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Insolvency and terminating supply contracts. Supplier beware!

In the current economic client, there is an increased risk of customers becoming insolvent and being unable to pay for supplies delivered. There is no automatic right under the law enabling suppliers (or customers) to terminate a contract if customers (or suppliers) become insolvent or enter into financial difficulty. In addition, insolvency does not usually excuse either the supplier or the customer from performing their contractual obligations. For this reason, commercial supply contracts typically allow suppliers to terminate if customers becoming subject to one or more insolvency related events such the appointment of administrators, liquidators or proposing a moratorium on debts.

However, new rules brought in by the passing of the Corporate Insolvency Act 2020 (‘CIGA’) mean that as of 26 June 2020 suppliers can no longer terminate contracts, refuse to supply goods and/or services or amend payment terms with a customer who experiences one of these insolvency related events except in limited circumstances. In effect these new rules apply whatever the parties have agreed in relation to customer insolvency, and as a supplier you should take note both in relation to your existing and future supply contracts.

In this article, we outline the new rules in relation to termination restrictions and provide some practical steps which you can take as a supplier in light of these changes.

Outline

CIGA amends the Insolvency Act 1986 (‘the amended IA’) This amendment serves to protect the supply of goods and/or services to customers which become subject to a ‘relevant insolvency process’. These include:

  • companies with the benefit of an insolvency moratorium;
  • companies in administration;
  • companies in liquidation; and
  • companies which are subject to a company voluntary arrangement or Part 26A Companies Act 2006 restructuring procedure

When a customer becomes subject to a relevant insolvency process, the amended IA prevents the supplier from ceasing to supply goods and/or services to the customer simply because the customer has become subject to that relevant insolvency process. The amended IA does this by invalidating the wording in the contract which enables the supplier to terminate if the customer becomes subject to that relevant insolvency process.

In addition, suppliers cannot make it a condition of their continued supply under the contract that any arrears on outstanding charges are met.

There is some relief for suppliers under the amended IA where the customer is subject to a moratorium. In such cases the moratorium’s monitor must conclude that the customer can be rescued and pay its debts in order for the moratorium to continue. If it is concluded the customer will be wound up within 12 weeks following the moratorium’s end, any customer debts arising from supply of goods and/or services benefit from priority status.

There are limited exclusions under the new rules, including termination:

  • by consent (of the customer or the insolvency officeholder);
  • with court permission (where the court is satisfied that the continuation of the supply contract would cause the supplier hardship); or
  • by ‘small suppliers’ during the period 25 June to 30 September 2020. This is a temporary measure designed to assist small businesses suffering from the effects of the ongoing Coronavirus pandemic.

In addition, the new changes will not apply to certain financial institutions, whether as a supplier or customer, such as insurers, banks and electronic investment exchanges. Financial contracts (such as contracts for lending, financial leasing or providing guarantees), contracts for securities, commodities, futures/forwards, swaps, and inter-bank borrowing of three months or less are also excluded.

Practical steps

Due diligence

It may be self-evident, but the best advice is to do proper due diligence of customers and to make sure your due diligence is operated properly by all customer facing parts of your organisation. This includes reviewing the financial performance and trading history of the customer in order to give an indication of potential insolvency. However, a customer’s historical financial performance and trading history must be considered in light of the increased risk to the vast majority of businesses owing to the ongoing Coronavirus pandemic.

Payment terms

Review contractual provisions in relation to payments, deposits and invoicing. Payment in advance is the most favourable to a supplier. Payment by reference to milestones or staged payment dates can be useful, particularly in larger, project-based supply contracts. Such payment provisions may not always be practicable but depending on the facts as a supplier you could adopt this as your initial position in negotiation.

Retention of title clauses

Try to ensure retention of title clauses are drafted so that title (ownership) in goods supplied only passes to the customer when all amounts owed in respect of any such supply are paid in full. Such a retention of title clause may not always be practicable but again depending on the facts as a supplier you could adopt this as your initial position in negotiation.

Personal Guarantees

As a supplier you could ask for a personal guarantee of all amounts owed by the customer under the supply contract from for instance a customer’s director. However, personal guarantees can be difficult to set up and enforce, and they are usually best deployed as a lever to get payment from the customer and under the amended IA their use as a lever will be weaker as the customer will have the right to carry on demanding to be supplied. 

Other Guarantees and Escrow

A better option may be a bank guarantee for instance a letter of credit. These are widely used in international trade but may now have an addition attractiveness for larger domestic transactions.  Alternatively, a parent company guarantee can be a good alternative; unlike some jurisdictions in English law a parent company does automatically guarantee the debts of its subsidiary. 

For those not wishing to pay the time and cost of setting up letters of credit an emerging option is escrow.  Under these arrangements payment(s) (these arrangements are useful where there is a consortium of customers) is/are placed with an escrow agent and released on delivery of the goods ordered.  

Security

Taking security over assets is a theoretical possibility but at least until now the simpler and cheaper commercial solutions such as upfront payment and retention of title have been favoured. 

Round up

It remains to be seen how the market will adapt to the new protections afforded by the amended IA and how supply contracts will be negotiated in the future. Suppliers are likely to become more wary of extending credit as a consequence of the new legislation and we can therefore expect to see a tightening of credit policies.

In practice, suppliers are going to be loath to seek the court’s permission to terminate with the inherent risk and expense that will involve and may instead under perform its contractual obligations in order to try and force the customer to terminate.

Our Corporate and Commercial law teams in Bristol and London specialise in advising SMEs and large businesses. If you have any questions about this article and/or you are for legal guidance in relation to supply contracts, please call 0117 906 9400 or email enquiries@gregglatchams.com 

The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.

Categories: Business Support | Commercial | Corporate

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