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Termination for insolvency: The clock is ticking

The government has published the Corporate Insolvency and Governance Bill which, if passed, will significantly restrict suppliers’ ability to exit commercial agreements due to restructuring or insolvency-related causes.

That the current pandemic has thrown a curveball at many businesses is a given.

At the end of February, the Bank of Scotland Business Barometer reported that overall business confidence in the UK was at a net balance of 23%. Only two months later and confidence plunged to minus 29%.

This shouldn’t come as any surprise. The lockdown has but a brake on the economy and left millions of businesses reeling. Many among them are grappling with cash-flow difficulties and, sadly, are facing insolvency.

An initial reaction for many businesses has been to dig out their relevant contracts to see if they can offer a ready-made solution. Many of these contracts contain clauses in them which state, in one way or another, that they can terminate the agreement if an insolvency-related event happens, or even, in some cases, if it is threatened. These types of clauses—sometimes called ipso facto clauses—are typically added by legal advisors because, in the absence of an express contractual right to terminate for insolvency-related events, a party has no common law right to do so.

On 20 May, the government introduced the Corporate Insolvency and Governance Bill into the House of Commons. This draft law, to be rushed through Parliament, is an attempt to help businesses get the breathing space they need to continue trading. But it also proposes to suspend the operation of many termination clauses.

This will have a major impact on how termination provisions operate in the future.

Corporate Insolvency and Governance Bill

The aim of the Bill is to maximise the chances of businesses surviving the pandemic.

So the Bill has introduced draft rules that mean:

  • typically suppliers won’t be able to rely on any termination provisions in their contracts if a business has entered into an insolvency event;
  • where an insolvency event has occurred that would have allowed a supplier to terminate their contract before the business entered that event, but that right has not been exercised, it is suspended once the business enters the insolvency procedure;
  • if the supplier’s right to terminate arises after an insolvency event begins (for example, for non-payment for goods supplied after that time) then this right to terminate won’t be prohibited.

However, there are exemptions. The supplier may terminate their contract:

  • where an officeholder or the business in question (as applicable) consents to the contract being terminated; or
  • with the permission of the court, where the court is satisfied that the continuation of the contract would cause the supplier hardship.

Suppliers will also be prohibited from making payment of outstanding charges a condition of any continued supply.

While many of the provisions in the Corporate Insolvency and Governance Bill are stated to be temporary to deal with the COVID-19 crisis, the above measures will be permanent. (Although on a temporary basis the measure will not apply to suppliers that are ‘small entities’.)

Contractual termination provisions are not invalid in relation to contracts for the supply of goods or services to a business in the context of financial services.

What does this mean?

Put simply, this will be an additional burden for suppliers, but a gain for creditors:

  • for suppliers, this may mean an increase in ongoing insurance costs (check with your broker) and possible legal costs in applying to a court to be exempt using the hardship exemption
  • for creditors, they will need to be aware of these provisions and how they operate. In particular, they should be mindful of the fact that, even though contracts may have an express right to terminate in them when the Corporate Insolvency and Governance Bill becomes law, such provisions may cease to have effect against the supplier

In due course, some businesses may also want to amend their contracts so that the Corporate Insolvency and Governance Bill is not overlooked by mistake. This may not be strictly necessary as a matter of law, but may make sense if your contracts are used by (non-legally trained) stakeholders across your business to manage expectations and the contractual relationship generally.

The government’s best estimate of the cost to suppliers, one of the main affected groups, is that it will cost them £292.9 million over ten years, although it is unclear how much of this figure relates to the cost of, for example, suppliers going to court to bring a hardship claim against any creditors. Indeed, in the absence of any guidance on what supplier hardship is, and thus where the line should be drawn, it is unclear at this stage how much this exemption will be relied upon in practice. After all, litigation can be time-consuming and, for smaller suppliers in particular, not cost-effective. Many suppliers might choose instead to concentrate at looking to insure against these risks.

Guidance on responsible contractual behaviour

There is now non-statutory guidance in this area too.

On 7 May, the government issued, with little fanfare, non-binding guidance on responsible contractual behaviour.

The general approach that the government wishes to see is that businesses should concentrate on the long term and, it states, to ‘act responsibly and fairly in the national interest in performing and enforcing their contracts, to support the response to COVID-19 and to protect jobs and the economy.’ Or, in other words, bad behaviour will be bad for jobs and will impair our economic recovery.

In essence, the government’s view is, if you can, hold off relying on these types of clauses. Don’t terminate unless you have no alternative. Just because you can do something, doesn’t mean that you should.

Most notably, however, the guidance makes it clear that it doesn’t override ‘any specific support or relief available’ in any relevant contracts, such as any termination provisions.

In effect, this non-binding, please-play-nicely guidance is just that: non-binding. Businesses are not obliged to follow it and, frankly, it remains to be seen to what extent, if at all, they will embrace it, despite its worthy intentions. From a legal point of view, failure to comply with it may have no to few legal consequences.

In due course, the courts may look at this guidance when determining if a party has been reasonable in a contractual dispute or, indeed, they may decide not to pay any heed to it at all. At the moment, the legal risks of not following it seem very low.

What happens next?

The Bill is due to be fast-tracked through Parliament, although there is no indication when this is likely to become law. Parliamentary scrutiny over this Bill is likely to be somewhat lacking and things might not get picked up by legislators that ought to be picked up if there were more time. There may well be some unexpected surprises down the line in how this law works.

In the meantime, businesses may wish to review their position in supply chain eco-systems as their ability to utilise contractual protections they currently rely upon may soon be severely restricted.

Disclaimer

This information is for educational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.

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