Until the Corporate Insolvency and Governance Act 2020 (“Act”) came into force on 26 June 2020, there were few restraints on what suppliers of (non-essential) goods and services could do when dealing with business customers in financial distress. For instance, suppliers were typically entitled to terminate the contract and cease supply to a customer that became subject to a relevant insolvency event (such as administration). However, the Act has considerably narrowed the options available to suppliers. This article considers the key restrictions (both temporary and permanent) that suppliers now face.
The Act has introduced a new Section 233B to the Insolvency Act 1986. This new provision effectively prevents a supplier from stopping its supply of goods or services to a customer simply because that customer has become subject to a relevant insolvency event. Contractual provisions which are triggered by the customer’s insolvency will be invalidated, including the right to vary or terminate the contract. Importantly, once a customer has entered insolvency proceedings, this new provision will even prevent suppliers from terminating for a breach (such as non-payment) which occurred pre-insolvency.
The obvious implication of this new provision is that a supplier will be required to continue to supply their customer during its insolvency in accordance with the terms of the supply contract. Suppliers are not permitted to make this continued supply conditional on payment of outstanding charges in respect of supplies already made to the customer. Suppliers can take some comfort though from the fact that (although outstanding charges are likely to be treated as unsecured claims in the insolvency) any goods or services supplied during the insolvency should usually be paid for as an expense in priority to most other creditors.
For suppliers that are deemed to be small entities, Section 223B will temporarily not apply to them until 30 March 2021. A supplier is a small entity if at least two of the following conditions were met in its most recent financial year:
- the supplier's turnover was not more than £10.2 million;
- the supplier's balance sheet total was not more than £5.1 million;
- the number of the supplier's employees was not more than 50.
Section 233B will not apply to supply contracts where either the customer or supplier is involved in financial services nor will it apply to supply contracts which form part of a public-private partnership.
Section 233B does allow a supplier to terminate a contract with the consent of the insolvency office-holder overseeing the customer’s insolvency or with the consent of the customer in proceedings where the customer retains control (e.g. a Part A1 Moratorium). In the absence of such consent, a supplier may also apply for permission of the court to terminate the contract but the court will only grant permission if the supplier can show that continuing the contract would cause them hardship.
Key takeaways for suppliers
The introduction of Section 233B is designed to promote the rescue of businesses whose survival depends on the continued supply of goods and services. While suppliers may be prejudiced by this new provision, there are things they can do to protect their interests.
Early engagement with customers that appear to be in financial distress is key. Suppliers may be able to mitigate the effect of their customer’s insolvency if they can, for example, agree to shorten the term of the contract or vary pre-existing payment terms to more favourable terms such as requiring advance payments. When supplying goods, suppliers may wish to vary existing contracts or enter new contracts with their customers to include robust retention of title clauses that are capable of being exercised pre-insolvency.
If a supplier believes that they will be unduly burdened by having to continue supply to an insolvent customer, then they should consider their termination rights at the earliest possible stage once they are triggered and before they are nullified by the onset of the customer’s insolvency. However, suppliers must resist the urge to jump the gun on termination. They should ensure that they only do so when the right has arisen and should take legal advice if it is not clear whether or not such a right is available to them. Terminating, in the absence of a legal right to do so, could result in the supplier being financially liable itself for, among other things, repudiatory breach of the contract with the customer. When considering termination, suppliers are strongly encouraged to follow the current non-statutory guidance on responsible contractual behaviour in the context of the COVID-19 pandemic which can be found here.
As a consequence of the COVID-19 pandemic, the presentation of winding-up petitions has been severely restricted by the Act. During the period 27 April 2020 to 31 December 2020, suppliers can only present a petition against non-paying customers if they have reasonable grounds for believing that (a) COVID-19 has not had a financial effect on the customer; or (b) the customer would have been unable to pay its debts irrespective of COVID-19. Any statutory demand served during the period 1 March 2020 to 31 December 2020 cannot be used as the basis for a winding-up petition (even after 31 December 2020) and therefore are of limited use for the time being.
If you would like any further information on any of the above, or would like to discuss your particular circumstances and how Knights could help, please contact a member of our Restructuring and Insolvency team.