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Corporate Insolvency and Governance Act 2020 imposes significant changes on supply contracts

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Posted by Lindsay Ellis on 27 August 2020

Lindsay Ellis - Business and Commercial Lawyer
Lindsay Ellis Partner - Head of Commercial

Section 233B of the Insolvency Act 1986 (introduced by the recent Corporate Insolvency and Governance Act 2020) imposes significant changes on supply contracts. In summary, it prevents a supplier from ceasing to supply a customer simply because the customer has become insolvent.

Any term that provides for termination based on the customer becoming insolvent is, in effect, inoperable. It also renders inoperable any other consequence that is triggered by such insolvency (for example, a right to refuse to continue to supply or a right vary the terms pursuant to which ongoing supplies will be made). Further, a supplier cannot exercise a contractual termination right in respect of a pre-insolvency breach if the right is not exercised before the commencement of insolvency proceedings.

Section 233B applies:

  • Where a customer, being a company, becomes subject to an insolvency event.
  • To all contracts for the supply of goods and (non-financial) services.

It only applies to suppliers. As such, customers are not prevented from exercising a right to terminate where it is the supplier who becomes insolvent. It applies all supply contracts irrespective of when they were entered into (as long as the customer has entered into insolvency proceedings on or after 26 June 2020).

No termination

Any provision in a supply contract that provides for automatic termination, or which allows the supplier to terminate, based on the customer’s insolvency, ceases to have effect. This prevents a supplier from exercising an insolvency termination right and also from relying upon any provision as to automatic termination.

No doing of any other thing

Section 233B prevents a supplier from doing “any other thing or allowing any other thing to happen” based upon the customer becoming insolvent. The reference to doing “any other thing” (an active consequence) or any “other thing” taking place (a passive consequence) is deliberately broad.

No reliance on pre-insolvency events

A supplier cannot rely upon a provision that would have allowed them to terminate because of an event occurring before the company entered into insolvency, where the entitlement arose but was not exercised before the commencement of the insolvency proceedings. This does not prevent a supplier from exercising any available contractual termination rights in the run up to a company’s insolvency but does prevent it from relying upon an earlier breach once insolvency proceedings have begun.

No demanding that outstanding charges are paid

A supplier cannot make it a condition of continuing to supply that any outstanding payments are paid, or do anything that has this effect. It does not mean that the customer does not continue to owe the amounts outstanding under the supply contract. Rather, the supplier cannot make payment a condition of continuing to supply.

What is an insolvency event?

  • A Part A1 moratorium comes into force for the company (in effect, a process introduced by the Corporate Insolvency and Governance Act 2020 giving a company a short “breathing space” to consider whether a rescue is viable).
  • The company enters into administration.
  • An administrative receiver is appointed to the company.
  • A voluntary arrangement takes effect in relation to the company.
  • The company goes into liquidation or a provisional liquidator is appointed to the company.
  • The company enters into a Part 26A restructuring plan.

Section 233B is not triggered where a company enters into a scheme of arrangement or where a fixed charge receiver (as opposed to an administrative receiver) is appointed over the company’s assets.

What happens when a customer enters into an insolvency event?

Suppliers of goods and services generally benefit from higher payment priority in relation to goods and services supplied during an insolvency procedure. Debts generated during the insolvency procedure for the benefit of that procedure will usually be treated as an expense of the process. While expenses may not necessarily be paid immediately, they are paid in priority to most other debts.

Moratorium debts (incurred during a Part A1 moratorium), must be paid as they fall due as a condition of that moratorium continuing and if not paid they do have a formal priority during a subsequent insolvency process commenced within the next three months.

Nothing in section 233B prevents a supplier from terminating a contract or supply of goods or services in these circumstances:

  • In the period leading up to the insolvency proceedings.
  • In reliance on a termination right arising after the insolvency proceeding began, but not triggered by that proceeding.

Further a supplier can terminate:

  • With the consent of the office-holder appointed to administer the insolvency of the company.
  • With the permission of the court (on the ground that continuing the contract would cause the supplier hardship).

After a customer has entered a formal insolvency procedure, a supplier can:

  • Wait for new contract termination right to arise; for example, non-payment for supplies made after the commencement of the insolvency.
  • Exercise contractual rights to terminate for convenience. There is certain doubt as to whether section 233B would prevent a supplier from exercising a right to terminate for convenience (the concern being that a pre-existing right to terminate for convenience could be considered to be an “event occurring before the start of the insolvency period”). On balance, section 233B should not prevent a supplier from giving notice to terminate for convenience (provided it is a genuine right to terminate for convenience) after insolvency proceedings begin, as long as supplies continue to be made during the notice period.
  • Invoke other rights. Exercise any other contractual rights (for example, any contractual set-off and netting rights, although in some cases, these rights may be superseded by the application of mandatory insolvency set-off rules).
  • Reject new customer orders. A supplier could decline to provide further supplies where the existing contract is a single-purchase order. It may be possible to achieve a similar result with a contract which is structured as a framework agreement, where each new customer order constitutes a separate contract with the supplier free to decline such orders.
  • Refuse to renew an existing contract once expired.
  • Negotiate with the insolvency office-holder.

What should be considered for new contracts?

  • Reduce the contract term. A short contract term will ensure that the supplier will not be locked into supplying the customer for a considerable period in any insolvency procedure. Of course, this needs to be balanced against the commercial objective of securing a customer for as long as possible.
  • Structure the contract as a series of separate contracts. The supplier could structure its supplies under a framework agreement which provides that each supply is treated as a separate contract that the supplier is free to accept or decline.
  • Tighten the payment structure. Tighter payment terms may provide earlier warning signs of the customer experiencing financial problems.
  • Include retention of title provisions. If supplying goods, consider including retention of title provisions which are capable of being exercised prior to an insolvent event arising (a supplier’s ability to enforce is affected if the customer enters administration or becomes subject to a Part A1 moratorium).
  • Impose financial information reporting obligations on the customer. The supplier could require the customer to provide regular financial information to enable the supplier to assess its continued solvency. Information to be provided could include:
  • Information relating to the customer’s financial status, such as its credit rating.
  • Regular reports on the customer’s current and recent performance.

This could be linked to a right to terminate for financial distress (prior to the occurrence of an insolvency event).

  • Suspend further supplies for non-payment. As an interim step falling short of termination, a supplier could consider including a provision allowing it to suspend further supplies under the contract for repeated or lengthy periods of non-payment by the customer. Once the customer enters insolvency proceedings, section 233B may require the customer to restart supply, but the suspension may have helped manage the size of the outstanding payments.
  • Allow termination for convenience. Ensure that the supplier can terminate for convenience and include as short a notice period as makes commercial sense.

Practical steps

On a practical level, a supplier may wish to consider the following steps:

  • Conducting deeper due diligence on customers’ financial position before entering into contracts and actively monitoring customers’ payment performance and financial position during the contract to get earlier warning of likely difficulties.
  • Providing training to employees who manage contracts on the impact of the changes set out above.
  • Ensuring that it has a good working knowledge of at least its key customer contracts, so that it is familiar with its rights if a customer shows sign of financial trouble and is able to exercise them promptly.
  • Ensuring that invoices are paid when due and (if necessary) tightening debt collection procedures.
  • Exploring invoice finance options and/or obtaining trade credit insurance, if available.
  • Being ready to promptly exercise contractual rights to stop supply or terminate the contract promptly if a customer starts showing clear signs of financial distress.
  • Reviewing standard terms and conditions to make sure they still protect the supplier against a customer’s insolvency, as far as possible.

About the author

Lindsay Ellis

Partner - Head of Commercial

Lindsay advises on outsourcings, procurements and commercial contracts.

Lindsay Ellis

Lindsay advises on outsourcings, procurements and commercial contracts.

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