The Corporate Insolvency and Governance Act 2020: a refresher on termination clauses in supply contracts

Many businesses have been, and continue to be, under financial strain as a result of the pandemic, with some having to resort to liquidation or other insolvency processes.

The Corporate Insolvency and Governance Act 2020 (“CIGA”) was enacted in June 2020 and introduced certain business rescue reliefs and insolvency measures, some temporary and others permanent in nature. Now, 18 months later, as the UK emerges entirely from Covid-related restrictions, the temporary measures have fallen away, but what is the continued impact of CIGA from a supply point of view?

Typically, most supply agreements (whether of goods or services) include provisions regulating when and how the agreement may be terminated, often including the right for a party to terminate if the other party suffers an insolvency event. CIGA aims to assist the rescue of a struggling business by limiting a supplier’s right to terminate supply. Barring certain exceptions, a supplier is unable to exercise its termination rights upon the occurrence of an insolvency event and must continue to supply the goods or services, thereby allowing the business to continue to trade during the insolvency period.

Another important provision of CIGA provides that termination rights which arose prior to the occurrence of an insolvency event but which weren’t exercised at the time they arose, may not be exercised after the insolvency event has occurred for the duration of the insolvency period.

There is a debate about whether CIGA applies to ongoing termination rights, that is termination by way of notice, and in particular whether this pre-existing right would constitute an “event occurring before the start of the insolvency period”. If not, a party could terminate the agreement upon notice, even after the occurrence of the insolvency event, but would have to continue its supply until expiry of the notice period.

CIGA also renders inoperable any other provisions that are triggered by the insolvency event, such as using variation rights to change payment terms or pricing.

While CIGA prohibits a supplier from demanding that outstanding amounts are paid as a condition of its continued supply during the insolvency period, the supplier may take comfort in the knowledge that it will enjoy increased payment priority for the goods or services supplied during this period as these are typically considered to be an expense of the insolvency process. Furthermore, if the supplier is not paid for the supply of goods or services made during the insolvency period, the supplier may then exercise any available termination rights for non-payment on the basis that these were not triggered by the insolvency event. The supplier may also terminate the agreement with the consent of the insolvency practitioner or other applicable office-holder depending on the rescue procedure being used, or with the consent of the court. A supplier who can prove that it would suffer hardship caused by the continuation of the agreement may petition the court for its consent to terminate the agreement. What qualifies as “hardship” is unclear, but the government’s guidance suggests that this exception would be available to a supplier whose own solvency would be threatened by a continuation of the agreement.

So, if CIGA renders insolvency-related termination rights inoperable, why do we still see them in supply agreements? The answer is simply that in certain cases as described above, such as where the supplier suffers hardship or permission is granted by the relevant office-holder or court, termination may still be available to the supplier and failing to include such a provision in the supply agreement would remove that right. Further, termination rights may now capture termination in circumstances where insolvency might reasonably be expected to occur, enabling suppliers to potentially make the call to terminate the agreement prior to the insolvency event taking hold and the CIGA provisions biting.

It is clear that these CIGA provisions are here to stay, so how can suppliers adapt and obtain the comfort they need?

• Undertake enhanced financial due diligence on your customers prior to entering into any supply agreement
• Keep up-to-date on your customers’ financial situation and, where appropriate, consider including information rights or an obligation on the customer to provide you with certain financial information in the supply agreement itself
• Monitor customers with overdue accounts (prior to any insolvency events taking place) and open conversations to allow you to assess the situation and risks
• The best commercial outcome for both parties is usually the rescue and continued trading of your customer in the long-term and so if you are able to continue supply and maintain a good relationship with them during their difficulties, this may be the preferred course of action

Disclaimer

This note reflects our opinion and views as of 15 February 2022 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.