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Supply contracts: the new rules on termination

10th August 2020, 9:57 am

On 26 June 2020, the Corporate Insolvency and Governance Act 2020 (the “Act”) came into force. Although much of the publicity focused on it being brought about by the Covid-19 crisis, these changes are permanent. The Act sees significant reforms brought into the commercial contract arena; the new proposals are more debtor friendly than the previous position, making it harder for companies to terminate contracts on the grounds of insolvency. This article will focus on how termination of contracts will be affected, providing some clarity and tips for companies to consider.

The Act brings in changes that companies need to be aware of and which may change the way in which businesses risk assess new contracts, who they contract with and when they may wish to terminate their relationships. The Act applies to contracts for the supply of goods and services only.

There are now measures in place which prevent the supplier from terminating a contract for the supply of goods on the grounds of the customer’s insolvency. Previously contracts would generally provide for the termination of a contract in the event of the customer’s insolvency.

However now once an “insolvency procedure” is in place, companies will be prevented from terminating the contract because of the insolvency position.  An “insolvency procedure” includes things such as administration, the appointment of an administrative receiver, CVA, liquidation procedure, a convening order to allow re-structuring or the new moratorium (where companies will now be given time, initially 20 working days, to re-structure their company – similar to the Chapter 11 protection in the USA).

In addition to not being able to terminate where there is an insolvency procedure under the Act, a suppler would be prevented from doing “any other thing”, which although not defined would apply to any other contractual rights which would be triggered by the insolvency procedure.  This includes such things as prevention of the right to rely on a guarantee, interest provisions etc. Due to the fact that this is a very vague term, there is no clarity as to what happens in the event that a company within a group structure becomes subject to an insolvency procedure but the rest of the group is solvent. It will require case law for matters to become clearer – and that is far from ideal.

If a supplier considers that continuing to supply to the company would cause it “hardship”, it may apply to the court for permission to terminate the contract. Again the Act does not define “hardship” so suppliers will be in the hands of the court as to whether the circumstances they describe amount to hardship and will have no guidance until such time as there is a body of case law which might assist.

Given the potentially detrimental impact on them, suppliers will need to consider the credit worthiness of those they contract with even closer. In addition terms and conditions will need to be revisited. Finally there needs to be close contract management to ensure that payment terms are adhered to and debts chased before the customer enters into an insolvency procedure and the supplier is locked into the new arrangements.

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