.
The 2020 Act will prevent a supplier from terminating the supply contract (for insolvency related reasons) unless it falls within the category of exempt suppliers (an ipso facto provision). It is a statutory override of the insolvency terminations clauses in a contract. As a result, suppliers will have to continue to supply under the terms of the contract, notwithstanding the fact that their customer is insolvent.
The provisions apply where the customer has entered a “relevant insolvency procedure”. Those include the new moratorium (introduced by the 2020 Act), administration, administrative receivership, CVAs, liquidation, provisional liquidation and the new rescue plan proceedings (but not schemes of arrangement).
The new provisions prevent suppliers from:
- terminating a contract or supply or doing “any other thing”, because the company has entered a relevant insolvency procedure;
- terminating a contract or supply for breaches which occurred prior to the relevant insolvency procedure; or
- making it a condition of future supplies that pre-insolvency arrears are paid.
Suppliers will still be allowed to terminate the contract:
- for new breaches which happen after the insolvency procedure begins;
- with the permission of the insolvency office holder or directors (depending on which insolvency procedure the company is in); or
- with the permission of the court provided the court is satisfied that continuation of the contract would cause the supplier hardship.
The wording “any other thing” is not specifically defined but is a broad concept. The government explanatory notes provide just one example – that changing payment terms will be prohibited. However, the wording is much broader than that and likely to apply to the exercise of any contractual right triggered upon an event of insolvency.
“Hardship” is similarly undefined and likely to require clarification from the courts on a case by case basis.
Some comfort is offered to suppliers due to the fact that supplies made during an administration or liquidation are deemed expenses of the process and will rank ahead of most other creditors.
It should be noted that there is an extensive list of contracts and companies which are excluded from the operation of these measures; primarily financial services institutions or ‘financial contracts’. There is therefore no obligation to continue to supply finance to companies which have entered a relevant insolvency procedure.
i) Turnover of less than £10.2 million;
ii) Balance sheet total of less than £5.1 million;
iii) No more than 50 employees.
The exemption for small suppliers is only temporary and due to end on 30 September 2020, after which these smaller companies will also be caught by the new regime and be unable to terminate for insolvency related reasons.
The measure only provides protection for the recipient of the supply when it enters a relevant insolvency process. It does not protect an insolvent company’s customer contracts.
The measures will not affect agreements which are made on an ad hoc basis; only those where there is a contract in place for regular supply or provision of services.
Retention of Title clauses are not affected directly by the 2020 Act but if the customer company has already entered an insolvency process, there may be a moratorium in place that prevents a supplier enforcing a retention of title clause.
These measures are a welcome attempt to improve the rescue opportunities for companies in financial distress. Preventing suppliers from using their considerable power to disrupt a struggling company’s supply chain is sensible but does not sit easily with the freedom of contract which commercial parties are accustomed to enjoying. Further, whilst they prevent the supplier from collapsing a supply chain, they do not prevent the purchaser from doing so.
The undefined terms of ‘hardship’ and ‘any other thing’ likely need clarification by the courts given the relatively scant guidance provided so far on the scope of the measures, though it would be sensible to assume a relatively restrictive approach will be adopted in order to promote the essential aim of the legislation which is to provide assistance to struggling companies. When considering the ‘hardship exemption for example, a court will have to balance the supplier’s hardship against the interests of other creditors.
The inevitable strain on the courts’ resources as a result of the pandemic may well make it unattractive or impractical for suppliers to apply to the court to have their contracts terminated under the ‘hardship’ exemption. This may be particularly so in the early days of this provision when such broad terms as ‘hardship’ and ‘any other thing’ remain undefined and without judicial guidance to assist with interpretation.
This is a significant change to the UK insolvency law and one which is does not require the circumstances leading to a company entering an insolvency procedure to be specifically coronavirus related. Parties will need to keep an eye out for how the case law develops surrounding the supplier hardship exemption in particular.
 Section 12 which inserts a new section 233B into the Insolvency Act 1986.
 Schedule 4ZZA of the Insolvency Act 1986.
 Section 15 the 2020 Act.