On 26 June 2020 the Corporate Insolvency and Governance Act 2020 (the Act) came into force, introducing a number of permanent reforms to English insolvency and restructuring law. Among these reforms is a restriction on the effectiveness of certain termination clauses in contracts for the supply of goods and services where a counterparty enters an insolvency procedure.
The Restriction on Ipso Facto Clauses
Under the Act, clauses that allow termination of an agreement for insolvency-related reasons (so called ipso facto clauses) will no longer be enforceable in contracts relating to the supply of goods and/or services. This restriction, which applies retroactively, also applies to clauses that provide for "any other thing" (i.e. any other contractual right) to be triggered or the supplier to "do any other thing" on the commencement of a relevant insolvency procedure. A "relevant insolvency procedure" includes: administration, administrative receivership, company voluntary arrangements, liquidation, provisional liquidation, or the new moratorium or restructuring plan tools created by the Act.
There is no guidance as to the meaning of "any other thing" except for the explanatory note which provides the example of changing payments terms, but it is likely that this prohibition will be broadly interpreted and cover provisions that are activated on the commencement of a relevant insolvency procedure, as well as any post-filing variation or suspension of terms. There is also no definition of what a "supply of goods or services" covers.
Aside from ipso facto clauses, if the supplier had a right to terminate the contract for non-insolvency related reasons before the insolvency procedure (e.g., for non-payment) but did not exercise that right, the supplier may not terminate on those grounds during the insolvency. The Act also expressly prohibits suppliers from conditioning future supply on payment of pre-insolvency debt. Subject to the carve-outs and exceptions discussed below, suppliers must continue to perform their obligations during the insolvency.
There are notable carve-outs to the ipso facto restrictions, including certain specified entities and contracts. The list of excluded entities includes deposit-taking banks, investment banks and investment firms, as well as insurance companies. Excluded financial contracts include loan agreements, swap agreements and derivatives, and capital markets contracts.
The existing protections for "essential suppliers" will continue according to the Section 233A of the Insolvency Act 1986 which protects suppliers of, among others, electricity, gas, water, communications services and information technology.
A supplier can terminate and stop supplying:
- for new breaches (e.g. non-payment or breach of contract) occurring after the insolvency procedure has begun.
- with the permission of the insolvency office holder or directors (depending on the insolvency procedure).
- with the permission of the court after it has been satisfied that the continuation of the contract would cause the supplier hardship.
In this scenario the supplier must be paid for any goods or services supplied post-filing, otherwise a new ground for termination would arise. The supplier’s pre-insolvency debts will be unsecured and will be paid pari passu after payment of insolvency expenses and secured charge-holders.
Next week’s alert focuses on the new standalone moratorium, which provides companies in financial distress breathing space from creditors and allows them to later enter into an insolvency process if necessary. Where the ipso facto restriction applies as a result of the new moratorium, then the supplier will be paid ahead of other creditors in any subsequent insolvency.
Litigation to Come?
Already there has been much comment on some of the opaque language of the restriction, including the references to "supplier hardship" and "any other thing." The scope for broad interpretation of this language is likely to increase the uncertainty commonly associated with a new regime.
While the Act does provide suppliers with protection, compared with other insolvency regimes, the burden of proof may rest on suppliers to access that protection. Suppliers may need to demonstrate that hardship, for example, exists in their circumstances and in the absence of statutory guidance it is left to the Courts to provide a steer as to what constitutes hardship or a thing — and what tests should apply.
Even some of the more clearly laid out aspects of the restriction are likely to be heavily litigated. For example, whether or not there are continuing obligations under a contract is not likely to be a straightforward matter.
Next week, Faegre Drinker will be completing this series of briefings with an overview of another of the permanent reforms introduced by the Act – the temporary moratorium. In the meantime, if you have any queries, please contact a member of the London corporate restructuring team.