The Corporate Insolvency and Governance Act 2020 (the Act) came into force on 26 June 2020. The Act is the most significant shake-up of corporate insolvency law for almost 20 years. With a raft of insolvencies anticipated due to the COVID-19 pandemic, the Act contains several provisions designed to help viable businesses survive.
We have previously written about the Act's temporary impact on the ability of creditors to present winding up petitions after service of a statutory demand here , and the relaxation of meeting and filing requirements here. Amid fears of a second wave, the effects of these temporary measures have since been extended to 31 December 2020.
However, the Act also introduces several permanent reforms that were consulted on pre-covid but fast-tracked in response to the pandemic. Along with new moratorium and restructuring procedures, the Act permanently overrides the operation of insolvency termination clauses, often known as "ipso facto clauses", in contracts for the supply of goods and services. An ipso facto clause allows the supplier of an insolvent company to terminate the contract on account of that company's insolvency. These clauses often come as boilerplate in standard form contracts, including those of the Scottish Building Contracts Committee and UK Institution of Civil Engineers.
What does the Act do?
Under the Act, a supplier's contractual rights under an ipso facto clause will be statutorily extinguished when the other party enters a "relevant insolvency procedure". Relevant insolvency procedures include the new moratorium and restructuring procedures, as well as administrations, CVAs and liquidations. Once the company has entered a relevant insolvency procedure, the supplier cannot:
- terminate the contract, stop supply or "do any other thing" on account of the other party entering a relevant insolvency procedure;
- terminate a contract or stop supply because of breaches that occurred prior to insolvency (for example, default or non-payment); or
- make clearance of pre-insolvency arrears a condition of future post-insolvency supply
The term "any other thing" is not defined by the Act, but the explanatory notes refer specifically to amendment of payment terms. The term is widely drawn, though, and seems intended to capture any new conditions attached to future supply under the contract.
When can a supplier terminate?
Once a relevant insolvency procedure has been entered, the supplier can only terminate when:
- there are new breaches after the insolvency procedure began (for example, default or non-payment);
- the company or appointed insolvency practitioner consents to the termination; or
- the court grants permission for termination because continuation of the contract would "cause the supplier hardship"
The Act does not define what "hardship" means in this context and this will need to be fleshed out by case law. However, if the provisions of the Act are to have teeth, the test will need to be onerous and a high threshold seems likely.
The Act does, however, contain a wholesale carve-out for financial services contracts and a temporary exclusion until March 2021 for "small suppliers", which are defined by the Act as companies satisfying two of the following criteria: turnover of less than £10.2 million, a balance sheet of less than £5.1 million and 50 or fewer employees.
The practical implications of the Act in relation to supply contracts remain to be seen, and key terms such as "any other thing" and "hardship" are yet to be judicially tested. However, large suppliers with long-term contracts will need to rely on non-insolvency related means of termination going forward and should be vigilant of cash flow issues down the supply chain before a relevant insolvency procedure begins. A shift to more ad-hoc, order-to-order supply contracts, at least for the time being, could be one way of avoiding a dispute before it arises.
In line with the other provisions of the Act, these new rules are intended to help companies weather the COVID-19 pandemic by preserving supply contracts with the hope of sustaining an insolvent company as a going concern. However, the permanent reforms of the Act also seek to create a new and lasting corporate-rescue culture in the UK, but they do so at the expense of freedom of contract. Ipso facto clauses, at least in some circumstances, are now a thing of the past.