A new law recently came into force that has major implications for suppliers and what they can include in their contracts to protect themselves. Suppliers need to review and update their existing and new contracts as a result.
What Does the New Law Do?
The Corporate Insolvency and Governance Act 2020 inserts a new Section 233B into the Insolvency Act 1986 that restricts the remedies available to the supplier where the customer is suffering from a wide variety of insolvency processes. In summary:
- The supplier can no longer terminate the contract where the trigger is that insolvency event. The supplier has to continue to supply, even to a customer who is undergoing the insolvency process, and even if the contract provides for a right to terminate in that situation. Likewise, any automatic termination triggered by the insolvency event is void.
- The supplier is also prohibited from doing "any other thing" by virtue of the insolvency event, such as increasing the contract's pricing, changing credit periods, or adding a one-off or balloon payment.
- Even if the supplier had a right to terminate or supply which had arisen prior to the insolvency process taking place, the supplier loses that right once the insolvency event starts if it was not exercised before the commencement of the insolvency process. For example, if the contract gives the supplier a right to terminate for late payment and the customer is late in paying, that right is lost for a "past" event once the insolvency process started. However, the supplier would be able to terminate if exercising any available contractual termination rights before the insolvency process starts.
- A supplier must not make it a condition of continuing to supply that any outstanding payments are paid, nor do something that has the same effect. Therefore, the supplier must continue to supply, regardless of any amounts that may be owing.
- The wording of the Act is not 100% clear on this point, but it is likely that the supplier can still exercise rights to terminate for convenience if the contract provides for this, and the common law rights to terminate for repudiatory breach should also still continue.
The new law does not prevent the supplier from terminating a contract in the period leading up to an insolvency process (for example if an insolvency practitioner is about to be appointed and there is a contractual right to terminate available at that stage), nor from exercising a right arising after the insolvency process started if not triggered by that process.
The law came into force in a rush due to the current coronavirus (COVID-19) pandemic but has retrospective effect. It generally applies to all existing contracts, but there are a few limited exceptions. However, the inability to terminate due to insolvency is not restricted to situations where coronavirus has impacted on the customer or client's financial health - it applies much wider than that.
So What Can a Supplier Do to Protect Itself in the Contract?
The supplier should review all its customer contracts carefully and consider changing the following in its existing contracts and including the following in its new ones:
- Reduce the contract term or have a series of shorter contracts to reduce the potential exposure, or reduce the contract volume. However, this would be unpalatable when trying to tie the customer into a long-term deal and may not always be practical.
- Have less credit risk and tighter payment terms. This would help with the supplier's cash flow and also give an early warning sign of a customer experiencing financial problems. The supplier could consider: higher sums in advance; having more payments by instalments rather than afterwards; reducing the credit period; giving the supplier rights for late payment (such as suspension) earlier than it would have previously agreed to; and requiring third party guarantees.
- Ensure that the supplier has retention of title provisions for the supply of goods. This was always important, but even more so now. The remedies under these provisions have sometimes been triggered on the customer's insolvency only; these should now be drafted to be capable of being exercised pre-insolvency.
- Impose financial information reporting obligations on the customer to keep a check on whether the customer is about to go into an insolvency process - to act before it is too late. This could form part of governance clauses, which could require the customer to attend periodic meetings and provide information and discuss its financial matters at them. The supplier should have the right to terminate according to issues showing in the financial indicators being reported, or if the information is not provided.
- Insert a clause allowing for termination for convenience with as short a notice period as makes commercial sense.
- Have a clause allowing for termination for non-payment, with any cure periods being limited in time.
What Other Practical Steps Can a Supplier Take?
The supplier could also take the following practical steps:
- Conduct deeper due diligence on the customer's financial position before entering into the contract.
- Train its staff on the impact of this new law and to watch out for warning signs and the need to act quickly if an insolvency process could be imminent.
- Be familiar with the provisions in its customer contracts and have a plan for how to act quickly if necessary.
- Observe even more carefully the payment performance and financial position of its customer to have earlier warning of possible difficulties.
- Tighten its debt collection procedures.
- React quickly when necessary to avoid losing its right if an insolvency process starts.
These are massive changes to the risk profile of suppliers, at a time when risks are increasing of customers facing financial difficulties.
If you would like help with updating your commercial contracts with customers in light of this new law, please contact Paul Gershlick in our Commercial team on 07795 570 072, or complete the form below.