16th June 2020
In March, business secretary Alok Sharma announced measures designed to improve the insolvency system and give companies time and space to weather the coronavirus storm.
One of the measures sought to protect supplies into companies undergoing restructuring by ensuring continuity of supplies, even after a company enters a formal insolvency process. The Corporate Insolvency and Governance Bill is being debated in Parliament and is expected to become law by the end of June.
The current state of play
Suppliers often have arrangements with customers to provide goods and services which they are allowed to terminate if the customer fails to make payment or is insolvent.
Customers facing cash flow difficulties often accrue extra debt to suppliers, either by stretching credit to absolute limits, or seeking to agree terms to pay arrears over a period. These are key signs for suppliers to beware of.
Currently, if a customer becomes insolvent, a supplier can (with certain exceptions) put the customer “on stop”, insist on payment of cash on delivery (COD), or insist on payment of arrears as a ‘price’ for continuing to make any supplies. This means some suppliers may obtain ‘ransom payments’ for arrears, while other suppliers and creditors are left unpaid.
These ransom payments can disrupt the continuity of the customer’s business and what may be critical short-term cash flow in the customer’s profitable but insolvent business. This can be particularly disruptive to a company seeking a rescue by trading in administration to repay arrears from profits or to better secure a sale of the business as a going concern. Ransom payments may risk the viability of any rescue plan. An administrator seeking to trade will be forced to accept a termination of supply or seek other suppliers or ‘do a deal’ that is objectively better for all creditors to secure continuity of supplies.
Of course, for the supplier the ability to terminate supply and recover old debt could mean the difference between survival and its own insolvency.
What are the new laws?
When the bill becomes law, the rights of suppliers will be limited (subject to a hardship exemption).
A supplier will no longer be able to terminate a supply contract or ‘do any other thing’ (e.g. impose different payment terms) once the customer is in any insolvency process unless given permission by the customer, or the court. Suppliers will not be able to require ransom payments, place the customer on stop or COD. It does not matter whether the right to terminate arose before the customer entered an insolvency process, or whether the reason for stopping supplies relates to something other than the insolvency of the customer. Once the insolvency process has started, it will be too late to take action. This means a supplier will not be able to use the threat of terminating or reducing supplies as a tool to secure a ransom payment to get the older debt paid.
Will suppliers be paid for new supplies?
Yes. The contract with the customer may have been important to your business as a supplier. Often that is why suppliers suffer payment delays – to continue to secure profit from the contract (provided they are paid eventually).
Suppliers who choose to make new supplies (or are obliged to continue supplies under this new law) cannot be forced to supply goods or services for free. In any insolvency process the debt for new agreements for supplies and supplies delivered after the insolvency process commences are treated differently and will be paid for by the customer in priority to all their suppliers’ arrears. The timing for payment will depend on the agreed terms and conditions and the insolvency process. Existing suppliers cannot impose new COD terms. It will be even more important to be clear on delivery terms, payment terms and credit limits.
As an existing supplier, if you are not paid for new supplies made during the insolvency process, you will be able to terminate the contract and put the customer on stop or COD terms. However, you will only be paid for the debt that arose before the insolvency process began, if the insolvency process successfully pays a dividend to you and other creditors.
Will the debt for new supplies be guaranteed by the insolvency practitioner?
No. Careful consideration is needed to understand what this means for your business, when you will be paid, whether you must continue supplies and practically, what the customer and the insolvency practitioner will do if you nevertheless refuse.
Do I have a relevant supply contract?
Every agreement and accepted order for delivery of goods or services will be a relevant contract and the new law will apply to those contracts. If goods have been ordered and agreed to be delivered with deferred payment, they will have to be delivered; and if they are accepted, these will be ‘new’ supplies and be paid for in the insolvency process in priority.
Whether there is an existing contract to provide ongoing supplies of goods and services (rather than a series of individual contracts) will depend on your agreed contract terms and conditions, and any formal credit terms previously agreed that supplement those. Whether your terms apply or not is also a key consideration.
What is the hardship exception?
If, as a supplier, you can satisfy the court that by in continuing to supply on existing you would suffer ‘hardship’, the court may grant you permission to terminate the contract. The bill does not explain this further. This means the scope of this exception, whether insolvency practitioners will agree to termination/variation without you applying to court, or how the interests will be balanced is very likely be fact-specific to the particular contracts and those parties (for example, if the ongoing contract is unprofitable or will require capital costs).
Temporary “small entity” exemption
For a temporary period, these changes will not apply to you if you qualify as a ‘small entity’ (if you fall within two of turnover <£10.2m, balance sheet <£5.1m and <50 employees). This temporary exemption is expected to last only for one month after the law becomes effective. Therefore all businesses need to understand how these changes will affect their existing and new supply contracts (and any changes made by your own suppliers)
Note: this is a commentary on draft legislation that may be subject to change. It is important to plan for those changes but to take specific advice before taking action. Nothing in this article constitutes legal advice and we are not liable for any reliance on the information provided. This is a rapidly changing subject, and whilst correct at the time of writing, circumstances may have changed since publication.
If you are seeking advice or would like to discuss any of the points raised in this article, please contact Melissa George or Mark Cullingford in Thrings’ Restructuring and Insolvency team.