When a supplier’s customer appears to be in financial difficulties it’s natural for suppliers to want to consider whether to ‘cut their losses’ rather than extend ongoing credit.
Mark Cullingford, Thrings’ Head of Restructuring and Insolvency, discusses the important issues businesses need to look out for and why such decisions need to be considered carefully.
Start with the contract – what does it say?
Consider the nature of the contract terms. Some supplier relationships for supplies of goods or services are a series of ad hoc agreements and there is no obligation to make further supplies at all; other contracts may require ongoing supplies until a contract is terminated. Take care to understand the contract terms and whether there is any possible dispute about the relevant terms.
It is important to understand the nature of the contract and whether there is an ongoing supply obligation and what triggers permit the suspension or withholding of further delivery of goods or services or the termination of all future obligations.
The contract with the customer may include express contractual rights that permit the suspension or termination of either specific one-off supplies or ongoing obligations (e.g. right to withhold deliveries upon simple notice, non-payment, failure to remedy a remedial breach, events indicating financial difficulty and formal insolvency). Some obligations may remain or arise on or after termination.
Care is needed in considering options and notice provisions will provide for how to communicate your decisions. The supplier should comply with their obligations to ensure the supplier is not found in breach of contract themselves and exposed to a risk of being liable for damages for causing loss to the customer.
Formal insolvency procedures – restrictions on insolvency related terms?
The contract terms may not however be the last word on the issue. The nature and importance of the goods and services supplied may also be a factor to consider because terms may be implied into the contract by legislation or regulations that restrict the right to rely on those terms.
If formal insolvency proceedings have commenced, provisions of the Insolvency Act 1986 (s.233, 233A and 233B) may restrict the exercise or effect of contract terms that are intended to protect a supplier if the customer is insolvent by permitting the termination of the contract or changing the terms. These provisions seek to strike a balance between the interests of the insolvent customer (and all its creditors) and the supplier.
There are three types of cases:
In each case the timing of action is key. A right to terminate or suspend or alter supplies may arise contractually before these Insolvency Act restrictions arise. Likewise, there may be an opportunity to recover goods delivered if they have not and may never be paid for. If rights are not exercised in that window, the power to exercise them may be constrained except on conditions.
A clear understanding of the available rights and whether relevant insolvency procedures have commenced is vital because the restrictions under the Insolvency Act 1986 only arise once specific insolvency proceedings/events have occurred and in some respects to specific types of supplies.
It should be noted that the descriptions of a businesses in financial difficulty are often prone to rumours, misdescriptions or errors leading to misunderstandings. A statement that administrators or liquidators ‘have been appointed’ are often made in the days or weeks before any actual insolvency proceedings have commenced and the appointment is effective. The customer may be taking urgent advice from insolvency practitioners who may become appointed in the future but the restrictions on the exercise of the suppliers under the contract may not have actually arisen.
Striking a balance – the benefit of getting paid for continued supply
The provisions prevent both termination and ‘ransom payments’. Contracts that permit suppliers to benefit from or impose more onerous terms after a relevant insolvency event has arisen cannot be relied on as a condition of further supplies.
The reason for restricting termination rights or for more onerous terms to be dis-applied is to avoid further loss to the customer and its creditors generally. But avoiding that loss should not flow at the cost of the supplier, so the law makes it clear that the supplier is entitled to added protections to require payment for goods or services provided during insolvency proceedings if the insolvency practitioner seeks those supplies. These payments for new supplies are given a priority status and treated as an ‘expense’ of the administration or liquidation, ranking ahead of existing unsecured creditors.
The supplier can clarify this and require a documented commitment from the insolvency practitioner to acknowledge and undertake that they will be paid and paid on time. In practice, this means the supplier forces the insolvency practitioner to make an election to adopt the contract (or not) and gives suppliers confidence that ongoing and agreed services will be paid for. It is important the suppliers to know where they stand and a confirmed ongoing income, if only for a short period, may also be important to the supplier and serve all parties interests.
If the insolvency practitioner wishes to cancel supplies, he may elect to do so at no immediate cost but if the insolvency practitioner seek to reduce the supplies or to agree new terms, the supplier may not be obliged to accept new terms.
There are also safeguards for a supplier if the continuation of supply may cause hardship to the supplier as they can ultimately ask the court to permit termination in those circumstances
Timing of decision making for the supplier
The timely interruption of deliveries of goods or services before formal insolvency proceedings start can prevent financial loss to a supplier.
If a supplier is entitled to and actually terminates the contract for supplies before the Insolvency Act restrictions arise, the supplier will not following the commencement of the insolvency proceedings be required to re-instate services under a terminated contract (unless the services are for utilities - where default contracts will arise or IT services under s.233). If they could have terminated or exercise other rights but failed to do so and they may be restrained from lawfully doing so once formal insolvency proceedings have commenced.
Orders compelling continuing supply are possible, but the imperative of continuity pragmatism and costs considerations mean that consensual arrangements are normally secured if issues arise.
A quick and balanced decision on suspension or termination or enforcement of rights is generally required of the supplier.
What if the company does not pay for supplies after insolvency proceedings commence?
If the insolvency practitioner that is appointed and requests the goods of services fails or refuses to adopt the existing obligations and commit to the existing payment obligations, suppliers may:
In short, the law stops suppliers from walking away just because of insolvency, but they are not trapped into providing further services without payment if the insolvency practitioner seek those goods or services.
IT suppliers – special considerations?
Almost no business can now operate without IT services and supplies. For some IT providers, the instinct may be to terminate services or stop supplying goods once they are notified that a business is in financial difficulty.
A break in the continuity of goods and services provision may prevent struggling businesses from what may be a fighting chance of survival or a better realisation of value for creditors. To keep vital supplies running, IT suppliers are among those that are generally prevented from lawfully terminating contracts or imposing more onerous terms simply because a customer has entered an insolvency process.
For IT suppliers, this means that even if standard terms allow for termination on the commencement of formal insolvency proceedings, they may have to continue providing services - whether cloud hosting, data storage, or hardware support - unless the insolvency practitioner appointed consents that they cease, or the court permits otherwise.
UK GDPR
An IT supplier may be a data processor or a data controller and access to the data may be very important to the customer and their own customers and also to the insolvency practitioner.
If IT systems were cut off overnight, the insolvent company could lose access to financial and business data and also customers and employees’ personal data, when that remains critical and the customer could incur new liabilities if it fails to meet GDPR obligations or suffer data breaches. By keeping systems running suppliers help ensure continuity of processing and protect data security - obligations that remain binding while the contract continues despite the intervention of formal insolvency.
Managing access to data and responsibility for GDPR compliance, access to and return or deletion of data when the data owner is financially unstable or in formal insolvency proceedings can be mutually beneficial to both supplier and customer, but care is needed.
Key takeaways
Thrings’ Restructuring and Insolvency lawyers are highly experienced in advising insolvency practitioners and also successfully advising business owners facing financial difficulties, helping them to take a strategic and tailored approach to the challenges they face that secures the best future of the business. To find out how the team can support you at a time when you need it most, please get in contact.