Uncertain times have a ripple effect on all aspects of life, including business. The pandemic, Brexit, ever-higher inflation and now a wartime energy crisis in Europe have put many companies in financial difficulty.
Suppliers and customers face extraordinary pressures, which can affect key supply contracts. This means that the importance of insolvency law and practice in this area has increased considerably.
What happens if a customer becomes insolvent?
Over the years, insolvency laws have been introduced to protect customers who become insolvent against the loss of important supplies. First, the Insolvency Acy 1986 was introduced containing Section 233 and in 2015 Section 233A was introduced. More recently, in June 2020, the Corporate Insolvency and Governance Act 2020 further amended the Insolvency Act by adding Section 233B which made it even more difficult for suppliers to terminate contracts with customers subject to insolvency proceedings.
Sections 233 and 233A
Sections 233 and 233A were introduced to provide some degree of protection for insolvent businesses, but they covered essential supplies and no other goods or services. The term “essential supplies” covers the supply of gas, electricity, water, communications and IT goods and services. In Sections 233(3)(f) and 233(3A), computer goods and services are defined as supplies “for the purpose of enabling or facilitating the doing of something by electronic means”. This definition encompasses the supply of computer software and hardware, information and technical assistance related to the use of information technology, storage and processing of data and hosting of websites. However, where a computer supply is not covered by Section 233, it is likely to be swept aside by Section 233B – see below.
Section 233 prevents a supplier from requiring payment of unpaid charges incurred prior to insolvency as a condition of its continued supply. However, the article also allows the supplier to require the holder of the insolvency office to personally guarantee payment for the supply pending after the insolvency. Section 233 is triggered when:
- a company goes into administration
- an administrative receiver is appointed
- a CVA has taken effect
- a company has gone into liquidation, or
- a provisional liquidator has been appointed.
Section 233A expanded Section 233 by adding a restriction on the termination by the supplier of essential supply contracts referred to in Section 233 when the customer has entered into administration or a CVA has taken effect. It does not apply to the other insolvency scenarios that apply to Section 233 listed above.
So essentially Sections 233 and 233A together ensure that suppliers continue to be paid for essential supplies that they must continue to provide when a customer goes into administration or a CVA takes effect, and they prevent the supplier to terminate the contract if this is the case. The supplier also has the right to require the CVA administrator or supervisor to personally guarantee that they will be paid in the future.
Section 233B entered into force on June 26, 2020 and applies to insolvency proceedings after that date. It goes further and excludes stopping the supply of everything services (except financial services)1 and property in the event of the client’s insolvency. Any contractual right of the supplier to terminate in the event of the insolvency of a customer or an automatic termination clause in the event of the insolvency of a customer are no longer enforceable as well as all the contractual consequences triggered by the insolvency of a customer. . It also prevents a supplier from terminating the contract for a pre-insolvency breach after the start of insolvency proceedings. Section 233B applies to a wide range of insolvency proceedings under the IA 1986 and the restructuring of Part 26A under the Companies Act 2006.
Section 233B further prevents a supplier from “doing anything else or allowing anything else to happen” due to the customer’s insolvency. An example given by the Department for Business, Energy and Industrial Strategy in its explanatory notes of “doing something else” is to change payment terms2. Nor can a supplier make it a condition of continued supply that the customer makes outstanding payments. Therefore, the supply must continue even if the customer owes the supplier sums outstanding before the opening of the insolvency proceedings.
Section 233B applies to existing contracts for the supply of goods and non-financial services and is not limited to essential supplies like sections 233 and 233A. It should essentially sweep away situations where:
- the supplies are not essential supplies within the meaning of Sections 233 and 233A (except financial services); and
- the insolvency procedure is not an administration or a CVA.
However, the section does not provide any personal guarantees to the supplier that future payments will be made like section 233.
In the absence of clear guidance in the legislation, there have been discussions as to whether intellectual property license agreements such as software license agreements fall within the remit of S233B, given that a license can simply be a permission to use something. There are arguments for and against treating a software license as a supply of goods and services. Given that the intent of the legislation is to protect important supplies and that the termination of a critical software license could cause as much disruption as the termination of a contract for the supply of goods and services, it was argued that the expression “goods and services” should be interpreted in the broader sense. The line is even more blurred with SaaS agreements because the software is by definition service in this situation. It has also been suggested that documents released during the consultation period when the bill was passed by parliament mean the government intended ‘goods and services’ to include intellectual property licensing.3. This is clearly an area that deserves to be clarified.
But what else can a provider do to protect themselves?
Given the legislation, it is obviously important from the supplier’s point of view that they give themselves the best chance of becoming aware that a customer is in financial difficulty. beforeinsolvency proceedings begin. So what can be done?
Firstly, even before entering into the contract, the supplier must undertake sufficient due diligence on the financial situation of the customer and its main contracts with suppliers. The more prior information, the better.
When negotiating its contract with the customer, a supplier should look for provisions requiring the customer to provide regular financial information on its financial situation and the possibility of terminating the contract if certain trigger points are reached, i.e. – say if there is a clear sign that the customer is in a financial problem such as a deterioration in his credit rating or similar.
Proactive contract management and governance will also play a key role in ensuring the supplier is aware of any issues. Supplier personnel will need to be able to quickly grasp issues of concern and understand the implications of the legislation. The supplier will also want to ensure that they have strong payment arrangements in place that protect against late payment and the ability to terminate in the event of non-payment with repair periods as short as the supplier can negotiate. .
A supplier might also consider whether structuring the contract differently, for example, having multiple short-term contracts is a safer alternative to a single long-term contract. Giving themselves the right to terminate for convenience is also something a provider might choose. However, suppliers will need to balance the risk of customer insolvency with the revenue commitments they normally seek on their customer contracts.
But what if it is the supplier who becomes insolvent?
A customer does not benefit from the legislative protection mentioned above in the situation where a supplier becomes insolvent, i.e. there is nothing in the law to compel a supplier to continue its supply. A customer may wish to terminate the contract with a supplier facing insolvency and nothing prevents the customer from exercising its right under an ipso facto clause. However, there will be many cases where the customer needs the supply to continue. Then what ? By the time the supplier faces insolvency, it is far too late for a customer to seek protection, so it becomes all the more important for a customer to take appropriate steps to protect themselves, especially when the selection of the supplier, the pre-contractual and contractual stages.
First, full due diligence on the supplier’s financial position as well as its key relationships with suppliers and customers will be required. A customer will also need to negotiate adequate contractual protections such as vendor financial reporting requirements and properly drafted trigger provisions that give customers sufficient time and warning of any vendor financial difficulties. In outsourcing agreements, well-drafted stand-in clauses can be a useful tool and in software license agreements, a strong escrow clause and agreement can become more relevant. Like suppliers, customers will need to ensure that they proactively manage and govern their contracts with suppliers and that staff are able to detect issues and escalate them quickly.
1 paragraph 2, part 2, appendix 4ZZA, IA 1986 – Financial Services Exclusions – GOV.UK (www.gov.uk)
2 Para 35 – Explanatory Notes 71000 Chapter 12 EN 2020 Cover.indd (legislation.gov.uk)
3 Government response to consultation dated August 26, 2018, paragraph 5.104
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.