Managing contract performance in the new normal – moratoriums, insolvency provisions and responsible contracting
Last updated: 11:50, 6th October 2020
Managing your contracts so as to best protect your business is always an important consideration, but even more so in the context of the Coronavirus pandemic and the difficult conditions businesses find themselves operating in. This can include measures such as carrying out due diligence on contracting parties to ensure their solvency and stability, reducing payment terms to secure prompt payment, and keeping a close eye on performance to KPIs and other contractual obligations.
However, recent Government guidance and the now-implemented changes to the insolvency regime introduce an additional layer of considerations that businesses should have in mind when doing business in trying times.
Introduction of moratoriums
The Corporate Insolvency and Governance Act came into force on 25 June 2020, having been “fast-tracked” through Parliament from its introduction on 20 May 2020. It will have a significant impact on businesses’ ability to manage contracting counterparties in financial difficulties.
The Act introduces the ability for companies to apply for a moratorium period, initially for a month but with the possibility of extension, during which those companies will be protected from enforcement of debts, repossession of goods, the commencement of insolvency proceedings, and other matters. For further information on the insolvency-related aspects of the Act, see our Coronavirus: Insolvency FAQs.
If a business is dealing with a company in moratorium, this will mean that they will be restricted in their ability to enforce that company’s debts, whether by commencing court proceedings or by repossessing goods in that company’s possession (with certain exceptions). Additionally, the company in moratorium will not be able to make payments over a given value without the permission of their moratorium monitor (an insolvency practitioner), who will only be able to give consent if they think it will support the rescue of the company as a going concern.
These provisions will make it increasingly important that businesses have effective processes in place to monitor the solvency and stability of the companies that they do business with, to ensure that they obtain prompt payment and take any necessary enforcement action before those companies enter into moratorium arrangements.
Termination for insolvency provisions to become ineffective
Also included in the Act are provisions around the protection of supplies of goods and services. These mirror existing provisions relating to the supply of essential goods or services (primarily utilities and communications services), but extend this to the supply of goods and services more generally (albeit subject to a small supplier exclusion, applicable through to 30 March 2021, for companies with at least two of a) a turnover of no more than £10.2m, b) a balance sheet total of no more than £5.1m, and c) no more than 50 employees).
If a company enters into the new moratorium arrangements or into any other of the usual insolvency procedures such as administration, for any contract for the supply of goods or services to that company (including those already in place), any clause entitling the supplier to terminate the contract or supply (or automatically triggering such termination) due to that insolvency will be invalid. This includes where the entitlement to terminate arose before the moratorium / insolvency period, but had not yet been exercised when the period started. In addition, suppliers are not permitted to impose conditions making the continued supply of goods or services through moratorium / insolvency dependent on the company first paying any outstanding charges accrued prior to the moratorium / insolvency period.
There are limited routes to obtain the consent of either the relevant insolvency practitioner or the company itself, but it is likely that this will only be granted if it is in the interests of supporting the rescue of the company. It will also be possible to apply to the court for permission if continuation of the contract would cause the supplier hardship. Given those limited exceptions, there is still some benefit to retaining termination for insolvency provisions in contracts, but businesses need to be aware that these will provide limited protection.
Note also that the supplier may still terminate if the right to terminate arises under another (non-insolvency-related) termination provision during the moratorium / insolvency period, for instance where the customer fails to make payments, and the contract includes a right for the supplier to terminate for non-payment.
Whilst the new measures may seem unfair on suppliers, the reasoning behind them is that the supplier’s right to withhold supply can be detrimental to corporate rescue attempts and can remove significant value out of the business during any restructuring exercise. By introducing these changes the Government hopes to increase the chances of survival for struggling businesses.
What steps should suppliers take in light of the proposed Bill?
Risk profile customers
Suppliers should consider profiling their customer base and moving riskier customers onto tighter credit terms, agreeing credit limits or perhaps requiring payment in advance so as to minimise the effect a moratorium / insolvency would have. Consider also seeking security, including personal / corporate group guarantees, and speak to your insurance brokers about potential insurance cover that might be available.
Revisit terms of supply
Suppliers should check that their contractual rights and protections are not reliant on insolvency event triggers. Ensuring retention of title clauses are included and well drafted would be sensible, as would having an express right to suspend supply in the event of non-payment. Supply contracts should clearly state that a failure to enforce rights does not amount to a waiver of those rights. Consider also whether moving customers to shorter rolling contractual periods would be beneficial – whilst this does have an impact on a supplier’s long term projections, it will at least reduce the risk of the supplier finding itself in the position where it is obliged to continue supplying a customer in the middle of an insolvency procedure in circumstances where it has little chance of recovering amounts owed.
Enforce, enforce, enforce
Prompt enforcement of contractual rights on an ongoing basis will be key to ensuring that suppliers do not face unnecessary exposure in the event that a customer suffers a relevant insolvency event.
Separately to the new Act, the Government issued in early May the document Guidance on responsible contractual behaviour in the performance and enforcement of contracts impacted by the COVID-19 emergency. The message given in this guidance is that “parties to contracts should act responsible and fairly, support the response to COVID-19 and protect jobs and the economy.” It goes on to say that responsible and fair behaviour in contractual arrangements will contribute to supporting the immediate response to COVID-19, and to protecting public health, jobs and the economy, as well as ensuring cashflow, preserving supply chains and markets, and generally ensuring that contractual and economic activity can be preserved and ready to continue post-Covid-19.
The guidance strongly encourages responsible and fair behaviour, and gives a number of examples of particular areas in which this is encouraged, including giving relief for impaired performance, extensions of time for performance, force majeure claims, payment under contracts, exercising remedies, claiming breach of contract, enforcing termination provisions, and varying contracts. The list seems reasonably comprehensive, and covers most actions parties would seek to take in order to protect their own contractual positions.
It is important to note that this is only guidance, without legal effect, and expressly says that it is not intended to override specific contractual relief or any other legal duties or obligations. However, the approach requested by the guidance does share characteristics with the concept of “good faith”, which can be implied into contracts by the courts in certain circumstances. It is possible that the courts may consider that this guidance implies a form of good faith obligation into contracting relationships, where this might not have otherwise been the case, and so putting the requirement for responsible and fair behaviour on more of a legal footing. We will continue to monitor thinking on this issue and provide updates in due course.
The Freeths Commercial Team can help with the review and updating of your standard terms & conditions and supply agreements, and our Debt Recovery and Dispute Management Teams are here to help you quickly and effectively deal with late payments and supplier disputes. Please get in touch to discuss how the Corporate Insolvency and Governance Act will affect your business, and what you can do about it.
If you would like to talk through the consequences for your business, please email us and one of our team will get in touch.
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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