Supplier Termination Rights on Customer Insolvency No Longer Enforceable

9th July 2020 Corporate

The newly enacted Corporate Insolvency and Governance Act 2020 (CIG Act) (which came in to effect on 26 June 2020) has, for the non-insolvency people amongst us, gone under the radar especially as it has been fast tracked by the Government during the Coronavirus pandemic.   Its aims and general approach is to bring the UK’s insolvency regime into line with many other countries by taking a more debtor led approach focused on providing opportunities designed to facilitate a rescue.

It is however important for supplier businesses to take note of the CIG Act as it impacts significantly on suppliers and seemingly brings a ground shift in their rights and remedies once a customer business goes into insolvency.

What are the key changes for suppliers?

For suppliers, the key change relates to their ability to exercise their contractual right to terminate a contract or exercise any other right (which is triggered by an insolvency event) if the customer enters a relevant insolvency procedure. Most well-drafted commercial contracts have a clause allowing for a party to terminate should the other party enter into an insolvency procedure - the thought process being that, as a supplier, you would not want to continue to be obliged to supply a customer with no guarantee of payment. The CIG Act states that any clause that allows a supplier to terminate on the occurrence of the customer’s insolvency will have no effect. The legislation also states that if a supplier has a pre-existing right to terminate the contract, but has not exercised this right before the beginning of an insolvency event, then this too will become ineffective.      

Once the customer enters a relevant insolvency procedure, (which is defined by the CIG Act but includes the new moratorium, administration, administrative receivership, voluntary arrangement, liquidation, provisional liquidation and the new restructuring plan), the contract will only be terminable by the supplier with the consent or the customer or relevant office holder or with the permission of the court on the basis that continued supply would cause the supplier hardship.  ‘Hardship’ however, has not been defined in the CIG Act and so we will need to wait for courts’ decisions to understand how this is to be interpreted – given the nature of the legislation, we would expect the threshold to be a high.

Further, the new legislation prevents suppliers from taking any other action under the contract (such as amending payment terms) which becomes exercisable because of the insolvency and from making continued their supply dependant on the customer settling pre-insolvency debts. This removes another common tactic that a supplier facing an insolvent customer may have considered.

It's important to note that if there are unpaid debts or any other breach after the insolvency process starts, then a supplier will (subject to the rights under the contract) be entitled to terminate the contract. Equally, the new legislation has no impact on termination for convenience using contractual notice periods.

Are there any exemptions?

There is a temporary exemption to the new regime for small suppliers (defined in the CIG Act as an entity meeting two of the following criteria i) turnover of not more than £10.2 million, ii) the supplier’s balance sheet total not more than £5.1 million; or iii) the number of the supplier’s employees was not more than 50) until 30 September 2020.

So, how can suppliers protect themselves?

  • Review your existing agreements to familiarise yourself with any other rights that may help (eg a right to refuse orders, terminate prior to an insolvency, terminate for convenience);
  • Undertake thorough due diligence prior to entering into a long term contract with a customer;
  • Monitor customers’ financial positions closely on an ongoing basis so that action can be taken at an earlier stage and prior to a relevant insolvency procedure;
  • Give consideration to the provision in the CIG Act during negotiations of contracts - it may be that suppliers start asking for a right to terminate if they reasonably believe an event of insolvency is about to occur.  However, it’s unlikely that this will be acceptable to customers as this could potentially lead to uncertainty for that customer as to continuity of supply should they hit difficult times. The acceptability of this type of provision will depend on the bargaining position of the parties (or what becomes accepted market place standard);
  • It’s worthwhile to continue including these type of termination clauses as they will give protection if there is an insolvency and the office holder or company is willing to allow an early termination;
  • The new legislation will not really impact supplies made on an order by order basis (as you can choose not to accept ongoing orders), but will impact longer term agreements – one solution could be to use shorter term contracts. A shorter term contract will allow you greater visibility surrounding the solvency of a customer during the contract period; an obvious and significant downside however, is that you can’t lock in the value of a longer term relationship;
  • Consider shortening your credit periods – this will help your cash flow and ensure that if the customer does enter an insolvency procedure, your exposure in respect of unpaid invoices is minimised and amounts falling due in respect of any continued supply is paid quicker.

If you want to discuss the issues raised by this, please contact a member of our commercial contracts team on 0345 241 5305.

This note is for general guidance only and should not be used for any other purpose. It does not constitute, and should not be relied upon as legal advice. It relates to the position in England only.

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Richard Parkinson is a Partner located in Manchesterin our Corporate and CommercialSports Law departments

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