A party’s right to terminate a contract in the event that the other party becomes insolvent is a commonly seen termination right in technology and outsourcing contracts. However, the enforceability of such clauses could change as a result of powers given to the Government in the Enterprise and Regulatory Reform Act 2013 (the “ERRA”). The objective is to ensure the continuity of certain essential supplies to insolvent businesses with the aim of helping such businesses to be rescued from insolvency.
What is the current law?
The powers given to the Government in the ERRA enable it to build upon existing legislative provisions contained in the Insolvency Act 1986 (the “IA”) relating to the protection of the supply of essential utility services to insolvent businesses. The supplies covered by the IA include the supply of gas, electricity, water and communications services and the provisions of the IA apply in a case where a company enters into most formal insolvency processes.
The IA currently prevents suppliers of such services from withdrawing their services by reason of their customer’s insolvency. It also prevents them from seeking to impose preferential terms as a condition of continued supply or demanding payment of pre-insolvency debt as a condition of further supply.
The IA does however provide some safeguards to protect suppliers of essential services, for example the supplier may make it a condition of the supply that the administrator personally guarantees the payment of any charges in respect of the supply. It should also be noted that there is nothing in the IA preventing suppliers from relying on clauses in supply contracts which allow them to terminate their contract on the onset of formal insolvency proceedings.
What is the current practice in the IT industry?
As the provisions of the IA do not currently apply to suppliers of IT services, when a business enters insolvency, IT suppliers may take a number of actions. For example, a supplier may:
- withdraw their services;
- demand additional ‘ransom’ payments before they agree to continue to provide the services they were providing before the insolvency;
- put businesses on more expensive tariffs; or
- change the terms of the supply more generally.
Such actions can severely impede any chances of business rescue and this is what the Government is seeking to change by exercising the powers given to it in the ERRA.
What is being proposed?
The ERRA allows the Government to pass secondary legislation to add supplies “for the purpose of enabling or facilitating anything to be done by electronic means” to the list of essential supplies that are currently protected under the IA.
Insolvency practitioners have long argued that the actions of some essential suppliers in insolvency are hindering otherwise viable business rescues. However, at the same time, the Government recognises that the interests of essential suppliers should be protected and the powers given to the Government in the ERRA contain strong safeguards to protect such interests.
There is clearly a balance to be struck in any new legislation between protecting the interests of IT suppliers and the facilitating the rescue of businesses in financial difficulty. As a result, the Government has recently carried out a consultation to consider how the powers contained in the ERRA may be exercised and what the likely impact of any new legislation will be, in order that the interests of all concerned may be taken into account in framing the provisions. The consultation closed on 8 October 2014 but, at the time of writing, the results of the consultation had not yet been published.
In summary, the Government has consulted on the following proposed changes:
1. Applying existing provisions to ‘on-sellers’ of utility supplies
Commercial practice and supplier behaviour has moved on considerably the IA was enacted in 1986. The utilities and telecoms markets have become much more fragmented and this has led to differences in interpretation and application surrounding the existing obligations contained in the IA. In particular, intermediate providers (or “on-sellers”) of utilities and telecoms services and equipment (e.g. landlords who charge tenants for the supply of electricity or other services) are not generally considered to be covered by the provisions of IA.
The Government’s intention is that the scope of the current provisions should be extended so as to specifically apply to on-sellers. In short, this will mean that any supplier of utility or telecoms services that carries on a business of providing such supplies will be subject to the provisions.
2. Adding IT suppliers to the list of utility suppliers covered by the IA
Although it is not yet clear exactly which service providers will be caught by the any new legislation, the Government has recognised that, in today’s technologically advanced world, IT goods and services are often critical to the day-to-day functioning of a modern business. The Government believes that is would aid business rescue if suppliers of IT services (including “on-sellers” of such services) were therefore brought within the scope of the IA.
It is anticipated that suppliers of a range of different services including computer software and hardware, accounting software, servers, cloud storage solutions, electronic payment systems and website hosting services may be caught in the ambit of “IT services”.
3. Preventing reliance on insolvency termination clauses
The Insolvency Act does not in itself provide for the continuity of supply of utility services as this obligation is derived from the specific utilities legislation. Moreover, there is not currently a requirement for IT supplier to continue to supply to an insolvency business. However, the powers in the ERRA allow the Government to render void the following clauses in the event that a company enters administration or a voluntary arrangement:
- termination clauses which allow supplier to withdraw their supply;
- clauses which cause a contract to automatically terminate when a business enters administration or a voluntary arrangement takes place; and
- contract terms which automatically, or provide the supplier entitlement to, increase the charges of supply on account of the business entering into insolvency (so called “ransom payments”) or do any other thing when the business enters administration or a voluntary arrangement takes place.
How will this affect IT suppliers?
Most contracts for the supply of services entitle the supplier to terminate the agreement on the customer’s insolvency. If the Government’s proposals become law, then this type of provision will become ineffective. The proposals would also prohibit contract terms enabling the supplier to increase its charges on the customer entering into an insolvency process.
When exercised, the powers will impose an effective obligation on utility and IT suppliers to continue their supply to an insolvency business on their existing terms. However, such requirement will be subject to a number of safeguards including:
- the right to request a personal guarantee from the insolvency office-holder as a condition of continuing to supply an insolvent company;
- the ability to withdraw post-insolvency supplies if any charges in respect of that supply are not paid within the period of 28 days beginning on the day on which payment is due; and
- the ability to apply to the court for permission to terminate the contract is they believe that being required to continue to supply with cause them undue hardship.
Moreover, it should be noted that supplies made to an insolvent business will, in the case of an administration, rank as an expense of the administration and will therefore have priority over other creditors.
What can IT suppliers do?
It remains to be seen what the terms of any secondary legislation will be but suppliers of IT services should begin to think about whether they should be altering their terms and conditions of business or their business behaviours in light of the new powers introduced by the ERRA. In particular, suppliers should consider:
- the validity of any clauses contained in their terms and conditions which grant them a right to terminate the agreement in the event that the customer becomes insolvent (as any new legislation may negate such provisions); and
- whether their terms should contain any of the following:
- a requirement for any insolvency practitioner appointed to personally guarantee the future cost of supply in the event that the customers enters insolvency;
- a right to terminate in the event that insolvency practitioner does not provide such a guarantee; and
- a right to terminate in the event that any post-insolvency fees are overdue by 28 days or more.