Terminating the right to terminate – UK Government announces measures to protect distressed businesses
In the world of retail, 2018 will be remembered as the year of the Company Voluntary Arrangement (CVA).
A CVA is a UK-specific procedure which enables an insolvent company and its creditors to repay a portion of the company's debt over a period of time.
The number of CVAs being deployed in the retail sector is on the rise, driven in part by the pressures on margins, increased costs and fierce competition from online sales. However, CVAs themselves are often not enough to save a failing business and this had led to the UK Government deciding to step in and take action.
Prohibition of certain contractual termination clauses
The UK Government has announced it will introduce measures to support companies through a business rescue process by the introduction of new rules to prevent suppliers terminating contracts solely by virtue of a company entering an insolvency process. These measures are part of the Government’s wider response to its consultation seeking views on proposals to improve the corporate governance of companies that are in or are approaching insolvency, as published by the Department for Business, Energy & Industrial Strategy (BEIS).
Suppliers entering into long term supply agreements should take note of the following points contained in the Government's response:
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The Government will legislate to prohibit the enforcement of ‘termination clauses’ by a supplier in contracts for the supply of goods and services where the clause allows a contract to be terminated on the grounds of a party entering formal insolvency (i.e. a corporate insolvency procedure provided for in the Insolvency Act 1986 such as administration, liquidation or a CVA). This will mean that suppliers must continue to fulfil their commitments under their contract with the debtor company.
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The supplier will need to seek permission from the court in order to terminate supplies. As a last resort, in rare cases where a supplier will be significantly and adversely affected by not being able to rely on a contractual termination clause, the supplier will be allowed to exercise such a right on the grounds of undue financial hardship. The threshold to be exempted will be purposefully high so that a supplier should only resort to court if continued supply threatens its own solvency.
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Personal guarantees will not be required (whether from a director or insolvency office holder) where a supplier continues to supply due to not being able to rely on insolvency-related termination clauses. Suppliers who are prevented from relying on such clauses will have "super priority" for supplies made during a pre-insolvency moratorium period in the event of a subsequent insolvency (meaning that they are unlikely not to be paid for any supplies they provide should a debtor company enter an insolvency procedure).
However, suppliers will retain the ability to terminate contracts on any other ground permitted by the contract. These would include:
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non-payment of liabilities (e.g. invoices) incurred following entry into a moratorium, restructuring plan, or insolvency procedure;
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giving notice in accordance with other terms of the contract (e.g. a principal's right to terminate upon giving fixed notice); or
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any other ground that gives rise to termination (e.g. a breach of contract by the buyer), save for those connected with the financial position of the debtor company, or it entering into a moratorium, restructuring plan, or insolvency procedure.
BEIS has stated that the new measures will be set out in further detail in due course although it will be a few years before the measures become law (not least because of the distraction of Brexit). However, this development is relevant to any business entering into long term supply agreements as it is likely that the new laws, when passed, will apply to existing agreements.
Conclusion
These changes highlight the need for suppliers to assess their supply contracts, particularly those which are long term in nature, such as distribution or franchise agreements, and ensure that the rights for termination are sufficiently detailed, clear and broad to enable the supplier to take the necessary action when it is faced with an insolvent buyer.
Suppliers should also ensure that they have in place effective credit control systems to spot issues early on and effective retention of title clauses so they can take action to recover goods.
Finally, it is important that suppliers understand the consequences of the different types of liquidation. Whilst a members’ voluntary liquidation will mean the supplier will be repaid in full, a CVA or compulsory liquidation could be disastrous as the supply agreement may be disclaimed by a liquidator and the supplier would then rank as an unsecured creditor. A CVA will, however, give the supplier the chance to vote on the rescue proposal.