June 24, 2020

Corporate Governance and Insolvency Bill: contract management during uncertain times

Contract management

The Bill has had its first and second reading in the House of Commons, and is now being considered in the House of Lords. It is expected that the bill will be passed by the end of June/ early July.

View our series of articles summarising the Bill:

This blog sets out the key provisions and actions that contract managers and businesses should bear in mind in light of the measures introduced by the draft Bill.

Temporary company moratorium

The Bill introduced a temporary moratorium for companies in financial difficulties to provide them with breathing room whilst they try to rescue their business.

This moratorium has the effect of placing a stay on legal proceedings. If a business is dealing with a company in a temporary moratorium, this will impact the enforcement action it can take against the company to recover any amounts owed to them by the defaulting company.

However, there are certain exemptions from this general moratorium, as suppliers and creditors will be able to bring legal proceedings against the company:

  • with the written consent of the 'Monitor', namely an insolvency practitioner;
  • permission from the court;
  • as a set-off against any claim made by the company in any legal proceedings;
  • criminal proceedings against the company or any of its directors or officers; and
  • proceedings concerning any property or right over which the company exercises the powers of a trustee.

Impact for businesses dealing with a company in a temporary moratorium

Suppliers and creditors may be nervous about the introduction of the moratorium, which is relatively easy to access and may prevent recovery of their debts. However, there is some comfort in the fact that companies can only use the measures if it is likely to emerge as a going concern, with this being monitored and kept under review by the Monitor. The moratorium may be terminated if there is no prospect of rescue.

The Bill does divide the company's debts into three categories:

  1. pre-moratorium debts: with payment holiday;
  2. pre-moratorium debts: without payment holiday; and
  3. moratorium debts.

The following debts must continue to be paid:

  • liabilities arising under a contract/instrument involving financial services, which include bank facilities, capital market arrangements (which captures arrangements involving guarantee or grant of security), and contracts secured by financial collateral arrangements;
  • goods and services supplied during the moratorium;
  • rent in relation to the moratorium period;
  • wages, salaries and redundancy payments; and
  • the monitor's fees and expenses from the commencement of the moratorium.

Unpaid moratorium and pre-moratorium debts, which the company was required to pay during the moratorium, will have priority in a subsequent liquidation or administration where the company enters administration, or winding up proceedings are commenced 12 weeks following termination of moratorium.

Whilst there are some protections for suppliers and creditors, it is crucial that businesses have a comprehensive due diligence process and effective monitoring processes to ensure that the contracting parties are solvent, able to perform their respective obligations under the contract and are financially stable.

A prohibition on supplier termination clauses

One of the permanent measures set out in the Bill will limit the use of termination clauses in supply of goods or services contract that are triggered when a company has entered into an insolvency procedure.

The Bill proposes that where a company has entered into a insolvency or restructure process, or has otherwise made use of the new moratorium right, suppliers to that company will not be able rely on any termination clauses in any supply contracts. The supplier will be prohibited from terminating or otherwise varying the terms of the agreement, even where such a right will have arisen prior to the defaulting party entering into an insolvency process.

The exceptions are limited essentially to small suppliers, which meet two or more of the following requirements:

  1. They have a turnover of no more than £10.2 million per annum;
  2. They have a total net worth as outlined on a balance sheet of no more than £5.1 million;
  3. They have no more than 50 employees.

Suppliers (of any size) are afforded some protection through the right to forego their obligation to continue to supply to the company in question if it is likely to cause them hardship.

Contract management: action points to consider

1.  Communication is vital to maintain effective working relationships with key suppliers and customers. The issues arising from the Covid-19 pandemic are far reaching and are impacting many organisations across a number of sectors. Working together to discuss issues and explore potential solutions will benefit both parties by providing business continuity, certainty and will help to avoid potential costly disputes.

2.  Consider carrying out an internal audit of your contracts:

  • what are the contractual commitments;
  • read and understand the contracts to ensure you know what your rights and obligations are under the contract;
  • review the payment terms -will they need to be re-negotiated? Consider upfront payment or reducing the payment period to ensure prompt payment;
  • consider the allocation of risk in relation to changes of law and regulations;
  • review the risks of any disruption in the supply chain and assess whether it will cause interruptions in the business and performance of the contracts;
  • consider how to protect against such risks, including the availability of alternate sources of supply.

3.  Carry out a mapping exercise to review contracts that may be high risk or susceptible to claims to excuse performance and any other potential issues relating to force majeure, triggers for defaults, termination rights and related contract terms. For further information on this topic please see our earlier blog.

4.  Keep an accurate record of all documentation evidencing the key considerations and justifications of commercial actions/decisions, including any discussions (whether formal and informal), any changes, events giving rise to delays and any actions taken to mitigate any risks.

5.  Maintain an on-going review of the contractual obligations, key milestones, service levels and KPIs. Prepare a mitigation plan and continue to communicate and update the contracting parties.

6.  Ensure that all amendments, variations, suspensions, delays and terminations are recorded in writing and made in accordance with the requirements under the contract.

7.  Ensure that there are robust due diligence processes in place to ensure the contracting parties are solvent, able to perform their obligations under the contract and are financially stable.

8.  If you have concerns that the contracting party will be unable to perform its obligations, consider requesting security for its performance of the contract for example a parent company guarantee, or personal guarantee from a company director.

9.  Understand the process that needs to be followed if a dispute does arise and take prompt action. It is important to take pre-emptive action rather than find your own cashflow severely compromised.

10.  If in any doubt, seek and obtain professional advice quickly, contact us to help guide you through the process and ensure that you do not compromise your position.

Government guidance on responsible contractual behavior

On a separate note, further government guidance was issued in May to provide support and assistance to contracting parties.

The Government issued guidance on responsible contractual behavior in the performance and enforcement of contracts impacted by the COVID-19 emergency.

The guidance encourages contracting parties to "act responsibly and fairly, support the response to Covid-19 and protect jobs and the economy", placing responsibility on contracting parties to exercise foresight, and consider the Covid- 19 pandemic when entering into contracts, whilst simultaneously emphasising the need for good faith to be shown by the parties.

The guidance sets out a number of examples of what 'responsible and fair behaviour' is, most of the examples are actions that contracting parties would often consider then protection their own interest and preserving the on-going relationship.

It should be noted that the guidance does not apply to contracts or transactions which are speculative in nature in respect of risks similar to the Covid-19 emergency or to financial market transactions.

Although this is guidance, and therefore not legally binding, it remains to be seen how much weight it will be given by courts.

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