“Ipso facto” clauses will no longer bee the obvious route out

Emma Keeling

Yesterday, the Government’s Corporate Insolvency and Governance Bill, described by our restructuring team as the most significant insolvency reforms in the UK for a generation, passed through the House of Commons. For a full analysis see their bulletin here. In this post I will focus on so-called “ipso facto” clauses, ie clauses which allow termination due to the bankruptcy, insolvency, or financial condition of a party. [Ed: for an alternative use of ipso facto see Eric the half a Bee.]

Ban on operation of “ipso facto” clauses in certain supply contracts

Suppliers of goods and services should note provisions expanding the existing Insolvency Act 1986, preventing:

  • reliance on a supplier termination right triggered by the customer entering into an insolvency procedure;
  • a supplier “doing any other thing” in respect of that contract, where “that thing” is triggered by the customer entered into an insolvency procedure.

In short, a supplier must continue to supply goods and services to a customer entering an insolvency procedure, and must not look to vary or exercise rights under the agreement triggered by the same.

And what are the relevant insolvency procedures?

The insolvency procedures that trigger the ban are:

  • a moratorium;
  • administration;
  • administrative receivership;
  • approval of a company voluntary arrangement;
  • liquidation or provisional liquidation; and
  • a convening order under the new reorganisation measure contemplated by the Bill.

So what does this mean for the bottom line?

A supplier is entitled to continue to receive payment for the ongoing supply. but it must not make future supply conditional upon payment of outstanding fees arising prior to the insolvency procedure.

And what about a supplier’s other termination rights?

A supplier’s unexercised right to terminate for any other event or default, arising prior to an insolvency procedure, is suspended once the insolvency procedure begins.

A supplier may, however, exercise rights in relation any other event or default if it occurs after the insolvency procedure begins. The most obvious right and comfort for suppliers being termination for non-payment.

Do these changes apply in all contexts?

A supplier may rely on its “ipso facto” termination right in three limited circumstances, each involving uncertainty, additional time and potential cost. Specifically, (i) with the consent of the customer or (ii) with the consent of the relevant office holder (administrator, administrative receiver, liquidator or provisional liquidator), or (iii) with court permission due to supplier “hardship” (currently undefined).

Whilst restrictions apply to contracts for the supply of goods or services they do not apply to certain financial agreements nor to agreements where a financial services entity is party (see here for the full lists). For a short period of time (one month from entry into force of the Bill), “small company” suppliers (meeting at least two of: turnover not more than GBP 10.2m; balance sheet total not more than GBP 5.1m; and no more than 50 employees) are not caught by the ban on “ipso facto” clauses and are not compelled to continue the supply.

What next?

Many suppliers will already be keeping a closer eye on customer financial stability. Having a good sense of exposure to vulnerable companies and considering if, when, and how, to exercise termination rights, will help strategic thinking and risk assessment once the new provisions take effect.

The Government intends to use emergency powers to expedite the Bill, with a view to receiving royal assent this month or in early July.