Can I terminate a supply contract if my client becomes insolvent?

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Can I terminate a supply contract if my client becomes insolvent?

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Amongst the wide ranging measures aimed at assisting business through the Coronavirus Pandemic, new restrictions set to be introduced under the Government’s Corporate Insolvency & Governance Bill 2020 (the “Bill”), will (subject to certain exemptions) prohibit suppliers of goods and services from terminating supply contracts pursuant to an ‘ipso facto clause, should their corporate-client enter into insolvency.

What is an ipso facto clause?

 

An ipso facto clause is a contractual provision providing for the contract to be terminated by one party, upon the other party becoming insolvent or (if there is provision in the supplier’s terms and conditions) suffering a material adverse change in their financial position. There does not need to be any other breach of the contract. The other party’s entry into insolvency alone / financial distress is, ipso facto, the ground for termination.

 

Which Suppliers Are Presently Prohibited from Terminating Supply Contracts upon a client’s Insolvency?

 

In short, energy and utility suppliers as per Section 233(3) of the Insolvency Act 1986 (the “Act”). Section 233 of the Act is concerned with the continuity of essential supplies to companies in an insolvency measure, in the bid to bolster their rescue plan. In addition to being unable to terminate a contract in reliance of an ipso facto provision, Section 233(2) of the Act prohibits ‘essential suppliers’ from imposing further conditions for their continued supply (for example, demanding payment of outstanding charges).

 

How will the Bill affect Ipso Facto clauses?

 

Section 12 of the Bill intends to insert a new Section 233B into the Act, which will extend the prohibitions on energy/utility providers currently in Section 233 of the Act to all suppliers (save those which are expressly exempt).

 

The new Section 233B of the Act will prohibit a supplier from terminating a contract with a company, or from imposing conditions for continued supply by reason only of the company’s insolvency (the “New Prohibitions”).

 

Crucially the wording ‘do any other thing’ is intended to prevent a supplier from terminating a supply contract on account of an event or a breach of contract that occurred prior to a company’s entry into insolvency.

 

Once the company has entered an insolvency measure, the supplier will not be able to terminate the supply contract and it will (save for in certain circumstances detailed below) be compelled to provide an ongoing supply to that insolvent company.

 

Are any suppliers exempt from the New Prohibitions under the Bill?

 

Providers of financial services, inclusive of banks, commercial lenders, factors and providers of financial facilities and financial contracts - will be exempt from the New Prohibitions (as per Schedule 12 in the Bill).

 

Temporary exemption of small businesses

 

Up to 30th June 2020 (or the date being one month after the date the Bill comes into force), small businesses meeting the conditions in Section 13 of the Bill will be exempt from the New Prohibitions. These conditions are, that in the supplier’s most recent financial year up to the point of their corporate-client’s entry into insolvency, that supplier’s:

 

    1. turnover did not exceed £10.2 million;
    2. balance sheet total did not exceed £5.1 million; and
    3. average number of employees employed throughout its previous financial year was not more than 50.

 

Is there any way a Supplier can cease supply / terminate a supply contract once a company has entered Insolvency?

 

Yes. A supplier can terminate their contract with an insolvent company where the Administrator or Liquidator or the company itself consents to the same. Also, a contract may be terminated where the company moves into a new insolvency measure (such as Administration to Liquidation).

 

Moreover, a supplier can apply to Court for permission to cease supply or terminate the supply contract with an insolvent company. The Court will only likely grant permission however, where the supplier can prove to the Court’s satisfaction that their continuing supply to the insolvent company will cause them financial significant hardship. 

 

Practical Considerations

 

The prohibitions on terminating a supply contract in the Bill have the potential to cause significant difficulties to suppliers. Our advice to all suppliers is to keep contracts with corporate clients under constant review and consider withdrawing facilities or terminating the contract (ensuring this is done lawfully), should you suspect them to be in financial distress or nearing insolvency. Suppliers should also look to update their terms & conditions if necessary, to provide for termination based on a material adverse change in their client’s financial position.

 

If you have concerns over the termination of supply agreements, ensuring adequate provisions in your terms & conditions to deal with distressed or insolvent clients and/or on the effects the Corporate Insolvency & Governance Bill 2020 may have on your business generally, please contact Ian LindleyWilliam Angas and Ben Ashworth.

The content of this webpage is for information only and is not intended to be construed as legal advice and should not be treated as a substitute for specific advice. PDT Solicitors LLP accepts no responsibility for the content of any third party website to which this webpage refers.

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