The Restructuring and Insolvency Reforms: What You Need to Know - Termination Clauses in Supply Contracts

The Corporate Insolvency and Governance Bill 2019 (the "Bill") is designed to enshrine in law the measures that the Government has introduced to protect business from the effects of the COVID-19 pandemic.

What do I need to know?

The key takeaway for companies in relation to termination clauses in supply contracts is that suppliers will be unable to terminate or vary contracts for the supply of goods and services, when a company enters an insolvency or restructuring procedure, or when a moratorium is in place.

It should be noted that until the Bill is passed, amendments are possible which could affect the provisions set out below.

What was the position before? 

When a company entered a formal insolvency process, certain suppliers had to continue to provide services to the company if so requested by the insolvency office holder (on the basis the company continued to pay for them). These services were gas, electricity, water, communication services and IT suppliers.

This was designed to ensure that insolvency officer holders (e.g. the liquidator, administrator, trustee in bankruptcy) had access to the relevant supplies needed during the insolvency process. Services were to be provided even if the company had outstanding debts with the suppliers, incurred before the point of formal insolvency. 

However, in many cases suppliers which were vital to the operation of a company did not fall within the narrow definition of 'key suppliers'. These suppliers could therefore hold a company to ransom by refusing to provide any further goods or services until their outstanding bills were paid, or by increasing the price of the supply.

To ensure the ongoing viability of the company, insolvency officer holders were often forced to pay such 'ransom' suppliers' bills or higher rates, to the detriment of the other creditors.

What changes will the Bill implement? 

The Bill states that:

• Where a company enters an insolvency or restructuring procedure, or when a moratorium is in place, a supplier will be unable to rely on contractual terms to either vary the terms of a contract or terminate it.
• A company must pay for all supplies provided during the insolvency process but are not required to pay amounts outstanding at the point of insolvency: these debts will be considered during the insolvency process.

The Bill gives the Secretary of State for Business, Energy and Industrial Strategy the power to make regulations to amend these provisions at a later date.

Are there any exceptions?

Yes:

1. If continuing to supply the company would cause a supplier hardship, they can apply to court for permission to terminate the contract. The court would balance the hardship on the supplier against the effect on the company's creditors and the prospect of rescuing the company.
2. Small suppliers are excluded from these new provisions: to qualify as a small entity a company must satisfy at least two of the following conditions in its most recent financial year:
   • turnover was not more than £10.2 million
   • the balance sheet total was not more than £5.1 million
   • the number of the supplier’s employees was not more than 50
3. The provisions do not apply to some financial services such as insurers, banks, electronic money institutions, investment banks and investment firms, payment institutions and operators of payment systems.

What if the company is unable to pay for supplies whilst a moratorium is in place? 

If a supplier provides good or services to a company whilst a moratorium is in place, that supplier will have super priority – in other words their bills will be paid first, when the company enters a formal insolvency process.

What is the likely effect of this change?

 The Covid-19 pandemic has already forced many companies into insolvency procedures and it is inevitable there will be many more. The Bill's new provisions on termination clauses in supply contracts will increase the likelihood that a company will be rescued or sold as going concern, by ensuring a company has all the supplies that it needs to operate.