An overview of the essential supplier regime: Key issues for insolvency practitioners

Insolvency practitioners will be well accustomed to the difficulties of dealing with a company’s suppliers post-insolvency, but what if the supplies are critical to the turnaround or pre-pack sale of the company’s business? What powers do office-holders have to ensure continuity of supply and avoid being held to ransom by suppliers seeking to leverage their position?

The essential supplier regime under sections 233 and 233A of the Insolvency Act 1986 (“IA”) aims to address that power imbalance. Under these provisions, office-holders (administrators, liquidators, administrative receivers and supervisors of voluntary arrangements) have the power to:

• limit the terms that essential suppliers can impose (directly or indirectly) as a condition for the continued supply of their service (section 233 IA); and
• compel continued supply by restricting the effect of existing insolvency-related terms in an essential supply contract (section 233A IA).

Whether an insolvency office-holder is entitled to exercise these powers will depend on (among other things) (i) whether the supply falls within the scope of ‘essential supplies’ under section 233 IA; and (ii) the date the essential supply contract was entered into by the parties.

Type of supply

‘Essential supplies’ are listed in section 233(3) IA and, after the amendments made by The Insolvency (Protection of Essential Supplies) Order 2015 (the “Order”), broadly cover the supply of:

• Electricity
• Gas
• Water
• Communications services
• Information Technology

The changes implemented by the Order widened the scope of utilities undertakings that are subject to section 233 IA to cover, in particular, “on-sellers” of utilities who are an intermediary between the supplier of gas, electricity etc. and the insolvent business (which would include, for example, a landlord supplying utilities to a tenant), and supplies for the purpose of enabling or facilitating anything to be done by electronic means (i.e. “information technology supplies”). This includes suppliers of:

• point of sale terminals;
• computer hardware and software;
• information, advice and technical assistance in connection with the use of information technology;
• data storage and processing; and
• website hosting.

Although not expressly referred to in section 233 IA, services for internet access, broadband or email will likely be caught as IT-related supplies (and, in any event, would fall within the supply of ‘communication services’ under section 233(3)(e) IA).

The key point of section 233 IA is that the office-holder may request the continuation of the essential supply and the supplier cannot insist on the payment of any ‘pre-appointment’ charges outstanding as a condition to continuation. However, the supplier may make it a condition that the office-holder personally guarantee the payment of any charges in respect of any period post-appointment (section 233(2) IA).

The government has confirmed in its guidance that it is likely that charges incurred under a contract continued at the discretion of the administrator will constitute administration expenses.

Termination rights and ransom payments

Importantly, there is nothing in section 233 IA to prevent suppliers from:

• exercising valid contractual termination rights which have, for example, been triggered by the appointment of an administrator or liquidator, or following non-payment; or
• holding the insolvent company to ransom (for example, by exercising a contractual right to switch tariffs, raise prices or change payment terms).

Section 233A IA was therefore introduced by the Order to bolster the protection for businesses by preventing suppliers of essential goods or services from relying on their ‘insolvency-related terms’ to charge higher prices or terminate the contract, or indeed do any other thing, just because a business enters into administration or a voluntary arrangement. This means that suppliers will be under a continuing contractual obligation to supply the essential goods or services to the business during the insolvency at the pre-insolvency rates.

Critically, section 233A IA only applies where the supply contract was entered into on or after 1 October 2015.

Restriction of termination rights

Suppliers are prevented from relying on their insolvency-related contractual terms to terminate the contract / supply because a business enters into administration or a voluntary arrangement (section 233A(8) IA), unless:

• (in the case of a contract): the insolvency office-holder consents to the termination of the contract, or any charges in respect of the supply that are incurred after the company entered administration (or the CVA) took effect are not paid within 28 days of their due date.

The supplier also has the option of applying to court on the ground that continuing to supply is causing them 'hardship'. As part of its assessment, the Court will balance the interests of the supplier against those of the general body of unsecured creditors of the insolvent company and, in the case of an administration, consider what impact the termination would have on achieving the statutory objective (section 233A(4) IA).

• (in the case of supply):  the supplier gives written notice to the insolvency office-holder that the supply will be terminated unless the office-holder personally guarantees the payment of any charges in respect of the continuation of the supply, and the insolvency office-holder fails to give that guarantee within 14 days (section 233A(5) IA).

Ransom payments

Section 233A IA also prevents the supplier from doing ‘any other thing’, such as raising prices or changing payment terms, where those rights are triggered by the entry into administration or the taking effect of a CVA.

It is important to note that the protection for insolvent businesses under section 233 and 233A IA is not absolute:

• A supplier may continue to rely on the insolvency-related terms insofar as they relate to other insolvency procedures other than administration or a CVA, e.g. liquidation.
• Whilst insolvency-related terms will cease to have effect where a business enters administration or a voluntary arrangement, the supplier is not prohibited from relying on other (non-insolvency-related) contractual terms for the purpose of terminating an essential supply contract.
• Insolvency-related terms do not include events which are indirect consequences of the company entering into administration or a voluntary arrangement, such as a downgraded credit rating. Suppliers can continue to rely on these events to trigger other non-termination rights (including, for example the right to change payment terms).

Key considerations for office-holders

Here are some key points that IPs should be thinking about, particularly when conducting their pre-appointment contractual due-diligence:

1. Check the date of the supply contract - were the services or goods contracted for under a pre- 1 October 2015 master or framework agreement but provided on terms set out in a post- 1 October 2015 schedule? Have material amendments been made to a pre-1 October 2015 agreement after that date (e.g. extension to the scope of services or revised payment terms)?
2. Are there any non-insolvency related terms in the contract upon which the supplier may seek to rely to terminate the essential supply contract or exercise other rights?
3. If there is a single agreement for the provision of a wide variety of different services, how will this impact the supplier’s ability to terminate (or increase prices for), individual supplies which fall outside of the essential supply regime? Will the termination of these supplies harm the continued provision of the other essential supplies?
4. Is the supply agreement governed by a foreign law? Is the supplier is a foreign company? The application of section 233A IA regime in a cross-border context is likely to be complex and legal advice should be sought.

The Government has urged office-holders to contact essential suppliers “at the earliest possible time and as soon as reasonably practicable” to notify them of the insolvency. To promote the efficient supply of essential services, office-holders are also encouraged to keep suppliers informed of intended future use of the essential goods / services and updated on any further changes in the supply needs of the business during the insolvency.

The information in this alert is provided for the purposes of information only and is not a substitute for appropriate professional advice which should be sought based on the facts of any particular case.