17 August, 2020
It is standard practice in a contract for the supply of goods or services, for the parties to agree a clause that allows the supplier to terminate the contract with immediate effect upon the customer's insolvency. However, the Corporate Insolvency and Governance Act 2020, which came into force on 26 June 2020, introduces wide-ranging reforms to the Insolvency Act 1986 that impact the pre-agreed contractual obligations of supply contracts.
The key reforms which affect supply contracts are:
Going forwards, rather than terminating the contract, suppliers will be obliged to uphold their contractual obligations with insolvent customers, even if their previous invoices have not been paid. Whilst the reforms are likely to be viewed with alarm by suppliers who have previously relied on termination clauses when faced with insolvent customers, the aim of the reforms is to protect companies who may otherwise fall into insolvency with huge debts.
Given the scale of the economic downturn caused by the COVID-19 crisis, the UK Government is keen to take the stigma away from the insolvency process and lead to a more safe and secure rescue culture. The expectation is that by allowing distressed companies to continue to trade, the likelihood of selling the business as a going concern will increase.
When entering into new contracts, a supplier that wants to protect its position in case of a customer's insolvency should carefully consider clauses such as the contracts term, volume and payment structure. Particular attention should also be given to the termination provisions, including whether to allow termination when the customer shows the first clear signs of financial distress.
Given that the reforms have retrospective effect, suppliers should also review their existing contractual arrangements with customers that are, or may become, in financial distress. As the UK plunges into an unpredictable recession, it may be prudent to terminate contracts if future insolvency appears likely. Even where suppliers do not wish to terminate immediately, they may need to take steps to prevent termination rights being lost, such as sending a reservation of rights letter and/or making it clear that ongoing supply should not be taken as acceptance of the customer's default.
Despite the somewhat draconian reforms, there are limited termination options open to suppliers such as seeking consent from the insolvent party, or an application to the court to show that continuing the contract would cause hardship. There is also a temporary exemption until 30 September 2020 for suppliers who meet the statutory definition of "small entities".
For advice on, and assistance with understanding the changes to the UK insolvency regime and how they may impact your business and suppliers, or reviewing and updating your contracts to ensure their suitability, contact John Pickervance, Head of our Commercial department via email or phone on 0333 207 1134. Alternatively send any question through to Forbes Solicitors via our online Contact Form.