Government announces plans to prohibit certain contractual termination clauses
Which termination clauses will likely be prohibited by any new legislation?
Should termination clauses which do not adhere to the new regime be included in contracts? What will be the legal status of termination clauses which are non-compliant with any new legal regime? Will they be void or unenforceable?
In August the Government’s response to the insolvency and corporate governance consultation (the response) was published. In addition to other suggested reforms, the Government proposed a prohibition on suppliers enforcing termination clauses on the grounds that a party has entered into a formal insolvency procedure, or one of the two proposed restructuring arrangements: the new moratorium or the new restructuring plan. The prohibition may also apply to ‘ipso facto’ termination clauses, which relate to the debtor company’s financial position.
Currently, the provision of ‘essential supplies’ to companies which are in administration, or have entered into CVAs, is regulated. Rather than adapting the existing regime and amending the definition or designation of what an ‘essential supply’ is, the Government has opted for a new blanket regime, whereby certain termination clauses are banned. Such a move encroaches upon the freedom of contract but is more in-line with other jurisdictions, such as the USA.
The aim of the reforms is to increase protections for creditors and to provide a fair balance between the rights of the company seeking to be rescued and the rights of the creditors seeking payment of the company’s debts.
There are exemptions to the proposed blanket regime. For example, some financial services are not covered by the prohibition, which reduces the risk that providers may remove debt facilities in order to avoid the effects of the new regime.
Suppliers will still be able to terminate on other grounds, including for non-payment of debt. The efficacy of the ground of non-payment depends upon how long the supplier’s payment term is and how much was left unpaid. If a supplier invoices a company infrequently for large amounts of money, it will be less happy to wait to invoke the non-payment ground for termination in light of the large amount of money which will likely be unpaid.
Why is this important?
If the proposals are enacted into law, contracts for the supply of goods and services will be subject to prohibitions which restrict the abilities of suppliers to terminate contracts. However, the remit of such restrictions is yet to be determined. For example, it is unclear whether ipso facto clauses which are within the scope of the legislation will be void or unenforceable.
Other uncertainties arise in relation to the question of whether ipso facto termination clauses should continue to be included in contracts. It may be desirable to include ipso facto clauses for the following reasons:
- ipso facto clauses might permissibly be invoked before a trigger event such as insolvency.Although, it waits to be seen whether this will be the case
- a supplier which is significantly adversely affected by not being able to invoke a termination clause may apply to the court for permission to rely on the clause if it were more likely than not that the supplier would enter into an insolvency procedure if it continued to supply
- prohibited grounds for termination may need to be included in the contract for liabilities accruing to the supplier to be given priority as expenses of a moratorium, liquidation or administration.Again, this depends on the shape of any future regime.
Any practical tips?
Keep watching! Future announcements and publications issued by the Government on this topic which outline the scope of any prohibition should clarify the uncertainties mentioned above.