Guidance

Prohibition of termination clauses

Updated 5 June 2020

This guidance was withdrawn on 22 February 2023

This bill became law on 25 June 2020. See the Corporate Insolvency and Governance Act 2020.

What are we going to do?

When a company enters an insolvency or restructuring procedure, suppliers of goods and services will often either stop or threaten to stop supplying the company. The supply contract often gives them the right to do this, but it can jeopardise attempts to rescue the business. The Bill will mean suppliers will not be able to use contractual terms to jeopardise a rescue in this way. The proposals do not apply to termination events after an insolvency procedure commences, in that suppliers can be relieved of the requirement to supply by agreement or by the court if it causes hardship to their business. There will also be a temporary exemption for small company suppliers during the emergency.

How will it work in practice?

Take this example case study:

A large wholesale food/drink supplier has suffered a reduction in turnover as a result of COVID-19. One of its customers with which it has an ongoing contract, a catering firm, enters a moratorium. Under the contract, the wholesaler can stop supplying food and drink to the catering firm. Under the new provisions, the wholesaler cannot terminate the contract solely on the grounds of the catering company’s insolvency. There are no arrears outstanding on the contract.

The wholesaler contacts the company to seek agreement to terminate the contract. If the directors of the catering company agree, the contract can be terminated.

In this example, the directors of the catering company explain that they are using the moratorium period to seek additional finance and the contracted supplies are critical to continued trading. Rather than agree to termination, they request further supplies under the contract. The contract with the wholesaler commits it to supply for a further 5 months.

The wholesaler considers whether it can afford to provide the supplies. If supplying the catering company will cause the company hardship (for example, if its own solvency is threatened) the wholesaler can apply to Court for permission to terminate the contract.

In this example, the wholesaler decides not to apply to Court to terminate the contract. It provides the requested supplies to the catering company under the contractual payment terms of 28 days from date of invoice.

After 28 days, the catering company remains in a moratorium. If the supplies are not paid for when they fall due, the wholesaler is allowed to terminate the contract. As payment of ongoing supplies is also a condition of the moratorium, the moratorium monitor will bring the moratorium to an end.

In this example, the catering company pays for the supplies within the payment terms. It obtains additional finance and exits the moratorium as a going concern.   ##Who will it apply to?

These measures will apply to:

• The main incorporated forms
• Mutuals (including co-operatives and community benefit societies but not credit unions)
• Limited liability partnerships
• Other bodies and associations, whether or not incorporated

These measures will apply to suppliers that are:

• All the main incorporated forms
• Mutuals (including co-operatives and community benefit societies)
• Limited liability partnerships
• Other bodies and associations, whether or not incorporated
• Individuals carrying on a trade or business

Exclusions will apply to:

• Financial services firms and contracts
• Public-private partnership project companies
• Utilities, communications and IT service providers that are already covered by sections 233 and 233A of the Insolvency Act 1996

Pandemic specific measures mean we will temporarily exempt small suppliers from the requirement.

How will a supplier know if it is exempt during the temporary period?

A company enters administration during the temporary period.

The company has contracts with three suppliers. Each of the contracts includes a clause that permits termination on the grounds of insolvency. The suppliers know that new legislation prohibits the use of such clauses but that (for a temporary period) ‘small’ suppliers are exempt. They are uncertain whether the exemption applies to them.

The provisions state that a supplier is small if, in its most recent financial year, at least two of the following conditions were met:

• Condition 1- the supplier’s turnover was not more than £10.2 million;
• Condition 2- the supplier’s balance sheet total was not more than £5.1 million;
• Condition 3- the average number of the supplier’s employees was not more than 50.

In its most recent financial year Supplier 1 had an annual turnover of £8.9 million, a balance sheet total of £3.5 million, and employed 60 people. Supplier 1 meets two of the conditions; it is therefore exempt from the provisions in the temporary period and can rely on the insolvency clause in the contract to terminate supply.

Supplier 2’s most recent financial year was only 9 months long. In this case the maximum figure for turnover is proportionately adjusted.

Once these adjustments are considered Supplier 2 meets only one of the conditions; it is not exempt from the provisions in the temporary period and may not rely on the termination clause in the contract.

Supplier 3 is a new company in its first financial year. In this case the conditions are adjusted as follows:

• For condition 1- the supplier’s average turnover for each complete month in the supplier’s first financial year is not more than £850,000;
• For condition 2- the aggregate of amounts which would be shown in a balance sheet of the supplier drawn up at the time the customers insolvency procedure began is not more than £5.1 million;
• For condition 3- the average number of persons employed by the supplier in the supplier’s first financial year is not more than 50.

Once these adjustments are taken into account Supplier 3 meets all three of the conditions; it is therefore exempt from the provisions in the temporary period and can rely on the insolvency clause in the contract to terminate supply.