Recent changes to insolvency legislation means that many suppliers may be required to continue providing goods and services to customers who become insolvent.
Sections 233 and 233A of the Insolvency Act 1986) already prevent contracts for essential goods and services such as gas, electricity and water from being terminated because the customer goes into an insolvency process. However, the recent Corporate Insolvency and Governance Act 2020 inserts a new provision (section 233B) that now applies to all contracts for the supply of goods and services (with a few exemptions as outlined below).
Given the challenges that all businesses are facing for the foreseeable future at least, suppliers will need to be particularly mindful of what these changes might mean to their business.
The purpose of this legislation is to avoid the termination or unfavourable variation of supply contracts which could jeopardise attempts to rescue an insolvent company. It applies to all contracts, regardless of when they were entered into and to any insolvency event that occurs after 26 June 2020.
How is an insolvency event defined?
An insolvency event is defined in a new schedule 4ZZA to the Insolvency Act 1986 as when:
- A moratorium under Part A1 comes into force for the company;
- The company enters into administration;
- An administrative receiver of the company is appointed (otherwise than in succession to another administrative receiver);
- A Company Voluntary Arrangement (CVA) takes effect in relation to the company;
- The company goes into liquidation;
- A provisional liquidator of the company is appointed (otherwise than in succession to another provisional liquidator); or,
- A court order is made under section 901C(1) of the Companies Act 2006 in relation to the company (order summoning meeting relating to compromise or arrangement).
How does the new section work?
No termination for insolvency
A contract for the supply of goods or services will not terminate (whether automatically or by the supplier’s election) in the event of the customer becoming subject to an insolvency event. Any clauses which attempt to do this will be of no effect.
No variation on insolvency
As with termination, any provision which permits the supplier to do “any other thing” in the event of the customer’s insolvency is now inoperable. “Any other thing” is a very broad concept and is likely for example to cover any contract terms that change payment terms, tariffs, credit terms or require balloon payments which are triggered by an insolvency event. This list is not exhaustive.
No termination for any prior breach
The supplier will lose the right to terminate for any breach of contract that has occurred prior to the insolvency event unless that right is exercised prior to the insolvency event.
No withholding services
The supplier is not entitled to make future supply conditional on the payment of outstanding invoices.
Termination or variation with consent
A contract can be terminated or varied by:
- Consent of the customer;
- Consent of the relevant insolvency practitioner; or,
- By application to the court that the continuation of the contract would cause “hardship” to the supplier.
Unfortunately the term “hardship” is not defined in the legislation so it will fall to Courts to determine what that might be.
Suppliers will need to seek legal advice in the event they find themselves faced with concerns over being compelled to continue to supply an insolvent customer.
Who is exempt?
The new legislation provides for a number of exemptions.
Temporary exemption for small entities
There is a temporary exemption until 30 September 2020 which applies to suppliers that are considered small entities. A small entity is defined in the legislation which can be viewed here. If you are unsure whether you qualify, you should speak to your professional advisors.
There are a range of exemptions for those in the financial services sector and in respect of financial services contracts.
If the contract for supply is already subject to the existing sections 233 and 233A then the new section does not apply.
Is there anything we can do to reduce the risk?
There are steps that suppliers can and should take to try and mitigate the risks that the new legislation creates, particularly in light of the uncertain times we are in.
- Review all existing customer contracts and standard terms and conditions with a view to amending or renegotiating where appropriate;
- Review all current customers to identify any that are potentially at risk;
- Review current internal processes and procedures related to monitoring customer contracts and limiting risks; and,
- Monitor customers closely for signs of distress.
The small entity exemption provides a brief window of opportunity within which qualifying suppliers can review and update terms and customer contracts in preparation for when the new provisions start applying to them. Regardless, suppliers should undertake these reviews and seek advice as soon as possible.