Lindsay Ellis from Wright Hassall solicitors based in Warwickshire, UK, looks at legislation that may prevent a company terminating the supply of services, or demanding the payment of outstanding charges, if a customer becomes insolvent.
The UK government has introduced legislation changes to help the UK’s economic outlook, but while many were simple, some changes will have far-reaching consequences for businesses unaware of the new conditions defining the customer/supplier relationship.
The most significant change for suppliers, appears in Section 233B of the Insolvency Act 1986 (introduced by the recent Corporate Insolvency and Governance Act), which now prevents them from terminating supply to a customer on the grounds the customer has become insolvent.
It applies to all contracts for supply of goods and (non-financial) services, but only applies to suppliers. Customers can terminate contracts if a supplier becomes insolvent.
This could be a tough situation for those in the global moving industry, who are also prevented from demanding outstanding charges be paid as a condition of continuing to supply, which for many is just good business practice.
When is a customer insolvent?
Insolvency is complicated and it’s important to understand what must happen for a customer to be considered to have become insolvent:
- A Part A1 moratorium comes into force for the company, offering a short ‘breathing space’ to consider whether a rescue is viable.
- The company enters into administration.
- An administrative receiver is appointed to the company.
- A voluntary arrangement takes effect in relation to the company.
- The company goes into liquidation or a provisional liquidator is appointed to the company.
- The company enters into a Part 26A restructuring plan.
Section 233B is not triggered if a company enters into a scheme of arrangement or where a fixed charge receiver (as opposed to an administrative receiver) is appointed over the company’s assets.
When does it not apply?
Nothing prevents a supplier from terminating a contract in the period leading up to the insolvency proceedings, or terminating after the insolvency proceeding began for a reason not triggered by that proceeding.
Suppliers can refuse to renew an existing contract once it has expired and can also terminate their contract with the consent of the insolvency administrator or with the permission of the Court, if they agree continuing to supply would cause the supplier hardship.
If a customer enters a formal insolvency procedure, a supplier can wait for a new reason to end the contract, like non-payment for supplies made after the commencement of the insolvency. They may also be able to exercise other contractual rights, like contractual set-off and netting rights.
A supplier may, if its contract permits, terminate for convenience, as long as supplies continue to be made during the notice period.
If the existing contract is a single-purchase order, the supplier may reject new orders from the customer, particularly when the contract is structured as a framework agreement and each new order constitutes a separate contract.
Considerations for new contracts
A few considerations for future contracts might include:
- Reducing the contract term to ensure the supplier is not locked into supplying the customer for a considerable period in any insolvency procedure.
- Structuring contracts as a framework agreement, so each supply is treated as a separate contract, allows the supplier to decline orders.
- Tightening payment processes to ensure an early warning of customers experiencing financial problems before insolvency is triggered.
- Requiring regular financial information from customers to assess continued solvency.
- As an interim step falling short of termination, a supplier could consider including a provision allowing it to suspend further supplies under the contract for repeated or lengthy periods of non-payment by the customer.
- Allow termination for convenience. Ensure that the supplier can terminate for convenience and include as short a notice period as makes commercial sense.
Choosing your customers wisely
There will be movers impacted by this legislation change and the future of many businesses in the sector will rely on their ability to carefully manage ongoing supply debt.
Also, choosing who you do business with has always been important but now takes on even greater significance and could protect suppliers from the consequences of continuing to supply customers trading insolvently.
Paying close attention to a customer’s financial position before agreeing contracts is also advisable, along with monitoring payment performance, to get an earlier warning of likely difficulties.
Suppliers must train contract managers about the legislation changes and what it means for the business, also with a focus on how to spot the warning signs, including ensuring invoices are paid on time and possibly tightening debt collection procedures.
Every supplier must understand their contractual rights and be ready to exercise them to stop supply or terminate the contract if a customer shows clear signs of financial distress.
Review standard terms and conditions to ensure they offer protection against a customer’s insolvency, as far as possible and if in doubt, seek expert legal advice, as small changes now, could save a lot of trouble in the future.
Lindsay Ellis is a partner and heads the Commercial Law team at Wright Hassall. He advises on outsourcing, procurement and commercial contracts, across a diverse number of sectors including: technology, transport/logistics, public, automotive, engineering (including aviation) and retail.
Photo: Lindsay Ellis