Brexit and beyond - Termination for insolvency

Victoria Robertson sets out her view upon the proposed legislative changes upon the right to terminate for insolvency.

Whilst the effects of GDPR and Brexit upon the commercial landscape have been key areas of consideration for many businesses over the last year, there are other matters which could have far-reaching implications and which it is important for businesses to keep an eye on. One such area is the Government’s current proposals regarding termination for insolvency.

The standalone moratorium

The Government has proposed as part of upcoming insolvency reforms that a company can enter into a ‘standalone moratorium’. A company would enter into this for a period of up to 28 days, which may be extended whilst it considers options for restructuring. During this period, insolvency proceedings cannot be started.

Termination for insolvency

Contracts between businesses tend to contain ‘boilerplate’ termination clauses, which give either party the right to terminate the contract in a number of situations, such as material breach, non-payment of debts and insolvency (including liquidation, winding up, and when a company is in a restructuring process, i.e. a moratorium, CVA or administration).

The Government at first considered allowing companies to designate contracts as ‘essential contracts’ which then could not be terminated or varied once the restructuring process had started. Following consultation, the Government’s current position is that it intends to legislate to prohibit the enforcement of any right to terminate upon insolvency. In its consultation document, the Government states that “The supplier would have to continue to supply, subject to safeguards”.

The Government’s view is that this will enable businesses to keep trading through restructuring processes. These proposals will follow the US and Australian approach, although the UK approach will, unlike in the US and Australia, only apply to supplier arrangements and not other commercial contracts. Supplier arrangements will, according to the consultation document, include contractual licences for software and patents (it is notable that the consultation does not clarify whether licences for other intellectual property rights will fall under this regime).

Risks for suppliers

Whilst updates to the UK insolvency regime will doubtless be welcome in general, we see these particular proposals as causing potentially major problems for suppliers, who will need to consider their current trading terms carefully if these proposals become legislation. In particular:

  • Suppliers will be forced to continue to supply goods and services or be in breach of their contractual obligations, whilst potentially still being owed payment for previous supplies and facing uncertainty over whether payment will be made for ongoing provision.
  • Commercial payment terms are generally anywhere between 30 – 120 days. Being forced to continue to supply customers which are in insolvency proceedings (and as an unsecured creditor) creates a high level of risk for suppliers and could result in knock-on insolvencies amongst suppliers and in particular SME suppliers. Carillion’s collapse, by October, triggered a 20% increase in the number of UK building firms becoming insolvent. If suppliers are forced to continue to supply insolvent customers, it is easy to imagine that spikes in insolvency in supply chains could massively increase when one customer becomes insolvent or puts itself into a standalone moratorium to consider its options.
  • The Government anticipates that suppliers would only be able to terminate a supply for undue financial hardship, where it will need to show that it is “significantly adversely affected”. The supplier would need to seek permission from the court, and the court would need to consider whether, if compelled to continue supply, the supplier would be “more likely than not” to enter an insolvency procedure. This will involve legal and court fees which a supplier may be ill able to afford.
  • Suppliers would still be able to terminate for non-payment, but the consultation envisages this would only be for non-payment of debts incurred during the insolvency process. This will doubtless lead to customers trying to pay for current supplies whilst leaving unpaid invoices for previous supplies.

Retention of title

It is unclear what the Government anticipates the effect of its proposals being upon retention of title clauses, which is not detailed in the consultation. Retention of title clauses can enable a supplier to, once a customer enters insolvency, stop any sales of goods which have not been paid for and retrieve these goods. As this would go against the principle of enabling customers to continue trading, we anticipate that the Government will review the effect of these clauses. If it does not, we may end up with an illogical situation whereby suppliers cannot terminate their ongoing supply but can exercise their retention of title to prevent customers from selling goods already supplied and/or retrieve these goods.

Considerations for suppliers

We advise suppliers of goods, services and software to ensure that they keep up-to-date with these proposals and, if the Government proceeds to legislate, to update their contractual documentation to better protect themselves. Suppliers may, for example, need to insist upon a right for termination on short notice for convenience (unconnected to insolvency). The right to apply payments to historic invoices before current invoices would also be useful to consider, as would the right to vary certain terms (such as payment provisions) upon notice to the customer.

If you have any questions or would like to know more about our update, please contact Victoria Robertson (Partner). The Weightmans commercial team advises a wide range of clients from various sectors, with particular expertise in IT, software, e-commerce, manufacturing and retail.

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