>
  • The prohibition of ipso facto clauses - what suppliers and insurers need to know
Article:

The prohibition of ipso facto clauses - what suppliers and insurers need to know

04 April 2022

What are ‘ipso facto’ clauses?

The ‘essential services’ regime required providers of critical services such as utilities and IT services, to maintain supplies to a company post-insolvency, if requested to do so by the officeholder.

‘Ipso facto’ provisions historically allowed a supplier to terminate its supply contract with a company that entered into an insolvency procedure, or formal rescue process. The Corporate Insolvency and Governance Act 2020 (‘CIGA’) has effectively prohibited ‘ipso facto’ provisions by introducing a statutory over-ride which voids any such insolvency termination clauses written into the existing agreement. Importantly, the provisions apply in rescue processes such as the moratorium and Part 26A restructuring plan.  

The intention is to broaden the existing regime with the aim of creating a more stable supply base to support company rescues.

To which contracts do the ‘ipso facto’ changes apply?

The prohibition of ipso facto clauses applies to contracts for the supply of goods and services where there is a continuing obligation to supply. This is in addition to the existing ‘essential services’ regime (ie. under s233 of the Insolvency Act 1986) which remains in place.

There are, however, some limited exceptions to its application:

  • where a contract relates to the provision of certain financial services
  • if a supplier can show to a court that continuing to supply will cause it hardship (although demonstrating this is likely to be challenging)
  • a supplier can terminate with the consent of the office holder (or the company if it is in a CVA, moratorium or restructuring plan)
  • Ad hoc/order-by-order supplies where there is no continuing obligation under a contract are not caught by the regime

Breaches of conract, including for non-payment, which occur after the date on which the company entered into an insolvency or formal rescue process would still allow a supplier to terminate.

What is the impact for suppliers?

There is an express prohibition on requiring the payment of pre-insolvency debts as a condition of continuing supply. Where a company is subject to a moratorium it is also prohibited from paying them.  So, suppliers cannot require ‘ransom’ payments as an important supplier to the business.

Suppliers are also prevented from terminating or doing ‘any other thing’ following a relevant insolvency procedure, which is likely to prevent suppliers from changing payment terms post-insolvency event.

How can a supplier mitigate the impact of these changes?

Potential mitigants include:

Pre-insolvency

  • Monitoring the financial position of a customer
  • Tightening payment terms and credit periods
  • Requiring parent company guarantees
  • Considering termination of a contract
  • Amending terms and conditions to remove a continuing obligation to supply
  • Taking out a trade credit insurance policy/ reviewing terms and conditions of existing policies
  • Requiring payment in advance (where commercially feasible).

Post-insolvency

  • Assessing terms and conditions to confirm whether there is a continuing obligation to supply
  • Reviewing retention of title clauses, including understanding when title to goods will pass
  • Refusing to supply and put the onus on the office holder or company to apply to court (although the legal ramifications and potential adverse costs for the supplier should be given careful consideration)
  • Keeping a close eye on payment terms as termination would be available for late payment
  • Once a rescue process is complete, there may be the ability to negotiate new contract terms.

What are the benefits for suppliers?

It is important to remember that the ipso facto regime has been implemented to give companies and businesses a better prospect of being rescued as a going concern. Where successful this is likely to result in a better return on pre-appointment debts and a customer for the longer-term.

While there is no mechanism to require an officeholder to provide a personal guarantee, there is an obligation that post-insolvency supplies are paid for in full. In the case of a moratorium, those liabilities would hold ‘super-priority’ status and rank above other costs and creditors in a subsequent failure which should provide additional comfort.

How could the regime impact on credit insurance?

Given the subdued numbers of insolvencies since the introduction of the prohibition on ipso facto clauses, the full effect is yet to be seen. However, there are several potential areas of consideration for suppliers utilising trade credit insurance:

  • If your customer is showing signs of financial distress, insurance may have been removed pre-insolvency. This should act as a trigger warning to you to review your trading relationship and terms.
  • Dependant on the policy terms, insurers may refuse to provide post-insolvency cover which could create a cash flow impact dependent on payment terms.
  • Credit insurance policies typically allocate receipts to the oldest debt. Where there is effectively a ‘payment holiday’ in place for pre-appointment debts this could similarly have a cash flow impact or have the same effect as if cover were withdrawn for on-going supplies.
  • Dependent on the nature of the supplies, an increase in premiums could be seen given that a supplier’s ability to require payment of pre-insolvency debts is effectively removed by the regime.

What does this mean for you?

Whilst the new regime has been in place for almost two years, its effects to date have been limited due to the lower numbers of insolvencies. You should still take time to understand its impact, assess contract terms and consider implementing additional monitoring or triggers to minimise build-up of debts.

Where continued supply is obligated, on-going supplies should be paid for in full. Where the rescue of the business or company is a realistic prospect, this opens up longer-term options and benefits for suppliers. We can help you with any of these matters, please speak with your local BR contact for further information.