Corporate Insolvency and Governance Bill—restrictions on ipso facto clauses

Corporate Insolvency and Governance Bill—restrictions on ipso facto clauses

On 20 May 2020, the government published the Corporate Insolvency and Governance Bill. This News Analysis looks at the proposed changes to ensure the continuity of essential supplies to companies subject to an insolvency or restructuring event and to restrict contractual termination provisions on insolvency (ipso facto clauses).

Spurred on by the coronavirus (COVID-19) pandemic and a desire to mitigate the effect on businesses of the government-imposed lockdown, the government has published the Corporate Insolvency and Governance Bill. The government previously consulted on proposed changes to the UK’s insolvency regime in 2016 and published its response on 26 August 2018. The current bill is progressing through parliament with its second reading tabled for 3 June 2020. The bill largely follows the conclusions set out in the government’s response and this News Analysis comments on the bill as originally published.

Among the proposed reforms, the bill introduces new provisions into the Insolvency Act 1986 (IA 1986) to ensure the continuity of essential supplies and restrict contractual termination provisions on insolvency (ipso facto clauses).

For an overview of the bill, see News Analyses: Corporate Insolvency and Governance Bill and Corporate Insolvency and Governance Bill—a view from the restructuring and insolvency profession.

For more in depth analysis of the specific proposals, see News Analyses:

What are ipso facto clauses?

When a company is subject to an insolvency procedure, creditors often seek to improve their position by threatening to terminate their supply of goods or services to the company. Creditors can do this if the contract contains a provision entitling the creditor to terminate on the grounds of insolvency or the impaired financial position of the counterparty.

These types of clauses are known as ipso facto clauses.

Typically the creditor will refuse to continue supplying the insolvent company unless it agrees to settle any outstanding debts it owes to the creditor. This creates a problem for the company because it can divert limited funds away from keeping the business afloat. It also risks disturbing the statutory waterfall of payments on insolvency.

What is the current position?

One of the long-standing principles of English law is the freedom of parties to contract as they choose. However, the law has long recognised the need to impose certain restrictions and safeguards on that freedom, for example to prevent duress. The IA 1986 already imposes certain restrictions on termination in the event of insolvency because it recognises the importance to companies of ensuring the continuation of essential supplies (see IA 1986, ss 233–233A) to facilitate either a rescue of the company, or a better return to creditors as a whole. Therefore the supply of key utilities are protected and from 1 October 2015 the government extended the list of essential supplies to include private suppliers of utilities and IT supplies.

However, the existing legislation has its limitations and does not take account of the particular needs of individual businesses. What is considered an essential supply will vary from business to business.

Moreover, at present the guarantee of essential supplies referred to in IA 1986, ss 233–233A is conditional: the officeholder can request the continuation of the essential supply and the supplier may not insist on outstanding debts being paid as a condition of continuing the supply, but the supplier can ask for a personal guarantee from the officeholder in respect of future supplies.

What are the proposed changes to ipso facto clauses?

The Corporate Insolvency and Governance Bill seeks to provide companies in financial difficulties with a comprehensive toolkit to aid their survival. As such, the Bill is more radical with regard to ipso facto clauses than its predecessor legislation and seeks to restrict the enforcement of termination clauses in a wider range of circumstances.

Under new section 233B, suppliers of goods or services will be unable to rely on contractual clauses allowing for the termination of the contract or supply in the event of the counterparty’s insolvency or restructuring. This includes not only where the counterparty is subject to an existing insolvency procedure, but also where the counterparty is subject to the new restructuring plan or moratorium proposed by the Bill. However, where the counterparty enters into a scheme of arrangement under Part 26 of the Companies Act 2006, ipso facto clauses will remain enforceable.

The creditor will be unable to insist on payment of pre-insolvency debts in order to secure future supplies, nor will they be able to do ‘any other thing’ as a result of the insolvency or restructuring. For example, the creditor would be prevented from increasing its prices to secure future supplies.

The new provisions go further and prohibit the termination of a contract or supply where the creditor has a pre-existing right of termination which arose, but was not exercised by the creditor, before the relevant insolvency or restructuring commenced.

The restrictions will remain in place throughout the duration of the insolvency procedure. They also apply to any supply contracts the company enters into both before and after the new provisions become law.

As with other changes introduced by the bill, there are exclusions for regulated entities, financial and insurance companies. The new provisions therefore will not apply where either the company or the supplier falls within these categories.

What are the safeguards for creditors?

There are important safeguards to protect creditors:

  • first, the new provisions only apply to contracts for the supply of goods or services, so would not apply to commercial contacts generally eg to customers of the company
  • secondly, a supplier may apply to court for relief if continuing to supply goods or services would cause ‘hardship’, and
  • thirdly, it will remain permissible to terminate for grounds other than the insolvency or restructuring, provided the contractual right to terminate did not arise pre-insolvency and was simply not exercised. For example, it would remain possible to terminate for breach of contract or non-payment where this occurs after the commencement of the insolvency or restructuring

Financial contracts are also carved out from the new regime, meaning for example that a lender would be able to stop the supply of committed financing as a result of an insolvency event of default.

Finally, supplies may always be terminated with the company or officeholder’s consent (as the case may be).

Taking account of the unique set of challenges coronavirus presents to companies, there is also a temporary exemption for small company (or small LLP or individual) suppliers during the current crisis, applying until the later of 30 June or one month after the provisions become law.

Related Articles:
Latest Articles:
About the author:
Helen joined LexisPSL in 2019, prior to which she was a Professional Support Lawyer at CMS specialising in insolvency and restructuring. She has broad experience in advisory, non-contentious and contentious work, including directorsâ?? issues, formal appointments, security issues and cross border recognition and assistance. She advised on financial institution insolvency and the insolvency of professional partnerships.

Helen trained at Lovells (now Hogan Lovells), qualifying in 2008. She was previously an associate at Lawrence Graham (now Gowling WLG) as well as the commissioning editor of Corporate Rescue and Insolvency journal.