Businesses contract with other businesses is a fundamental part of trading in the UK, whether your purchasing from businesses to supply goods or they are supplying you for you to then supply the market, this form of commercial relationship is common place.
But, what do you do when a business that is a debtor to your business in that commercial relationship has financial difficulty or becomes insolvent? How do you protect your business position from bad debt?
It is standard practice to include a termination provision within any contract governing the commercial relationship with the debtor business. It will usually be worded to allow you to immediately termination the contract following an “insolvency event” that is usually an all encompassing term to include administration, winding up, insolvency, and any other event that would be considered an event where the debtor business is suffering some kind of financial difficulty.
It is important to consider where the clause’s worded allows for its enforcement “in anticipation” of an insolvency event or where the event has to be presently active or previously occurred before enacting the termination provision.
However, if the debtor business in this scenario is contracted for the supply of essential services (water, gas, electricity) or the supply of information technology services (hardware or software) and that business is in administration or a company voluntary arrangement, this contract termination provision may be affected by a prohibition under s233A of the Insolvency Act 1986.
COVID & Financial Distress
The pandemic has caused may businesses to otherwise become financially distress or, at least, have financial uncertainty. The issue with the above contractual termination clauses are that those enacting them could cause otherwise financially viable or ‘survivable’ businesses to close. The Corporate Insolvency and Governance Act 2020 seeks to prevent this, in the short-term, by making amendments to the Insolvency Act 1986 and Companies Act 2006.
The CIGA came into force on 26th June 2020 and some measured included are retrospective to 1st March 2020. These amendments include:
- Moratorium statutory process: Available for companies and LLP structures that are or likely to become, unable to pay their debts, where it is considered likely that a moratorium would result in the company being rescued as a going concern. It provides a 20 business day period extendable without creditor consent to an extra 20-days for a moratorium on creditors. If agreement is reached with creditors or the court, it can be further extended by up to a year or more.
- Restructuring procedure: This is a similar scheme to the scheme of arrangement under the Companies Act 2006. It allows the proposal, by a solvent or insolvency company, of a plan to creditors to be approved by a court even where a group of creditors have voted against it.
- Ipso facto clauses: This provision invalidates contractual termination clauses in contracts for the supply of goods or services in the context of insolvency proceedings where termination is purportedly triggered by the company’s entry into those proceedings.
It was mentioned above that some amendments are retrospective, this includes the following provisions:
- Wrongful trading: The courts will ignore the period between 1st March 2020 and 30th September 2020 when assessing the amount of compensation payable when assessing the amount of compensation payable by a director who is found liable for wrongful trading.
- Winding-up petition: No winding-up petitions can be presented on the basis of a statutory demand served during the period above. The only consideration to consider here is that petitions cannot be presented during that period on other evidence of an inability to pay debts, however, should a creditor have reasonable grounds to believe that the pandemic has not financially impacted the company or the debt issues would occur anyway, they may present a petition.
The key point from these changes are that you should not default to the contract wording without first checking any potential impact of new statutory changes to the usual processes of insolvency and financial difficulty of a debtor business you are trading with. As, there is the possibility of damaging commercial relationships, supply chains, and becoming liable to civil damages claims for incorrectly enforcing contractual termination provisions.