The bill introduces a permanent change to the use of termination clauses in contracts © NIKLAS HALLE'N/AFP via Getty Images
The bill introduces a permanent change to the use of termination clauses in contracts © NIKLAS HALLE'N/AFP via Getty Images

New insolvency law risks creating 'non-pay culture' in supply chains

The UK government has introduced legislation that means suppliers will not be able to stop supplying a company that has entered insolvency.

Under the Corporate Insolvency and Governance Bill, introduced to Parliament on 20 May, termination clauses that engage on insolvency will be prohibited, “preventing suppliers from ceasing their supply or asking for additional payments while a company is going through a rescue process”.

Lawyers have expressed alarm at the measure, telling SM there is a risk of supply chains becoming “characterised by a non-pay culture”.

The Department for Business, Energy and Industrial Strategy (BEIS) said the bill introduced a “permanent change to the use of termination clauses in supply contracts”.

“As a result of the measure, where a company has entered an insolvency or restructuring procedure or obtains a moratorium during this period of crisis, the company’s suppliers will not be able to rely on contractual terms to stop supplying, or vary the contract terms with the company, for example increasing the price of supplies.

“The customer is required to pay for any supplies made once it is in the insolvency process but is not required to pay outstanding amounts due for past supplies while it is arranging its rescue plan.”

BEIS added: “The measure also contains safeguards to ensure that suppliers can be relieved of the requirement to supply if it causes hardship to their business. There will also be a temporary exemption for small company suppliers during the emergency.”

The bill introduces the concept of a “moratorium”, which gives firms “breathing space to pursue a rescue plan during which no legal action can be taken against a company without leave of the court”.

John Whiteoak, a partner in law firm Herbert Smith Freehills’ disputes practice, told SM: “We are concerned that the new legislation will result in companies (whether genuinely because of Covid-19 or otherwise) being allowed to maintain liquidity by essentially not paying suppliers, running the risk that supply chains become characterised by a non-pay culture – which may lead to financial distress through the arteries of our economy.  

“For a supplier who is not paid on time this legislation offers little recourse other than them not paying their suppliers. And so on throughout the supply chain.

“It is not that the policy itself is wrong, and it is commendable that the government is acting quickly and decisively; it is just fundamental change introduced quickly and without time for full consultation leads to the risk of unintended consequences.”

Whiteoak added: “We support the underlying philosophy and goals of the proposed bill – to enable otherwise strong companies to survive during a period of unprecedented interruption and turmoil. 

“Nevertheless, we consider that many of those changes could have been achieved with less radical amendments and working within the existing insolvency law.”

Kevin Pullen, a partner in the firm’s insolvency and restructuring practice, said: “We would encourage the government to consider a more phased introduction of some of these measures to give time for industry, suppliers, financial creditors and practitioners to assess their impact.

“Insolvency law represents a delicate balance between a debtor and its creditors and that dynamic is fundamental to an efficient business environment and the free flow of credit and liquidity.  The UK has always been rightly cautious about interfering in that dynamic and it should remain so.”

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