Corporate Insolvency and Governance Act – Ipso Facto Termination Clauses

Posted on 09 June 2020

The Corporate  Insolvency and Governance Act 2020 (the "Act"), which came into force on 26 June 2020, contains provisions which will significantly impact upon the effect of so-called Ipso Facto termination clauses in contracts for the supply of goods and services in the context of insolvency proceedings.

The Act was fast-tracked through Parliament, as many of its provisions deal with business recovery issues arising due to COVID-19. However, the provisions relating to Ipso Facto clauses are not a temporary measure and will have permanent effect. These provisions will apply in the context of any form of insolvency proceeding (including the new forms introduced by the Act). Nonetheless, the primary aim of these provisions is to assist companies which wish to use insolvency proceedings to restructure or sell the business to maintain key contracts during the course of the insolvency proceedings (thus making it easier to achieve a successful sale or restructuring), and to prevent suppliers from holding their customers to ransom over crucial goods or services. In order to ensure that suppliers are not unduly prejudiced by these protections, the Act also contains provisions requiring the customer to pay for any goods or services supplied during the relevant insolvency proceedings (although suppliers will be unable to purse any historic debts).

We answer some of the key questions that this raises for suppliers of goods and services under English law contracts.

What is an Ipso Facto termination clause? 

An Ipso Facto termination clause is a clause which either automatically terminates, or entitles a party to terminate, a contract upon a particular event occurring. In supplier contracts, it is common to include a clause stating that the supplier can terminate upon the buyer entering into an insolvency procedure. 

What does the Act do in relation to Ipso Facto termination clauses?

Section 12 of the Act adds a new section 233B to the Insolvency Act 1986, which deals with the effect of Ipso Facto termination clauses in the event of the insolvency of the customer (but not a supplier) under a contract for the supply of goods and services. There remains a degree of uncertainty as to precisely how widely this will be interpreted. For example, licensing agreements (e.g. software licences) were mentioned in previous consultations on such provisions, but are not specifically referred to in the Act.

However, in many cases it will be clear where a contract falls under this provision. Where they do apply, Ipso Facto termination clauses will cease to have effect upon (and simply because of the fact of) the customer entering into a relevant insolvency proceeding (including the new procedures implemented under the Act). Clauses which provide for termination, whether automatic or optional, of a contract in the event that the customer becomes insolvent will therefore have no effect for the duration of the insolvency proceedings, even where the customer has unpaid arrears.  

Further, where the supplier has become entitled to terminate as a result of an event which occurred prior to the customer entering into a relevant insolvency proceedings, it will no longer be able to exercise that right for the duration of the insolvency proceedings. However, and this is an important point to note: where an event of termination occurs after the customer has entered into the insolvency proceedings, the supplier will be able to terminate.

Do these provisions affect other types of clause?

Potentially.

The provisions state that they will apply to clauses that either cause or permit "any other thing" (i.e. other than termination) to occur or be done by the supplier as a result of the customer entering into insolvency proceedings.

This could potentially affect other types of provision, such as clauses which lead to or permit the variation of the supplier's and/or customer's obligations under the contract upon the customer entering into insolvency proceedings. However, it will only have this effect where a contractual provision is triggered by the customer entering into insolvency proceedings specifically. As a result, it should not affect contractual rights which are triggered by other events that happen to coincide with the customer entering into insolvency proceedings.

For example, Retention of Title clauses (which prevent title in goods from passing to the customer until such time as payment for them is made, and thus allow the supplier to recover the goods if payment is not made) should not be affected where the rights may be exercised as a result of non-payment. However where that right is triggered by the customer entering into insolvency proceedings such provisions would, to that extent at least, be caught by the provisions of the Act.

It should also be noted, that, as with other insolvency procedures, the new moratorium introduced by the Act will have the effect of preventing a supplier from exercising their rights under Retention of Title clauses during the course of the moratorium.

Will this render clauses providing for termination upon the customer's insolvency entirely meaningless?

No.

Under the new provisions, where there is such a clause a supplier may still terminate the contract: (i) with the consent of the Insolvency Practitioner appointed as administrator, liquidator, or similar in respect of the customer; (ii) with the consent of the customer itself; or (iii) by order of the court if it considers that requiring the supplier to perform the contract would cause the supplier hardship.

Accordingly, Ipso Facto clauses continue to give rise to rights to terminate in the context of a customer entering into insolvency.  The new provision however prevents termination from being effected either automatically or unilaterally by the supplier during the course of insolvency proceedings. Instead, the counterparty (either the customer itself or through the relevant Insolvency Practitioner) or the Court must agree that such rights can be exercised.

For the purposes of obtaining the permission of the Court to terminate a contract, the Court will consider whether the supplier would be more likely than not to enter an insolvency procedure as a consequence. In addition, the Court will also consider whether allowing the supplier to avoid performing the contract would be reasonable in the circumstances, and in particular with regard to the effect this would have on the customer and its prospects of rescue. Suppliers will need to consider whether they can satisfy these requirements, and will also need to factor in the time and expense of Court proceedings, when considering making such an application.

Will I be at greater risk if my customer becomes insolvent?

These provisions will prevent you from walking away from a contract with a customer that has entered insolvency proceedings. As a result, you will be required to continue to perform the contract, and supply the customer in accordance with your contractual obligations, during the course of the insolvency proceedings, unless one of the exemptions apply.

Naturally, supplying a company undergoing insolvency proceedings carries some degree of risk. However, in reality, the risk is likely to be relatively limited. In the case of administrations, any sums due in respect of goods or services supplied during the course of the administration will be payable as expenses of the administrators, and will take priority over unsecured debts (including arrears payable for supplies made prior to the insolvency proceedings commencing). In the case of liquidations, the liquidator is unlikely to want you to perform your obligations in any event, as in most cases they will not be trading the company. The position is potentially more complex in the case of other forms of insolvency proceedings, but in these cases it is likely that there will be a restructuring, purchase, or other form of rescue plan that should allow the customer to continue to trade solvently.

Finally, if you find yourself in a position where you are contractually obliged to supply a customer in circumstances where you consider you are very likely to suffer financial hardship as a result, you will still have the ability to terminate the contract either by agreement with the relevant IP or the company, or with the permission of the Court.

Will I need to amend my contracts where I have such clauses?

Although the prohibition on enforcing ipso facto clauses on insolvency has retrospective effect and thus applies to existing contracts, there is no immediate need to amend your existing contracts if they contain such clauses.

The Act does not allow parties to contract out of these provisions, and it is likely to be difficult to draft around them. Further, Ipso Facto termination clauses will remain useful provisions, albeit that the rights they provide in the context of the insolvency of your customer will be more limited.

It may, however, be sensible to amend such clauses to refer to the relevant provisions of the Act. It may also be necessary to amend definitions of insolvency proceedings to account for the new forms of insolvency proceedings which the Act has introduced (see our previous article on the insolvency provisions in the Act here). You may also wish to consider adding additional Ipso Facto termination clauses that will be triggered before the commencement of insolvency proceedings (such as Material Adverse Change, or MAC, clauses). This will enable you to terminate such agreements prior to insolvency proceedings being entered into and these provisions of the Act being engaged.

Tips for re-negotiating or drafting contracts

Suppliers may wish to consider including additional termination rights which can be triggered before the start of an insolvency procedure, though it is possible that some or any of such clauses could be held open to challenge under the Act pending further clarification from the Courts.

 These could include: a right to terminate if the supplier reasonably considers that the customer's financial position has deteriorated such that the customer cannot fulfil its obligations under the agreement; restructuring the arrangement under a master agreement, with each supply treated as a separate contract which can be terminated separately; or an obligation on the customer to provide regular financial statements or updates to the supplier, following which the supplier can terminate if it reasonably considers that the customer will be unable to pay the contract fees.

Other ways in which suppliers can protect themselves include a request for all, or part of, the contract fees up front, a right to change payment terms or stop supply if the customer misses a specified number of payments and maintaining firm credit control with the customer.

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