Can you terminate a supply contract if your client is now insolvent?   

Can you terminate a supply contract if your client is now insolvent?   

'I am a supplier to a company that has gone into administration. Can I use the termination clause in our supply contract in order to stop supplying that company, now that it is insolvent? I’m worried I won’t get paid.' 

When a company you are supplying goes into a formal insolvency process such as administration or liquidation, as a supplier you are likely to be very concerned about any arrears that may be owed to you, as well as ensuring that you do not increase these arrears by continuing to supply goods you are worried you won’t be paid for. 

But what is your legal position in this situation, and what steps can you take to protect yourself as a supplier? Harper James insolvency solicitor Eleanor Stephens discusses the options available to you. 

The legal position

For many years suppliers were able to rely on a clause in their supply contract that allowed them to immediately terminate any further supply should the company they are supplying to go into a relevant insolvency procedure. This might be a liquidation or administration, for example. 

However, the law expressly excluded ‘essential’ suppliers, such as gas and electricity suppliers, who by law had to continue to supply a company in difficulties. This was on the basis that it would be impossible to rescue a company if it couldn’t use simple supplies such as electricity.  

The list of what is considered to be ‘essential’ supplies was extended in 2015 to include IT suppliers and other private utility suppliers. 

However, when Covid came along, a disproportionate amount of companies suffered financial difficulties and entered into a formal insolvency processes. The government recognised that to ensure these companies had a chance of being rescued, it needed to amend the law so that not just essential suppliers, but all suppliers had to continue to supply companies in insolvency, with certain limited exceptions.  

What is the position now as a supplier

As a result of changes in the law during covid, suppliers are not able to refuse to supply a company which is in an insolvency process, and can no longer demand payment of pre-insolvency debts as a condition of continuing to supply. The restrictions remain in place for the duration of the insolvency process. 

However, a supplier can insist on being paid for all ongoing supplies and it may also request a personal guarantee from the office-holder in respect of payment for those on-going supplies. 

What is in it for a supplier

While it may seem unfair that suppliers cannot make their own decision to terminate a supply contract due to insolvency, the rescue of a company can often bring a better overall return for a supplier in the long run than the end of that company. This is because a trading company always has a better chance of repaying its debts than a liquidated business. In addition, it is generally to the benefit of the economy overall for businesses to survive and prosper.  

What if I can’t afford to continue to supply

A supplier has the option to apply to court if continuing to supply will cause ‘hardship’. What that actually means in practice is not clear, but government guidance suggests that this might apply if the supplier company itself faces insolvency as a result of continuing to supply. 

A supplier can also speak to the office holder (for example, the liquidator or administrator) and agree a termination of supply. And if this is not going to be a major issue for the insolvent business, the office holder may agree to this. 

It is worth asking a commercial lawyer to double check your supply contract for other grounds for termination that don’t rely on insolvency. For example, breach of contract, as long as this breach takes place after the insolvency. If the breach was before, and it wasn’t acted on, then you lose the opportunity to terminate.  

Is it possible to prevent this problem in the future

Suppliers should take legal advice from a commercial lawyer on ways to tighten up their supply contracts going forward to allow for termination for other reasons. For example, termination for late payment, or for breach or default. 

You can also change your rights to terminate so that they cover a situation other than a formal insolvency event. For example, giving you a termination right if the company is taking steps to enter a formal insolvency process, such as filing a Notice of Intention to Appoint Administrators. Obviously, you may need to act quickly as soon as you become aware of the steps, because once the process is formalised, you lose the right to terminate. 

Depending on your negotiating strength, you could request a personal guarantee from directors in respect of unpaid sums.  

How can we help

Our Insolvency and Commercial law solicitors at Harper James have many years of experience in drafting supply contracts that will protect suppliers in all situations. Should the worst happen and you find yourself having to deal with an insolvent company, our teams can work with you to ensure that you minimise losses. 

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