Don’t terminate on the basis of your counterparty entering into an insolvency procedure

Commercial contracts usually have written terms that allow a party to immediately terminate the contract in the event of the counterparty becoming insolvent. 

Summary of CIGA

As from 26 June 2020, this contractual right has been curtailed as the UK Corporate Insolvency and Governance Act 2020 (the CIGA) has come into force.

The CIGA inserts a new provision into the Insolvency Act 1986 which removes the effect of a term in a contract for the supply of goods and services that allows a supplier to terminate the contract when  the other party to the contract enters into ‘an insolvency procedure’ (which includes administration, the appointment of an administrative receiver, liquidation).  In other words, in contracts for the supply of goods and services, a supplier can no longer terminate on the basis the other party has entered into an insolvency procedure. 

Further, once a party to a contract enters into an insolvency procedure, CIGA prevents the supplier exercising any other contractual termination rights (e.g. for material breach or non-payment) that arose before – but were not exercised before – the insolvency procedure started.

CIGA also restricts the supplier from insisting, as a condition for continued supply under the contract, to be paid all its outstanding charges.

Exclusions and safeguards

The CIGA provisions do not apply to certain financial services agreements (e.g. loan agreements and commodities agreement).

There is a temporary exemption running until 30 September 2020 for certain small companies that meet two of the three following criteria: 1) annual turnover of not more than £10.2 million; 2) a balance sheet of not more than £5 million; or 3) a company having less than 50 employees.

Other exemptions include the supplier being able to enforce a termination provision with the consent of either the company or the insolvent company’s office holder, or by obtaining a Court order.

Another safeguard is provided by the fact a supplier is entitled to terminate for grounds other than insolvency, provided the contractual right to terminate arose post insolvency.  For example, it remains possible to terminate for breach of contract for non-payment where it occurs after the commencement of the insolvency.

IP and Software Agreements

CIGA applies to software agreements. 

CIGA is unlikely to apply to IP agreements, such as assignments which do not relate to the supply of goods or services.  However, it is likely to apply to IP licence agreements because the Government has indicated in guidance that it is intended to cover ‘licenses, such as for use of software or patents.’

Comment

The changes introduced by CIGA are game-changing and are clearly aimed at helping struggling businesses survive.

As a result of CIGA, clients need to carefully consider their existing contracts.  Clients should also consider whether to amend certain terms (e.g. shorten credits terms), consider all contractual grounds for termination before terminating a contract and monitor its counterparty’s financial status (i.e. does it appear to be having cashflow issues).   

Clients should also generally ensure that termination rights are exercised promptly if there is a breach, as if they now wait and the counterparty enters into an insolvency procedure, it is likely they will have lost these rights.

Written by Ramsay Monime, Senior Associate