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This news analysis provides an in-depth consideration of the changes to termination clauses introduced by the Corporate Insolvency and Governance Act 2020. It is based on a webinar given for PRIME Finance on 27 July 2020. Written by Philip Wood CBE, QC (Hon)*.
The UK nullification of what are called ipso facto clauses (these are clauses in a contract which provide that a counterparty can terminate the contract on the commencement of insolvency proceedings against the other party) has been one of the permanent changes introduced by the Corporate Insolvency and Governance Act 2020 (CIGA 2020). For further analysis of the changes introduced by CIGA 2020, see News Analysis: Corporate Insolvency and Governance Act 2020—the rise of the moratorium and restructuring plan and the fall of the Scheme? The freezes on these terminations represent quite a major change to UK insolvency law.
Ipso facto clauses as events of default are typical of most formal contracts except the most ephemeral or short-term. In addition, English case law has held that the insolvency of a counter-party will be treated as a repudiation if the insolvency puts it out of the power of the insolvent party to perform the contract.
Statutes nullifying these clauses are widespread internationally. The statute follows the usual pattern of a provision for the nullity of insolvency events of default, followed by carve-outs for financial markets and other exclusions. These exclusions are wide in the UK case.
The freeze is one of the most intrusive of the stays on creditors which come into force on an insolvency and is controversial.
The first major freezes appeared in the US Bankruptcy Code of 1978 and in the French redressement judiciare of 1985. The UK introduced them in 1986 but only for essential utilities, to keep the lights on.
The issue has extra significance because of the role that English law plays as effectively an international public utility as a chosen governing law of major contracts and because the direction of a jurisdiction’s insolvency law is an important indicator of the credentials of its legal culture.
The freezes are contained in a new sections 233B and 233C inserted in the Insolvency Act 1986 (IA 1986). The exclusions are contained in a new Schedule 4ZZA to the IA 1986.
The first and main stay is that any provision of a contract for the supply of goods or services to the company ceases to have effect when the company becomes subject to insolvency proceedings if and to the extent that the supplier would be entitled to terminate the contract, or do any other thing, “because the company becomes subject to the insolvency proceeding” or if there would be an automatic termination or if any other thing would happen, including presumably acceleration or increases in the interest rate.
So an event of default sparking on insolvency is void for those supply contracts and the supplier is contractually bound to continue to supply. But the supplier can terminate for post-commencement defaults, including payment defaults. The statute does not nullify rights to terminate for other reasons, subject to what is said below. Payments will enjoy the priority of administration expenses.
The object is to maintain the company’s contracts so as to increase the assets available to creditors
IA 1986, s 233B applies to all the main corporate insolvency proceedings—including the new moratorium, administrations, administrative receiverships, liquidations and company voluntary arrangements. But it does not apply to resolutions and the like of banks and other regulated institutions which are subject to their own special stays.
It applies to contracts for the supply of goods and services. This would not include land contracts of contracts for the lease of land. Whether it would include intellectual property licences remains to be seen, but it is considered doubtful that these are contracts for services. There are wide exclusions, discussed below.
Secondly, if the supplier is entitled to terminate for any event before the commencement of the insolvency, not just insolvency, , then the supplier cannot terminate once the insolvency starts. So if the supplier does not pounce in advance, the right is lost for the duration of the insolvency.
Thirdly the supplier cannot condition the supply after commencement on the payment of prior charges incurred pre-insolvency.
The above freezes do not apply if either the supplier of the debtor company is one of the main regulated institutions in the financial sector, such as banks, insurers, electronic money institutions, investment banks, collective investment schemes, custodians, alternative investment funds, payment systems, recognized investment exchanges and securitisation providers, each as defined in the relevant regulation. There is an overseas activity exemption for the foreign equivalents.
There are wide exclusions (safe harbours) for financial contracts including for example, lending, factoring, financial leasing, giving guarantees, securities contracts, derivatives, financial commodities contracts, interbank deposits of three months or less, and master agreements for these, securities financing contracts such as repos, and contracts for traded capital market investments.
There is also a blanket exclusion for ‘set-off and netting arrangements’ and exclusions for settlement finality in clearing systems and financial collateral.
Intercreditor agreements are probably not contracts for services and so should be outside the freeze.
The debtor can consent to termination, and also the court can allow termination in the case of hardship.
Note that there are different regimes for security interests, including stays and exclusions from the stay.
There is a temporary coronavirus (COVID-19) exemption for small company suppliers up to 30 September 2020.
The government can amend the exclusions by regulation without primary legislation.
The freezes are not just rescue provisions because they apply also to liquidations. It appears that they are intended:
As is so often the case with insolvency law, choices must be made between advantages and disadvantages, the pros and the cons. The fact that this choice cannot be avoided on insolvency is one of the reasons that insolvency law is an effective litmus test of commercial law, eg whether the law protects debtors or creditors.
Some of the downsides include:
So the question here is whether the advantages outweigh the disadvantages or whether these new provisions are disproportionate.
If you take the view that the new provisions are inconsistent with the approach of English law, it would seem that they are not inconsistent with international trends amongst most highly developed countries.
According to my researches** and subject to recent changes, the following is very broadly the position on the take-up of statutes generally freezing ipso facto clauses, by region:
The scope of the freeze and the exclusions vary.
The overall result is North America and Europe versus the rest of the world—except for the African split and a few other exceptions. This remarkable division cuts across the background families of law inherited from the twentieth century and before.
**International data is based on volume 2 of my series in nine volumes on the Law and Practice of international Finance published in 2019.
*Philip Wood CBE, QC (Hon) is the author of over 20 law books and former head of Allen & Overy's Banking Department and Global Intelligence Unit. He is also a P.R.I.M.E. Finance Expert. Philip has spoken about the new Corporate Insolvency and Governance Act for PRIMEtime, P.R.I.M.E. Finance's virtual events programme. To see this and other PRIMEtime Virtual Events, see:
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