Insolvent customer? Supplier beware!

Insolvent customer? Supplier beware!

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Suppliers can no longer terminate contracts, refuse to supply goods or services or amend payment terms with an insolvent customer due to its insolvency, save in limited circumstances. The new rules - brought in by the Corporate Insolvency and Governance Act 2020 (“CIGA”) - governing protection of supplies significantly restrict parties’ autonomy in relation to customer insolvency and will be a cause of concern for many suppliers.

New protection of supplies to insolvent companies

As we reported previously, CIGA severely limits the ability of suppliers to terminate contracts or amend terms of supply - including (for example) requiring amended payment terms - in the event of a customer’s insolvency, subject to a small number of exclusions. Section 14 of CIGA inserts new section 233B into the Insolvency Act 1986 (“IA86”) for the protection of supplies of goods and services to companies which are in an insolvency process (including those with the benefit of an insolvency moratorium, in administration, liquidation or subject to a company voluntary arrangement (“CVA”), or new Part 26A Companies Act 2006 restructuring arrangement).

The new protection applies where a company enters into a relevant insolvency process (as above). It imposes a general prohibition on the unilateral termination of the contract or supply or “any other thing” as a result of the company becoming subject to a relevant insolvency procedure. Further, suppliers cannot make it a condition of their continued supply that any arrears on outstanding charges are met. In relation to customers subject to a moratorium at least, suppliers may take some comfort from the fact that the monitor must conclude that the company can be rescued and pay its debts in order for the moratorium to continue. If the customer were to be wound up within 12 weeks following the end of a moratorium, any debts arising from the supply of goods or services during the moratorium would benefit from priority status under further amendments to IA86 (new section 174A).

Exclusions

Limited exclusions apply to the general prohibition in section 233B IA86, including termination:

  • By consent (of the company or the insolvency officeholder)
  • With court permission (where the court is satisfied that the continuation of the contract would cause the supplier hardship)
  • 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 COVID-19

Section 233B will not apply to certain financial institutions - whether as customer or as supplier - such as insurers, banks, 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.

Existing protection for ‘essential supplies’

The new prohibition in section 233B applies in addition to the existing protection of ‘essential supplies’ in section 233A IA86, which covers supplies of basic utilities and communication services to companies in administration or subject to a CVA. Unlike under section 233A, the new rules apply to a much wider range of insolvency procedure and do not include an ability for suppliers to require insolvency officeholders to personally guarantee the payment of any future supply. Section 233B therefore significantly extends the protection of supplies to insolvent entities, arguably to the detriment of suppliers who may have high levels of outstanding charges and will receive no guarantee of payment for ongoing supplies.

Implications for suppliers

It remains to be seen how the market will adapt to the new protections and how contracts for supply will be negotiated in future. There is limited relief for suppliers to customers with the benefit of a moratorium, who will be granted super-priority status in the event of a subsequent liquidation as set out above, and the changes are also subject to a number of exclusions. While suppliers will be wary of extending credit due to the risk of insolvency, it is unlikely to be commercially acceptable to require advance payment in many cases. In practice, suppliers to insolvent companies may be forced to apply to court for permission to terminate supply or, more likely, may end up offering a substandard service to insolvent entities to seek to force a termination. While the US market has adapted in light of similar restrictions on contract variation/termination in Chapter 11 proceedings, we wait to see how these new provisions will play out in supply contracts here in the UK.

Contact our experts for further advice

View profile for David SteinbergDavid Steinberg, View profile for Lucy TrottLucy Trott

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