Corporate Insolvency and Governance Bill: Prohibition on Termination Clauses

June 2, 2020

By Lisa Feng

In guidance published on 1 June 2020[1] one of the aims of the Corporate Insolvency and Governance Bill is aptly summarised as to “introduce new corporate restructuring tools to the insolvency and restructuring regime to give companies the breathing space and tools required to maximise their chance of survival”.

Giving companies “breathing space” is a recurring theme in the Bill.

When a company enters an insolvency procedure, suppliers of goods and services will often exercise termination clauses to either stop or threaten to stop supplying the company. It has been recognised that this can jeopardise attempts to rescue the business.

One of the measures being introduced in the Bill to assist companies is a prohibition on termination clauses which are triggered on a party entering an insolvency process.

This will be dealt with by insertion of new sections 233B and 233C into the Insolvency Act 1986.

When does the protection arise?

Section 233B will apply when a company becomes subject to a relevant insolvency procedure. This will include the new style moratorium introduced by Part A1 of the Bill as well as administrations and liquidations.

What are the prohibitions?

When a company becomes subject to the relevant insolvency procedure, the following types of clauses would cease to have effect (new s233B(3)):

  • Any provisions which provide that the contract or supply would terminate or any other thing would take place because the company becomes subject to the relevant insolvency procedure; or
  • Any provision where the supplier would be entitled to terminate the contract or the supply or to do any other thing because the company becomes subject to the relevant insolvency procedure.

Additionally, if a supplier was entitled to terminate the contract or supply because of an event occurring before the start of the insolvency period and the entitlement arises before the start of that period, the entitlement may not be exercised during that period.

Further, a supplier cannot demand payment of outstanding pre-insolvency charges as a condition of continuing supply (new s233B(7)).

What can a supplier do?

However, where a termination provision is otherwise prohibited or if a supplier is otherwise prohibited from exercising a right to terminate, a supplier may terminate the contract if:

  • The office holder consents to the termination of the contract;
  • The company consents to the termination or
  • The Court is satisfied that the continuation of the contract would cause the supplier hardship and grants permission for the termination of the contract.

Notably, the prohibitions do not apply to termination events occurring after an insolvency procedure commences.

There are a number of practical examples in the guidance published on 1 June 2020 which may assist in interpreting the provisions (see here).

For example, in the guidance, it is suggested that one instance where the Court’s permission to terminate on grounds of hardship may be sought is if the supplier’s own solvency is threatened.

Are there any exempt suppliers?

Permanent exclusions from the prohibitions apply to contracts for the supply of goods and services to a company in the context of financial services; details of the same will be set out in the new schedule 4ZZA to the Insolvency Act 1986.

Further, a temporary exclusion applies to small suppliers under section 13 of the Bill. The prohibitions under the new Section 233B will not apply to a contract for the supply of goods and services to a company where:

  • the company becomes subject to a relevant insolvency procedure during the relevant period (being the day on which the section comes into force and ends with 30 June or one month after the coming into force of this section, whichever is later); and
  • The supplier is a small entity at the time the company becomes subject to the procedure.

Small entities are defined in sections 13(4)-(10) of the Bill.

Practical thoughts

The proposed changes will give rise to some important considerations for suppliers when dealing with a company at risk of becoming insolvent. It is possible that suppliers may seek to protect their position at an earlier stage if arrears arise: for example, should they be less forgiving of any defaults and seek to terminate a contract earlier, well in advance a company entering into any insolvency procedure?

Further, the parameters of when a Court might intervene on grounds of “hardship” to the supplier will undoubtedly be tested. Notably, there is no requirement for “exceptional” hardship. The only example given in the guidance is where a supplier’s own solvency might be affected. In a post-Covid world where companies may not have substantial cash reserves, it is possible that this example may be frequently encountered.