Ipso Facto clauses, insolvency and the Corporate Insolvency and Governance Act

After accelerated parliamentary process, the new Corporate Insolvency and Governance Act (the “Act”) came into force on 26 June 2020.

Seeking to support UK businesses dealing with the Covid-19 economic consequences and implement other longer term insolvency law reform, the Act brings significant changes to restructuring and insolvency practice. One of the key changes is a prohibition of termination on insolvency provisions (so called ipso facto clauses) in contracts for provision of goods and services.

This change has been considered from the construction law angle by our own James Forbes, so check out his update here.

What does the Corporate Insolvency and Governance Act do?

The Act seeks to ensure that provisions allowing termination (either automatically or by the supplier of the goods or services) of the contract on the insolvency of the customer will no longer be enforceable.

The scope of the ban is limited to contracts for goods and services.

As the Act seeks to protect struggling companies and preserve their business-critical contracts, this ban applies only where the recipient of the supply enters into a relevant insolvency procedure. In this way, the Act extends protection that is already available under existing insolvency law to recipients of certain “essential supplies”, such as gas, electricity, water and IT.

The Act goes further and prevents suppliers from exercising any other contractual rights a supplier may have to “do any other thing” due to the company entering into a relevant insolvency procedure, for example, to change payment terms or increase prices.

Are there any exemptions to the Corporate Insolvency and Governance Act?

A party’s right to terminate will still be available when the administrator or liquidator of the insolvent customer consents to such termination, when the insolvent company itself consents to termination, or when the court allows termination on the basis that the contract causes hardship to the supplier.

There is also a temporary exemption available to small suppliers:  provided that the supplier is below a certain threshold in terms of turnover and size, they will not be prevented from terminating contracts on ground of the counterparty’s insolvency. This temporary exemption will operate between 26 June 2020 and 30 September 2020 (unless extended).

The Act further states that the prohibition does not apply to contracts in the context of financial services. This includes any contract between a supplier and a company where one or both of those parties carries on one or more of a broad range of specified financial services (irrespective of what the actual purpose of the contract is), and any contract involving the supply of certain specified financial services.

What are the practical implications of the Corporate Insolvency and Governance for parties?

The Act has a retrospective effect and applies to contracts that are already in force, albeit it will only cover situations where insolvency has been entered into after 26 June 2020.

From the supplier’s perspective, affected companies are likely to use this opportunity to revisit their supply contracts to see if the effect of changes can be balanced out by renegotiating other provisions. For example, the suppliers might seek to decrease the payment periods and the customers need to be aware when negotiating such changes, as termination on the failure to pay, even if arising solely from the insolvency, is still possible.

Although the termination clause may now be void on an insolvency event, it will be prudent to retain these clauses in updated contracts in case if the supplier wishes to make an application to the court, or otherwise agree a termination under one of the exemptions.