In the dynamic landscape of UK commerce, companies rely heavily on supply contracts to ensure a consistent flow of goods and services. However, when one party enters insolvency, if not handled correctly, these contracts can bring significant challenges that ultimately disrupt the solvent companies own operations and financial stability. In this article, Beyond Corporate’s William Appleyard delves into the challenges and implications surrounding supply contracts with insolvent companies and explores strategies to navigate these precarious situations.
Legal Framework: Sections 233, 233A and 233B Insolvency Act 1986
The Insolvency Act 1986 (“IA 1986”) serves as the cornerstone of legislation governing insolvency proceedings in the UK. Over the years, amendments to the IA 1986 have introduced provisions aimed at safeguarding the interests of insolvent companies while attempting to balance the concerns of creditors and suppliers. At its core, this legislation has been designed in the spirit of affording an insolvent company a greater opportunity to recover from its insolvency situation and continue its business in the future. However, these provisions can also burden suppliers, potentially drawing them closer to insolvency.
Sections 233 and 233A of the IA 1986 offer limited protection to insolvent companies by preventing suppliers of “essential supplies” such as gas, electricity, water and communications, from demanding outstanding payments or terminating supply contracts. However, the definition of “essential supplies” is narrow, affecting only a relatively small percentage of supply contracts.
Recognising that what is considered essential supplies often falls outside of this definition and may differ widely from one company to another, Section 233B was introduced in June 2020. This legislation applies to the vast majority of contracts for the supply of goods and services, representing a significant shift in insolvency legislation. This broader scope prevents suppliers from terminating contracts for supply of goods or services as a result of their counterpart’s insolvency, thereby ensuring the continuity of essential services. Any automatic termination provisions within the contract that are triggered when a company enters the insolvency process are therefore, essentially, meaningless. It also prevents a company from terminating a contract for a pre-insolvency breach if the insolvency process has already begun.
Effects on your business
The combined effect of this legislation can lead suppliers to feel that they are effectively held to ransom. Suppliers may be obliged to continue to provide goods or services without receiving payment, straining their cash flow. Devoting resources to fulfil contractual obligations with insolvent companies may also divert attention away from other potentially more lucrative business opportunities. Finally, suppliers may face legal and compliance challenges if they fail to fulfil contractual obligations, even in the face of non-payment by their insolvent counterparts.
What can you do to safeguard your business?
Navigating the complexities of supply contracts with insolvent companies requires a multifaced approach that encompasses legal, financial, and strategic considerations. For non-insolvent parties, the following pro-active measures can mitigate risks and enhance resilience in the face of insolvency-related challenges:
- Maintain Good Relationships: Cultivate strong working relationships with your counterpart to identify financial distress signals early and foster open communication channels.
- Monitor Financial Health: Conduct thorough financial due diligence before entering contracts and regularly assess the financial health of your counterparts to identify potential risks and inform proactive risk management strategies.
- Implement Contractual Safeguards: Include robust provisions allowing for efficient termination in order to protect your businesses interest. This could include a term that is triggered should the other company take steps to enter a formal insolvency process.
- Proactively Manage: Monitor and follow-up on outstanding payments in a timely manner to mitigate financial losses and serve as an indicator of the possible financial distress of your counterpart.
- Invest in Staff Training and Knowledge: Ensure staff are equipped to identify and raise financial concerns with decision-makers, enhancing early risk management.
- Diversify Clientele: Reduce dependence on a single client to enhance your businesses overall resilience to disruptions.
- Engage with Insolvency Practitioners: Consider entering dialogue with insolvency practitioners to facilitate mutual understanding and foster collaborative solutions that balance the interests of all parties involved.
- Seek Expert Legal Advice: Instruct legal experts experienced in insolvency and commercial law to assist you in navigating these issues, both in responding to insolvency situations and in pre-empting them before they arise.
Conclusion
Navigating supply contracts with insolvent companies presents multifaceted challenges that require careful consideration and proactive strategies. By understanding the legal framework, maintaining robust contractual provisions, and fostering collaborative relationships with your insolvent counterpart and insolvency practitioners, this can allow you to effectively mitigate risks in an uncertain business environment. As businesses continue to adapt to evolving market dynamics, proactive risk management and strategic foresight remain essential pillars for ensuring resilience and sustainability amidst these increasingly uncertain times.
