Restrictions on terminating supply contracts following insolvency

Where a supplier has entered into a supply contract with a customer and the customer becomes insolvent, under recent legislation suppliers may be prevented from terminating the contract and, in many cases, will be legally required to continue to supply their insolvent customers.

s233B of the Insolvency Act 1986 (s233B) is aimed at protecting the supply contracts of insolvent businesses and was incorporated into the legislation with effect from 26 June 2020 by the Corporate Insolvency and Governance Act 2020. Although s233B was originally brought about because of Covid-19, it is a permanent provision.

Who does s233B apply to and what is its effect?

• s233B applies to contracts for the supply of goods and services (subject to certain exceptions – for instance financial services are excluded). It should also be noted that supply contracts for "essential supplies" (i.e. electricity, gas, water, communications and IT goods and services) are dealt with separately under existing rules. s233B will be triggered if the customer enters into one of a range of corporate insolvency procedures, such as administration, administrative receivership, voluntary arrangement, moratorium or liquidation.
• The provision only applies to suppliers and does therefore not restrict a customer's ability to terminate the contract if the supplier goes insolvent.
• The provision applies to all supply contracts which were entered into prior to 26 June 2020 as well as new contracts moving forwards, so long as the customer has entered into insolvency proceedings on or after 26 June 2020.

So effectively, and irrespective of what a contract actually says, the new rule will prevent suppliers from:

• terminating a supply contract or doing "any other thing" as a result of the customer entering into insolvency, e.g. a supplier cannot change payment terms or otherwise vary the contract
• terminating a supply contract for breaches which occurred prior to insolvency, e.g. for instance where the contract provides that the supplier may terminate for late payment and the customer fails to pay an invoice on time, it will be too late to terminate if insolvency proceedings have already begun
• making it a condition of future goods and services supplies that pre-insolvency debts/arrears are paid, so a supplier cannot insist on the settlement of unpaid invoices

Small supplier exemption

Until 30 March 2021, s233B will not apply to a supplier which is a "small entity". This temporary exemption had been due to end at the end of September 2020 but has since been extended.

A supplier in its first financial year will be a small entity if at least two of the following conditions are met:

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

Otherwise, a supplier will be a small entity if, in its most recent financial year, at least 2 of the following conditions are met:

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

Practical points for suppliers

Despite the restrictions described above, suppliers will still be allowed to terminate a supply contract:

• for new breaches which occur after the relevant insolvency procedure begins
• depending on which insolvency procedure the customer entity is in, with the permission of the insolvency office holder or directors
• although this is less likely, with the permission of the court if the court is satisfied that continuing the contract would cause the supplier hardship

In terms of drafting points for the supply contracts, suppliers should try and ensure they have broad termination rights which are not linked to insolvency, for instance, including a termination for convenience provision and/or including a right to suspend provision of further supplies in the event of non-payment or breach.

Suppliers should also ensure they chase payments of any outstanding sums promptly on the basis that even where the contract includes a specific termination right triggered by late or non-payment, if the customer entity enters a relevant insolvency procedure, the supplier will no longer be able to rely on that provision to terminate the contract.