Intro

The UK insolvency regime has changed. Our earlier alert set out a brief overview of the changes. This is note provides more detail and flags some practical steps that the suppliers of goods and services may wish to consider.

In a nutshell

The most significant change for suppliers is the introduction of an extensive restriction on the ability of a supplier of goods or services to terminate a contract or a supply (or to change its relationship with the customer in other ways) when the customer enters into an insolvency procedure, including one of two newly introduced procedures.

Two new insolvency procedures are introduced by the Act:

• a statutory moratorium (which contains restrictions on action against the distressed business similar to those that apply in administration); and
• a restructuring plan procedure (which has many similarities to the existing scheme of arrangement procedure).

Temporary changes to insolvency law are also being made in response to the COVID-19 pandemic, to restrict the use of winding-up processes and to relax wrongful trading rules to give directors some latitude in trading during the pandemic.

While a distressed supplier will be able to use the new insolvency procedures to deal with its financial distress, the issues and considerations where the customer remains financially sound but its supplier is distressed or unable to supply are largely unchanged.

The changes are introduced by the Corporate Insolvency and Governance Act 2020.

When did these changes come into force?

The relevant parts of the Corporate Insolvency and Governance Act came into force on 26 June 2020.

The Act includes wide ranging powers to make changes through secondary legislation if these are found to be needed once the new measures are in operation.

Prohibition on exercising termination and other rights (ipso facto clauses)

Suppliers will be prevented from exercising termination rights (and doing “any other thing”) if the customer enters into a relevant insolvency procedure, i.e. the new moratorium or restructuring plan or one of the established insolvency procedures (administration, administrative receivership, CVA, provisional liquidation or liquidation).

It is not only the supplier’s right to terminate the contract or the supply of goods and services, or do any other thing because of the customer’s insolvency that is prevented. All other termination rights are suspended if they relate to a breach which occurred before the start of the insolvency procedure, and were not exercised before that date. Most obviously, this means that the supplier cannot terminate for non-payment arising before the start of the insolvency procedure. The suspension also extends to breaches completely unrelated to the customer’s financial health, such as a supplier’s ability to terminate for customer breach of supplier IP, where this happened prior to the insolvency.

Suppliers are also not permitted to make payment of pre-insolvency arrears a condition of ongoing supply.

There is no restriction on suppliers exercising termination rights for new breaches which occur after the insolvency procedure began.

Rights to terminate due to events occurring prior to the insolvency procedure are merely suspended while the insolvency procedure is in place. It may therefore be possible for those rights to be exercised if the customer exits the insolvency procedure. Depending on the insolvency procedure the customer may well not emerge as a going concern; liquidation, for example, is a terminal procedure.

Whilst contractual termination rights are suspended, termination can still happen with the consent of the relevant insolvency office holder or the company (depending on the insolvency procedure the customer is in). Alternatively, a court can intervene to terminate the contract where the supplier can satisfy the court that it will suffer “hardship” if the contract does not come to an end. We have no guidance on this concept which will therefore require the court to develop the principles to determine what factors to apply. On the face of it, it looks like a fairly high bar for a supplier to satisfy.

As mentioned above, the supplier is not only restricted in exercising termination rights, but also may not do “any other thing” which would otherwise be triggered by the insolvency procedure. This is a rather vague term but certainly a supplier will not be able to accelerate payment by invoicing more frequently and/or or imposing shorter payment terms, increase its prices, alter the services and so on if certain contractual rights are triggered by the occurrence of an insolvency procedure.

How will a supplier know that its customer has entered into one of the relevant insolvency procedures?

In practice, a supplier is likely to be actively informed either because it is creditor (i.e. has an unpaid invoice and the customer is in an insolvency procedure where creditor notification is required, or simply because its customer tells it in order to secure the continued supply of the goods or services.

A search of Companies House and the courts should reveal whether a customer is subject to a relevant insolvency procedure.

However, there are limitations to both of these types of search. For Companies House there are differing time periods for notifying Companies House depending on the insolvency procedure, so there may be a delay between the insolvency procedure beginning and the notification showing, and it is possible, though unlikely, that the relevant persons neglect to file the notice. Court searches will not reveal all relevant procedures, court records are not guaranteed to be complete and up to date and there can be issues in searching depending on which court is dealing with the insolvency.

In some insolvency procedures there is a requirement to notify creditors post-commencement.

Which contracts will be affected by the restrictions on termination?

Both new and existing contracts for the supply of goods or services will be affected. However there are significant carve outs. A key exemption is supply contracts involving financial sector and insurance companies (as either customer or supplier). Small suppliers will also be temporarily excluded; this may be significant for supply chains in particular.

In addition, where the existing provisions prohibiting the termination of contracts and supplies in relation to certain “essential supplies” (broadly utility supplies and certain categories of IT supplies) apply, they will continue to do so instead of the new regime. Those provisions (sections 233 and 233A of the Insolvency Act), operate slightly differently and, notably, include requirements for insolvency office holders to provide personal guarantees to secure ongoing supply, which the provisions introduced by the Corporate Insolvency and Governance Act do not.

This has the potential to give rise to some anomalies, in particular as s233A does not apply to contracts entered into before 1 October 2015. This means that an essential supplier with contracts entered into both pre and post 1 October 2015 could have one contract dealt with under the existing “essential supplies” provisions and another under the new provisions.

Which customers could benefit from this new protection?

Broadly, the new protection from termination of supplies will protect UK companies and certain other types of entity (for example LLPs).

These changes are unlikely to be relevant for the public sector. Public sector bodies are unlikely to be subject to the ordinary corporate insolvency regime, and therefore supplies made to them are not likely to be affected by the changes. As mentioned above, the issues and considerations for customers where it is the supplier who is financially distressed are largely unchanged.

Where overseas companies enter a UK insolvency procedure (which they may be able to do depending on the procedure used and the connection of the company with the UK) the restrictions on termination will apply to supplies made to them. However, there may be enforcement difficulties where other jurisdictions are involved.

When does the moratorium occur and for how long?

In short, to be eligible for the new statutory moratorium a company must be (or likely to be) unable to pay its debts but not beyond rescue. Short term, the protection can also be used as breathing space for companies detrimentally affected by COVID-19 but which otherwise would remain viable. This means that moratorium protection is only available where there is fairly severe financial distress (although the moratorium is not intended to simply delay the inevitable insolvency of a company that has no realistic prospect of survival).

During the moratorium creditors are restricted from most types of enforcement action. The restrictions are broadly similar to those that exist now when a company enters administration and include prohibitions on enforcing security and repossession of retention of title goods.

The moratorium initially lasts 20 business days (beginning with the business day after it comes into force), but is extendable by the directors filing certain documents at court, without any creditor consent, for a further 20 business days. It is likely therefore that many moratoria will last 40 business days. Further extensions are possible, with creditor consent for up to a year, and by court order for unlimited duration. That said, if the company becomes beyond rescue during this time or is unable to pay certain of its debts, including amounts falling due for new supplies of goods and services during the moratorium, then the protection comes to an end.

How much risk is being pushed onto the supplier?

The moratorium is not all bad news for suppliers. While unpaid invoices prior to the insolvency procedure may be at risk, payment for supplies made to a customer in moratorium are protected. Supplies made during the moratorium must continue to be paid for, and if they are not the moratorium will end. Also, if the customer goes into administration or liquidation during the twelve weeks following the end of the moratorium the payments will have a priority ranking above all other debts (except fixed charges). In practical terms this means that the supplier invoices are likely to be paid although, of course, this is by no means guaranteed in an insolvency scenario. Debts due for supplies made during moratorium are also protected in a CVA, scheme of arrangement or restructuring plan occurring within twelve weeks of the end of the moratorium, as they cannot be compromised in such a process without the supplier’s consent.

The Act does not set out express consequences for a supplier which refuses to comply with the new statutory requirements by stopping supplies to the distressed company. It may be possible for the customer to seek an injunction to compel continued supply. It may also be possible for a customer to bring a breach of contract claim, though it is questionable whether it would have the appetite to do so in the circumstances.

Supplier actions

Suppliers should check their terms of supply. Are the financial distress events triggering the right to termination described sufficiently broadly to capture the new insolvency procedures? Do those events trigger early enough to allow the supplier an option to terminate before the prohibition on termination kicks in? Many contracts will require no change but terms should be amended if necessary.

Otherwise a supplier can mitigate its risk using the same steps that it would usually consider where the customer’s ability to pay might be a risk. Invoicing frequently with short payment terms is an obvious consideration. Whilst not common in standard T&Cs, more complex supply contracts can contain “early warning” provisions by which the supplier has visibility of customer financial issues sooner rather than later and a process is triggered to allow the parties to agree a way forward.

Contact

For more information please contact Mark Dewar, Huw Dolphin or your usual DLA Piper contact.