The Government recently introduced legislation changes to help resuscitate the economy, writes Wright Hassall's Lindsay Ellis – but while many are simple, some are more complicated, with far-reaching consequences for the unwary …
One of the most significant changes appears in Section 233B of the Insolvency Act 1986 (introduced by the recent Corporate Insolvency and Governance Act), which prevents businesses 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. There was also an interim exemption (until the end of September) for small suppliers.
This could be a tough situation for suppliers, who are also prevented from demanding outstanding charges be paid as a condition of continuing to supply – which will go against what many will consider good business practice.
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.
A supplier can also terminate their contract with the consent of the insolvency administrator or with the permission of the court – typically if 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.
Suppliers can also refuse to renew an existing contract once it has expired, and can negotiate with the insolvency office-holder to agree an end to the contract.
Considerations for new contracts
In future, the contract a supplier relies on to regulate their relationship with customers must change to protect their own business. A few considerations might include:
• Reduce the contract term to ensure the supplier is not locked into supplying the customer for a considerable period in any insolvency procedure (although this must be balanced against the commercial objective of securing a long-term customer)
• Structuring the contract as a framework agreement, ensuring each supply is treated as a separate contract, which allows the supplier to accept or decline orders
• Tightening the payment structure, which may serve as an early warning of customers experiencing financial problems before insolvency is triggered
• Requiring regular financial information from customers to assess continued solvency, including credit ratings and performance reports
• 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 suppliers impacted by the legislation changes, and, in future, choosing customers wisely may slow growth, but could protect suppliers from the consequences of continuing to supply customers trading insolvently.
Conducting deeper due diligence on a customer’s financial position before agreeing contracts and monitoring payment performance, to get an earlier warning of any likely difficulties, is also advisable.
It will be prudent for suppliers to train those managing contracts on the impact of the changes and how to spot the warning signs, including ensuring invoices are paid on time, and possibly tightening debt collection procedures.
Every supplier must understand its contractual rights and be ready to promptly exercise them to stop supply or terminate the contract promptly if a customer starts showing clear signs of financial distress.
And finally, it would be sensible for the supplier to review standard terms and conditions to ensure they offer protection against a customer’s insolvency, as far as possible. Seeking expert legal advice makes sense too, 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 Warwickshire-based solicitors, Wright Hassall.
