Suspension of termination rights on insolvency

Following public consultation and the UK Government’s response published in August 2018, on 20 May 2020, the Government published the Corporate Insolvency and Governance Bill (“CIGB” or the “Bill”). This Bill, as well as having broader corporate implications, also has significant impacts on commercial contracts.

With timing heavily motivated by the Coronavirus epidemic, one of the proposed changes is to restrict a contracting party’s’ ability to exercise contractual termination rights solely because a contracting counterparty enters an insolvency or restructuring procedure. Similar provisions are already in place in a number of other jurisdictions.

The CIGB suspends the rights of a supplier or service provider to terminate a contract or invoke other insolvency related provisions in contracts (in the legislation described as ‘any other thing’ e.g. amending payment terms) when a company enters an insolvency procedure for the duration of the procedure. These termination rights have been dubbed ‘ipso facto’ clauses, strictly translated meaning ‘by the fact itself’ because they become operational solely upon the occurrence of an insolvency procedure (as defined). This prohibition applies whether the clause in question operates automatically or requires an election to be made or notice to be given. The provisions would seemingly not prevent a contracting party simply terminating a contract on notice without cause at any time if an express right of termination for convenience exists in the contract.

An “insolvency procedure” includes the new company moratorium provided for in the Bill (see below) as well as the more traditional administration, liquidation, company voluntary arrangements (“CVAs”) and administrative receivership. Even if a right to terminate arose for reasons other than insolvency prior to the company entering the insolvency procedure, if that right was not exercised by the supplier prior to that time, then it will be suspended for the duration of the insolvency procedure. Suppliers will therefore have to think carefully when a right to terminate arises about whether to assert this right or potentially risk losing it temporarily. The Bill also prevents suppliers from requiring a company to pay outstanding charges (or anything of the same effect) as a condition of them continuing the contract or supply.

Introduction of a free-standing moratorium for UK companies.

The Bill gives struggling businesses a formal “breathing space” in which to pursue a rescue or restructuring plan. The moratorium would be time limited, initially 20 business days but with the possibility of a further 20 business day extension. Any extension beyond this would need court approval. During this moratorium no creditor legal action can be pursued against the company to recover outstanding payments without leave (i.e. permission) of the court i.e. the company in question effectively gets a payment holiday during the moratorium in respect of pre-moratorium debts and debts arising during the moratorium period except in respect of goods and services supplied during that period. The moratorium would be overseen by a monitor (a licensed insolvency practitioner) who would have to approve sales of assets outside the ordinary course of business and the granting of any new security over assets. Responsibility for the day-to-day running of the company would, however, remain with the directors. Crucially, all suppliers must continue to be paid during the moratorium although quite how that would work where there are prior outstanding debts and ongoing payments are to be made against an ordinary billing/ payment cycle is not exactly clear.

The directors of a company may obtain a moratorium by filing the relevant documents at court. The proposed monitor must state that in his / her view, it is likely that a moratorium would result in the rescue of the company as a going concern. The moratorium comes into force on the date and time at which the relevant documents are filed at court.

Protection for Suppliers and Service Providers

A supplier can apply to the court for permission to terminate its contract if its continuation will cause it [undue financial] ‘hardship’. The example given by the Government is if the supplier’s own solvency would be threatened as a result of having to continue the contract. The hardship threshold seems to be quite a high one. The court must assess whether the supplier would be more likely than not to enter an insolvency procedure as a result of being compelled to continue to supply and whether exempting the supplier from the obligation to supply would be reasonable in the circumstances.

Suppliers will be able to terminate if their right to do so arises after a company has entered the insolvency procedure, for instance, on the basis of further non-payment. This protects the supplier from the obligation to continue the contract if there is a further breach.

The suspension of termination rights introduced by the Bill do not apply to:

It will be interesting to see how, if at all, suppliers and service providers react to these changes.

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