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Throughout June our Restructuring and Insolvency Team are looking at the potential impact of the Corporate Insolvency and Governance Bill.  This article kicks off examination of the provisions that have been tabled in respect of termination clauses in supply contracts. Update: Since the Bill became law on 26 June 2020 the exclusion for small suppliers has been extended to 30 September 2020

We will be issuing further guidance in due course on the practical issues these provisions entail specifically for suppliers, for companies/directors, and for insolvency practitioners.

It is common place in supply contracts that the termination provisions include a clause terminating the contract upon insolvency of the customer. The clause either triggers automatically or allows the supplier to choose to terminate.  Suppliers may insist on this type of clause in their contracts, often via standard terms and conditions, to limit the supplier’s exposure to ongoing obligations where there is serious risk of non-payment.

The Bill

The Bill seeks to introduce legislation that will prevent suppliers from terminating contracts as a result of a customer entering into a relevant insolvency procedure.

Relevant insolvency procedures are defined in the Bill as being any of the following:- moratorium (which will be the subject of our next article), administration, appointment of an administrative receiver, approved voluntary arrangements, liquidation or the appointment of a provisional liquidator and where there are orders granted under section 901C(1) of the Companies Act 2006 (which is an amendment proposed by this Bill in relation to the calling of a meeting of the creditors).

If the insolvency trigger is no longer available to them suppliers may look to the contract to see if there are any other grounds for termination unconnected to the insolvency. However, to stifle this the Bill prohibits a supplier from relying on events that occurred prior to the insolvency procedure as a ground of termination.

The Bill goes further still and states that a supplier cannot terminate the contract, or do any other thing, because of the insolvency. This would include measures such as changing the contract payment terms.  Separately, where a company is in a relevant insolvency procedure the Bill says that a supplier cannot make it a condition of continued supply that any outstanding charges are brought up to date.

These measures may seem particularly burdensome for the supplier but the intention is to provide a greater opportunity for rescue of the company. It could prove to be particularly helpful for companies considering a restructure either during a moratorium period or when proposing a voluntary arrangement. 

Termination with Consent

If the company is in either administration, liquidation or has an administrative receiver or provisional liquidator appointed, the contract can be terminated with the permission of the insolvency office holder. In all other relevant insolvency procedures the company must consent to the termination of the contract, there can’t be a unilateral measure taken by the supplier. 

Termination by the Court

If consent is not received then a supplier can apply to the court for an order terminating the contract. The court will only grant such an order if it is satisfied that continuation of the contract would cause hardship to the supplier. 

We anticipate that to receive such an order suppliers will most likely need to lodge a Summary Application with the Sheriff Court. Until now, due to the lockdown, Sheriff Courts have only been dealing with a limited number of matters but there is an expectation that they will begin to process a greater volume of work in the coming weeks.  Given that the test applicable is one of “hardship” we would hope that courts will classify these applications as urgent and fix hearings accordingly.

There is no definition within the Bill as to what might constitute ‘hardship’ so it is difficult to anticipate what the court will require to satisfy the test. The Government guidance provides only one example: hardship might mean that the inability to terminate the contract would threaten the solvency of the supplier.  If the court were to follow suit then this would set a high bar to termination of a contract.  In practice, we anticipate that the court will inevitably consider things such as the proportion of the supplier’s business that comes from the customer, the payment terms of the contract and relative level of financial exposure continual supply exposes the supplier to, the impact the risk of non-payment presents to the cash flow of the company and no doubt other factors.  A supplier contemplating termination of an insolvent customer contract via the court should collate as much information as possible demonstrating how the continuance of the contract will have a detrimental impact on the supplier’s business, including forward projections, management accounts and statements of arrears. Confidentiality of the court proceedings will clearly be of importance from that perspective so as not to generate wider problems for the supplier. It remains to be seen how the court will deal with that on a practical level.

Temporary Exclusion for Small Suppliers

The Bill has potentially far reaching and long lasting consequences for commercial contracts and as a protective concession to small suppliers the Bill proposes a temporary exclusion to them.

If during the relevant period a company becomes subject to a relevant insolvency procedure and the supplier is a small entity the legislation proposed by the Bill will not immediately have effect.

The relevant period is defined as beginning on the date that the exclusion comes into force 26 June 2020 and ends on 30 September 2020.

After this period the exclusion will cease to have effect and even small suppliers will be impacted by the amendment.

To benefit from the exclusion a supplier, not in its first financial year, must satisfy 2 out of 3 of the following criteria:-

1. The supplier’s turnover was not more than £10.2 million

2. The supplier’s balance sheet total was not more than £5.1 million

3. The number of the supplier’s employees was not more than 50

Companies in their first financial year will require to satisfy proportional criteria depending on the number of months they have been operational. 

The importance of the temporary exclusion is that it provides small suppliers with a bigger window to consider the future of certain supply contracts. 

Exceptions 

With any rule there are always exceptions and the Bill is no different. The provisions introduced by the Bill will not apply to certain types of business such as those providing financial services and those already protected by the current insolvency legislation.  In essence a lender will not be forced to continue supplying finance to a company that is subject to a relevant insolvency procedure.  

Summary- How Will this Affect You?

As the Bill works its way through Parliament over the coming weeks we intend to issue further articles detailing our analysis on the impact of the legislation on insolvency practitioners, suppliers and companies.  However, some initial thoughts:-

Insolvency Practitioners

The provisions in respect of continuity of supply compliment the introduction of the moratorium. We expect that these provisions will be important when looking at saving the company rather than the business of the company.  There may also be value in situations where an Administrator is to remain in office for a prolonged period while seeking out a potential purchaser rather than a pre-pack sale to a third party. However, where the business of the insolvent company is to be sold these measures may be of limited benefit as they do not appear to go as far as forcing the supplier to novate their agreements to the new entity.

Suppliers

Suppliers need to act quickly to review their current supply contracts and outstanding accounts before the Bill is enacted. Contract amendments may be advisable. We anticipate that the Bill will become law at the end of June/start of July. For suppliers that qualify for the temporary exclusion they will have a little bit longer to review the position, but remember it is only until end of June 2020 or one month after the Bill comes into force, whichever is the later.

If upon review suppliers are concerned about any of their accounts they should consider if they have grounds to terminate the contract now or if they have any leverage to bring overdue accounts up to date.  

Companies in Financial Difficulty

Covid-19 has created challenging circumstances throughout the supply chain and many companies will now be looking at the viability of their business going forward.  As part of this analysis directors need to be mindful of the provisions that the Bill seeks to enact and think carefully about which insolvency procedure may be right for them. There are more options available than ever before and directors should seek advice from a licensed insolvency practitioner to review the best option for them.

We are at hand to work with and support parties dealing with any issues arising in connection with corporate insolvency. Follow/subscribe to Stronachs on social media to be kept up to date with our upcoming analysis of the Bill throughout June.

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