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New Law can Force Suppliers to Continue Supplying Insolvent Companies.

New Law can Force Suppliers to Continue Supplying Insolvent Companies.

The Corporate Insolvency and Governance Act 2020 came into force on 26th June 2020 and amongst other changes, it now prevents suppliers relying on any termination clauses in contracts for the supply of goods and services to insolvent companies.

The aim is to help struggling companies continue to trade through a restructuring or insolvency procedure, and in turn maximise the prospects of a rescue or sale of the business as a going concern.  It stops suppliers refusing to continue to supply or refusing to supply unless arrears are met.

Termination clauses in supply contracts – what is changing?

The current position is that suppliers will often cease (or threaten to cease) their supply of goods and services to a company entering an insolvency or restructuring procedure.   It is common for termination clauses triggered by insolvency to be written into contracts in order to allow suppliers to do this, as there is no common law right to terminate on insolvency.   

The new provisions, set out in Clause 12 of the Bill, essentially prohibit the enforcement of termination clauses triggered by insolvency.  This means that suppliers will be compelled to continue to supply, even where there are pre-insolvency arrears.  

Is the prohibition entirely new?

No, similar provisions are already in place for utility and other essential suppliers under sections 233 and 233A of the Insolvency Act 1986.  The Bill simply adds a new section 233B to the 1986 Act to widen the scope of these provisions to apply to a much wider range of suppliers.  Similar prohibitions already exist in insolvency regimes around the world, including Chapter 11 of the US Bankruptcy Code, so the UK is following suit in broadening the scope of the current rules.

Are there any exceptions?

Of course, there are a few exceptions or exemptions which apply.  First of all, the company could still consent to the termination of the supply contract should it wish to do so.  There are also safeguards for the supplier in that if the forced supply would cause the supplier hardship it can apply to Court for permission to terminate the contract.  Finally, ‘small suppliers’ are exempt from the new rules for a temporary period during the coronavirus pandemic.  The temporary period will end one month after the new provisions come into force.  A supplier is considered small if, in its most recent financial year, at least two of the following conditions were met:

  1. its turnover was not more than £10.2 million;
  2. its balance sheet total was not more than £5.1 million;
  3. the average number of employees was not more than 50.

Will suppliers be able to fall back on other grounds for termination?

Where a termination event occurs before the insolvency procedure commences, the supplier will not be able to exercise its right to terminate the contract during the insolvency period.  This effectively prevents suppliers from refusing to supply until older debt is paid.  It is therefore prudent that suppliers carry out regular diligence and are quick to take action where a termination event occurs and there is a perceived risk of insolvency, especially in the current economic climate.

On the other hand, the ban does not apply where a termination event occurs after the insolvency procedure commences.  Therefore if the supplier is not paid for the provision of goods and services during the insolvency period it will be allowed to exercise its right to terminate the contract.  It is important to note that this applies to non-monetary grounds of termination set out in the contract too.  Arguably this could include termination for convenience or without cause.  Such grounds are often useful where the customer no longer requires the goods or services or if the contract becomes uneconomic.  In the context of the new provisions, however, it could give the supplier grounds to terminate the contract during the insolvency period even if the company has not committed a breach. 

In summary, do the new provisions matter? Yes, absolutely – suppliers can be required to continue to supply with no guarantee that they will be paid, depending on the insolvency or restructuring process being used.  However, the new prohibition only limits the circumstances in which the supplier can terminate or alter the contract – as discussed above there may be ways around the forced supply and ultimately the supplier is given a ‘way out’ if the company defaults on their obligations under the contract during the insolvency period.

Insight from Pamela Muir, Corporate,Insolvency, Restructuring Partner, Chris Allan Corporate Partner and Liam McMonagle Corporate and Commercial Partner. For more information contact Pamela, Chris or Liam on 03330 430350.

About the authors

Pamela Muir
Pamela Muir

Pamela Muir

Partner

Corporate & Commercial

Chris Allan
Chris Allan

Chris Allan

Partner

Corporate & Commercial

Liam McMonagle
Liam McMonagle

Liam McMonagle

Partner

For more information, contact Pamela Muir or any member of the Corporate & Commercial team on +44 141 483 9029.