In the following article, UK supply chain and logistics consultant, Paul Trudgian, and logistics law firm, Wright Hassall LLP, consider the impact of certain provisions in the Corporate Insolvency and Governance Bill as they apply to the logistics industry.
On 20 May the Government published the eagerly awaited Corporate Insolvency and Governance Bill (CIGB), which includes measures that have been developed over a two-year consultation period and others that are going to be introduced specifically to cater for the current Covid-19 pandemic. It had its second and third readings in the House of Commons on 3 June and is being considered in the House of Lords. It is expected to be fast-tracked onto the statute books by the end of June/early July.
The temporary measures contained in the CIGB are designed to stop otherwise viable businesses going into liquidation as a result of the economic turmoil caused by Covid-19. They include the temporary suspension of wrongful trading and restrictions on statutory demands and winding up petitions being issued, where the debt is unpaid for reasons relating to Covid-19.
One of the permanent measures contained in the CIGB is the prohibition on the reliance by suppliers on termination clauses in contracts for the supply of goods or services that are triggered when a company has entered into an insolvency procedure.
Supplier termination clauses
Restricting suppliers from terminating contracts with insolvent customers is an extension of the law that already applies to utility companies and other suppliers deemed ‘essential’. This measure has been introduced in order to help companies trade through a restructuring or insolvency procedure and to maximise the opportunity for rescue or the sale of the business as a going concern. The new provisions allow a distressed company to continue to trade and to prevent suppliers from insisting on the payment of outstanding charges as a condition of future supply. The aim is to make affected companies a more attractive proposition to prospective buyers.
Regardless, the termination provisions are likely to be viewed with considerable alarm by suppliers who are currently able to rely on termination clauses to extract themselves from a contract to supply goods or services in the event of a customer becoming insolvent. The CIGB inserts a new Section 233B into the Insolvency Act 1986 which effectively prohibits this reliance if a customer enters a formal insolvency procedure.
In addition, if a supplier, under the terms of their current contract, is allowed to terminate it because of an event that occurred before their customer became insolvent (such as non-payment of debts), the supplier can no longer, under the new provisions, rely on that entitlement once the customer enters a relevant insolvency process.
However, for new breaches that happen after the insolvency procedure begins, suppliers will still be allowed to terminate. Furthermore, a supplier will be able to terminate a contract if, in the case of the company being in administration or liquidation, the office holder consents or, in any other case, the company consents. The court can also activate the termination if it is satisfied that continuing to supply goods and services would cause the supplier financial hardship.
Small suppliers are temporarily exempted and these are defined as meeting two out of the three criteria relating to turnover, headcount and balance sheet. Small suppliers are temporarily exempted where the insolvency procedure occurs during the “relevant period”, being the date the CIGB comes into force until the later of 30 June or one month after the CIGB coming into force.
Permanent exclusions from the prohibitions apply in the financial services, insurance and banking sectors, details of which will be provided in a new schedule 4ZZA to the Insolvency Act 1986.
What suppliers can do now
The new provisions will apply where the insolvency procedure commences on, or after, the day on which the CIGB comes into force. They will apply to contracts for the supply of goods or services entered into before, as well as after, that date.
When entering into new contracts, suppliers should carefully consider the termination provisions and how these may apply in practice. They should also consider whether the customer can compel ongoing provision of goods or services or whether this is subject to agreement. In many instances, call of procedures are designed to commit a supplier to supply rather than having an option to reject.
For existing contracts, suppliers should:
- Conduct a review of supply contracts and identify those which contain, and are heavily reliant upon, insolvency termination rights. In many instances, the rights of a supplier to terminate are limited (often to non-payment or insolvency).
- Identify any supply contracts which you may wish to terminate (including on the grounds of insolvency). The CIGB will not apply retrospectively to prohibit a termination event prior to the CIGB coming into force although, once it is in force, it will apply to prohibit such termination rights for both new and existing contracts.
- Ensure they consider the downstream supply chain of all supply contracts. Whilst it may be determined that a contract is low risk in isolation, it should be considered how the contract could be impacted by market changes several steps removed from the supply contract.
- Prioritise those supply contracts where the greatest risk arises in the event of non-payment and where you consider the customer may be at risk of an insolvency event.
- Where you consider there is a material risk, consider whether you should take steps to terminate prior to the CIGB coming into force, either to support payment of existing debts and/or as a means to negotiate more favourable terms. This may help to protect your business in the event a customer becomes insolvent once the CIGB has come into effect.
Furthermore, while we recommend that the proposed steps are undertaken with urgency, prior to the Bill being entered onto the statute books, suppliers must also ensure the review now forms part of their ongoing processes. Just like other repeatable business processes such as sales forecasting, inventory planning and product portfolio reviews, the review of supply contracts should now be undertaken periodically to ensure risk is appropriately managed.
However, before taking any steps to terminate, do check that the customer is not already subject to an insolvency event and, when terminating, do ensure that you have complied with any notice requirements and have considered other provisions which may be material (such as those requiring payment of compensation).
Trading conditions are difficult across all sectors at the moment and most companies will be anxious to preserve good relationships with their customers for the long term. These new provisions, although designed with the best of intentions, will have suppliers nervously watching for signs of failure so they can take pre-emptive action rather than find their cashflow severely compromised.