Corporate Insolvency and Governance Act: Ipso Facto (Termination) Clauses

The new Corporate Insolvency and Governance Act 2020 (the "CIGA"), which came into force on 26 June 2020, extends the UK's existing "essential supplies" regime (which ensures that certain critical supplies such as gas, electricity, water and IT continue to be available to a company post-insolvency) by introducing a so-called 'ipso facto' (termination) provision to the Insolvency Act 1986.

This provision restricts the ability of a supplier of goods or services to a company in a formal rescue or insolvency procedure to terminate the supply contract. The ipso facto measure will apply when the recipient of the supply enters a range of insolvency procedures, including for example the CIGA's new moratorium and restructuring plan, in addition to administration and liquidation (among others). Unlike some of the temporary changes contained in the CIGA, which we review in our CIGA overview briefing, the ipso facto provision is a permanent change to the UK's restructuring and insolvency regime.

Why has an ipso facto provision been introduced?

The ipso facto provision is a statutory override of the insolvency termination provision in a contract. It is intended to assist an insolvent company in preserving its business critical contracts with a view to facilitating a rescue of the company or its business. In this way, the ipso facto provision is designed to complement the other rescue tools in the CIGA: the moratorium, and the restructuring plan.

When will the ipso facto provision apply?

Ipso facto only applies to contracts for the supply of goods and services. The ipso facto provision is therefore narrower than its US Chapter 11 counterpart, which generally applies to all executory contracts (subject to carve-outs). This discrepancy in scope is highlighted by the conflicting judgments handed down by the US and UK courts in Belmont Park Investments PTY Ltd v BNY Corporate Trustee Services Ltd, in which a subordination or "flip" clause (an ipso facto clause which effectively reversed the parties' priority under the payment waterfall) was held to be valid and enforceable by the UK Supreme Court, but was found by the US bankruptcy court to be unenforceable pursuant to US bankruptcy law. Given the narrow scope of the CIGA ipso facto provision, the Belmont case would still be decided in the same way, thereby demonstrating a continuing difference between the two regimes.

There is a long list of exceptions to the type of supplier or contract which fall within the remit of the ipso facto provision in the UK. For example, contracts for the supply of goods or services to or from insurers, banks and recognised investment exchanges (amongst others) are excluded, as are financial contracts (including contracts for the provision of financial services), securities financing transactions and derivatives.

The provision applies in the event that a company that is party to a contract for the supply of goods or services enters a "relevant insolvency procedure", defined as a moratorium, administration, administrative receivership, a company voluntary arrangement, liquidation, provisional liquidation or a restructuring plan. Notably, the CIGA does not include a scheme of arrangement in this list notwithstanding that its close counterpart, the new restructuring plan is included. The decision to include liquidation is also interesting: whilst ipso facto would have been helpful in a trading liquidation such as Thomas Cook or British Steel, such liquidations are not the norm. Since the purpose of ipso facto is to aid the rescue of a company as a going concern or of its business, permitting such interference in contractual rights is arguably not justified in a typical liquidation where the business ceases to trade almost immediately.

Whilst the ipso facto provision is a permanent change to the UK's insolvency regime, the CIGA contains a temporary exclusion for small suppliers, which effectively permits such small suppliers to terminate contracts for the supply of goods or services with companies which enter into a "relevant insolvency procedure" between the date of enactment (26 June 2020) and 30 June 2021.* A supplier will be classed as a "small supplier" if it satisfies at least two of the following conditions in relation to its most recent financial year:

1. a turnover of not more than £10.2 million;
2. a balance sheet total of not more than £5.1 million; or
3. 50 or fewer employees.

What does ipso facto do?

Ipso facto has two main effects:

1. a supplier's contractual right to terminate on the grounds of insolvency is permanently switched off as from the date of the relevant insolvency procedure. This permanent switch-off also applies to any contractual rights a supplier may have to "do any other thing" due to the company entering into a relevant insolvency procedure (for example, amending payment terms); and
2. a supplier's contractual right to terminate on the grounds of any pre-insolvency events of default are temporarily suspended until the relevant insolvency procedure comes to an end (unless the company exits into a subsequent insolvency procedure).

Where the ipso facto provision is engaged, a supplier cannot make it a condition of post-insolvency supply that any outstanding invoices must be paid.

Are there any exceptions?

There are some limited safeguards for suppliers in the form of three exceptions, whereby termination by a supplier on account of an insolvency event will be permitted:

1. with the consent of an office holder (i.e. an administrator or liquidator) or the company itself, if it is subject to debtor-in-possession proceedings (for example, the new restructuring plan or a company voluntary arrangement);
2. with the approval of the court, where continuation of the contract would cause the supplier hardship (the CIGA does not define "hardship" and the onus will be on the judiciary to establish the relevant threshold, but our expectation is that a relatively high bar will be set); and
3. if a post-insolvency event of default occurs giving rise to a new event of default, such as non-payment.

How will ipso facto work in practice?

The scope of the ipso facto provision is limited to contracts for goods and services and only where the recipient of the supply enters into a relevant insolvency procedure. It will not protect, for example, an insolvent company's customer contracts.

Its scope is also limited to long-term contracts for supply, rather than arrangements which are made on an order-by-order or ad-hoc basis, so our expectation is that, in many cases, ipso facto will not be engaged.

Last (but not least), the ipso facto provision does not provide for circumstances in which an office holder does not want to continue taking supply of certain goods or services (unlike its Chapter 11 counterpart). In fact, under the new regime, suppliers contracted to supply goods or services will be under a statutory duty to continue performing their contractual obligations, regardless of the office holder's intentions or ability to pay for the goods or services. Both office holders and suppliers will have to resolve any supply issues early on in an insolvency, in order to avoid disputes over whether unwanted supplies should be paid for as a liquidation or administration expense.

When considering the extent to which the new ipso facto provision fetters a party's contractual right to terminate in the event of a counterparty's insolvency, the identity of the parties to the contract in question and the exact nature of the agreement between them will be crucial. It is clear that different stakeholders in an insolvent company will be affected to varying degrees. Banks are only be affected to a limited extent, whilst the impact on a supplier with a large market capitalisation which is bound to long-term contracts will be significant. The interaction between the ipso facto provision and other proposals contained in the CIGA should also be considered.

For more information on anything in this briefing or the CIGA, please contact your usual Ashurst contact.

* This date has been extended to reflect The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Extension of the Relevant Period) Regulations 2021.

With thanks to Charlotte Harvey and Samantha Ross for their contribution.