The Bill follows the UK Government’s announcement on 28 March 20202 that it would introduce new insolvency and corporate governance measures to support businesses facing funding and operational difficulties during the COVID-19 pandemic. It also implements the Government’s plans permanently to reform the UK’s insolvency law regime, following a 2018 consultation on insolvency and corporate governance.
For a detailed account of how the Bill intends to affect businesses in the UK more broadly, please refer to our recent client alert “Government publishes bill to reform insolvency and company laws”.
In this alert, we consider in more detail provisions of the Bill relating to (1) the moratorium – a new UK insolvency procedure, (2) limitations on the exercise of termination clauses in supply contracts, and (3) related exclusions.
The limitations on termination narrow the choices available to companies in contracts with counterparties that may enter a UK insolvency procedure. The Bill, though, excludes “contracts relating to financial services” from the scope of these provisions and from the moratorium. These exclusions are drawn broadly and include commodities sale and purchase contracts, and commodity derivatives. That said, some other contracts entered into by companies active in these markets may be affected by the new provisions.
In contracting with counterparties that may enter a UK insolvency procedure (e.g., because they are established in the UK or have UK assets), it will be important for companies to know whether the new provisions apply to their contracts, as this will affect the options available in protecting their position if the counterparty enters financial difficulties.
1. Company moratorium
The Bill introduces a new insolvency procedure into UK insolvency law. This is a stand-alone moratorium3 that will prevent creditors from taking enforcement action, and allow struggling companies a formal breathing space to pursue a rescue plan by restricting the enforcement or payment of pre-moratorium debts.
The moratorium would last an initial period of 20 business days, extendable by a further 20 business days without creditor consent, with further extensions at the agreement of creditors or the court. The company will remain under the control of its directors during the moratorium, but the process will be overseen by a monitor, who must be a licensed insolvency practitioner.
During a moratorium, a creditor would not be able to place the company in another formal UK law insolvency procedure, to institute or carry on legal proceedings against the company, or to enforce security.4 The company would also be restricted from making payments to creditors in respect of its pre-moratorium debts above a statutory maximum5 unless the monitor consented.
The moratorium provisions themselves do not prevent a creditor exercising most self-help remedies (such as set-off) that do not require court action or the company to make a payment, although there are exceptions, such as repossessing goods.
More importantly, the moratorium provisions do not apply to specified types of financial services companies and to a broadly set of financial and commodities contracts (see section 3 below).
2. Prohibition on enforcement of termination clauses in supply contracts
Termination clauses for an insolvency event
Where a company is subject to an insolvency event, its counterparties will often want to protect their business interests by terminating, or altering their position under, open contracts with that company. The principal risk is non-performance (e.g., a failure to pay or to make or take delivery). Especially where they are unsecured, claims against an insolvent company may have very little commercial worth.
Under English law, there is no common law right for a party to terminate a contract for reasons of its counterparty’s insolvency. For this reason, contracts governed by English law will invariably include a clause allowing a party to terminate the contract, or accelerate or modify the parties’ rights or obligations, upon an insolvency event affecting its counterparty (an insolvency termination clause). Such clauses are also commonly included in standard form international trading agreements, such as the ISDA Master Agreement and EFET General Agreement, which may be subject to other governing laws.
The insolvency laws of some jurisdictions seek to prohibit the use of an insolvency termination clause against a company that enters into a local insolvency procedure. This is because it is argued the exercise of such provisions undermines the viability of the business which the insolvency process may be seeking to preserve.
Protection of supplies of goods and services – new section 233B under the Insolvency Act
Section 12 of the Bill introduces a new section 233B into the Insolvency Act 1986. Section 233B applies where a company becomes subject to a relevant UK law insolvency procedure,6 including the proposed moratorium described above.
The proposed measures restrict the ability to terminate contracts and crystallise exposures against a company that has entered into a relevant UK insolvency procedure, and would apply to all suppliers, significantly expanding the scope of the UK’s existing ‘essential supplies’ regime,7 which only provides for the continuity of supply of essential services such as electricity, water and IT services.
Section 233B(3) provides that a provision of a contract for the supply of goods or services to the company ceases to have effect when the company becomes subject to a relevant UK law insolvency procedure if and to the extent that, under that provision:
(a) the contract or the supply would terminate, or any other thing would take place, because the company becomes subject to the relevant UK insolvency procedure; or
(b) the supplier would be entitled to terminate the contract or the supply or to do any other thing because the company becomes subject to the relevant UK insolvency procedure.
The effect of sub-section (a) is that automatic termination provisions or other provisions providing for automatic changes will become ineffective when the company becomes subject to a relevant UK law insolvency procedure. Sub-section (b) renders ineffective provisions allowing the supplier to (i) terminate the contract or (b) do other things (e.g., by giving notice, increasing prices or requiring payment on delivery) in each case because of the company entering into a relevant UK insolvency procedure.
While the company is subject to a relevant UK insolvency procedure, section 233B(4) also prevents the exercise of any termination rights or other rights that arose before such insolvency procedure commenced.
Note that section 233B only applies with respect to a contract for the supply of goods or services to the company becoming subject to a relevant insolvency procedure. Other contracts will not be affected. This would include contracts where the company entering the insolvency procedure itself is supplying goods or services, and contracts that are not for the supply of goods and services.
The question of whether a contract is one for the supply of goods or services may require analysis and may not always be straightforward.
Under this regime, there remain limited circumstances where a supplier to a company that has entered a relevant UK insolvency procedure may terminate the contract – if the relevant insolvency office-holder or company consents, and as a last resort, they may apply to court to be relieved of the requirement to supply if they demonstrate that a continuation of the contract would cause financial hardship.
Termination on other grounds remains possible. Suppliers will retain the ability to terminate contracts on any other ground permitted by the contract, except where the ground had already arisen prior to the insolvency trigger. This could permit termination, e.g., for non-payment for supplies made following the insolvency trigger or for breach of the underlying contract.
3. Exclusions for certain financial services firms and contracts
For policy reasons, and following consultations with trade associations and relevant interest groups,8 the Bill excludes certain contracts and certain entities from the scope of the moratorium and the restrictions on insolvency termination clauses.
In particular, specified types of financial services firms will not have available to them the company moratorium, and the moratorium will not affect certain excluded contracts. The restrictions on termination clauses will also not apply to excluded contracts or to any contract entered into by an excluded entity irrespective of whether the excluded entity is the supplier or other party.
The Bill contains provisions enabling the scope of the exclusions to be amended by regulation. This means that there are future opportunities for the UK government to ‘fine-tune’ the scope of the exclusions.
Most excluded entities are regulated financial institutions which are subject to special insolvency regimes or in respect of which it is regarded as important for market confidence that those entities (or their counterparties) can terminate contracts or take enforcement action.
Banks, insurers, investment banks and investment firms, payments and electronic money institutions, operators of payment systems, infrastructure providers and securitisation companies are excluded. Recognised investment exchanges, recognised clearing houses and recognised central securities depositories are also excluded.
Other trading facilities, such as multilateral trading facilities (MTFs) and organised trading facilities (OTFs), will also fall within the exclusion provided in the Bill for “investment firms” within the meaning of section 258A of the Banking Act.
Overseas entities whose functions correspond with the list of excluded entities are also excluded.
The Bill contains broad and, in some cases, overlapping exclusions for contracts under the heading “Contracts involving financial services”. These exclusions are not limited to regulated financial services. This will exclude from the moratorium, and the restrictions on insolvency termination clauses, spot and forward commodity purchases and sales, commodity repos as well as commodity derivatives.
Treating such a wide range of contracts as in some sense ‘financial’ is not new. The main exclusion in this section (which covers most of the commodities contracts referred to above) is derived from the definition of “financial contract” in the Bank Recovery and Resolution Directive9 (“BRRD”), which provides these contracts with certain protections from measures available to resolution authorities dealing with failing banks.
We consider how the exclusions apply with respect to commodities and commodity derivatives below.
Commodity spot and forward contracts
Among the excluded contracts are “financial contracts” which are defined to include “a commodities contract”, which is itself specified to include “a contract for the purchase, sale or loan of a commodity or group or index of commodities for future delivery”. It also includes commodity options.
The requirement that a commodity sale or purchase contract be “for future delivery” had raised some concerns with industry. The Bill now separately excludes intra-day and short-term trading in commodities and in FX under an exclusion for “spot contracts”, which refers to the Article 7(2) and 10(2) of the MiFID II organisation regulation.10 This is particularly important for gas and power markets in which such short-term trading is very common.
Facility agreements to make loans, or provide guarantees or other commitments are excluded.
Many commodities title-finance structures will also be excluded by virtue of being “securities financing transactions” (SFTs) as defined in the Securities Financing Transactions Regulation.11 Commodities SFTs include commodities repos, commodities lending transactions, buy-sell back transactions and sell-buy back transactions.
Guidance from the European Securities Markets Authority on the reporting of SFTs has indicated that commodities transactions that are entered into for operational and/or industrial purposes would not be considered SFTs, as a result of which they would not be covered by the exclusion in the Bill for SFTs. Some such transactions, however, would be excluded from the moratorium and restrictions on insolvency termination clauses in any event because they are “commodities contracts”, which include: “(iii) a repurchase or reverse repurchase transaction on any such commodity, group or index”.
Therefore, most trade and commodities financing transactions will be excluded from the moratorium and the new restriction on termination. In some cases careful analysis will need to be applied to confirm this
Definition of “commodities”
The term “commodities” is not fully defined in the new exclusions.
The exclusions for spot contracts and SFTs refer back to EU legislation in which “commodity” is defined to mean:
“any goods of a fungible nature that are capable of being delivered, including metals and their ores and alloys, agricultural products, and energy such as electricity”.12
The MiFID II definition does not cover various intangible products (such as emissions allowances and green products) but some of these are included as “commodities’ by an express provision in the Bill.
Emissions and green products
The exclusions extend the meaning of “commodities” to cover certain specified types of units, emissions allowances and green certificates recognised under UK legislation, including EU emissions allowances. This means that spot and forward sales contracts, as well as repos, relating to such products are excluded.
The current definition only addresses forms of allowance or certificate recognised under UK legislation, although some contracts in respect of such units would appear to be covered in any event by the definition of a “futures or forwards contract”:
“a futures or forwards contract, including a contract (other than a commodities contract) for the purchase, sale or transfer of a commodity or property of any other description, service, right or interest for a specified price at a future date”.
If a contract is not covered by these exclusions, it would be subject to the restriction on termination, unless one can argue that it is not a contract for the supply of goods or services. In any case, the moratorium would apply.
All derivatives (as defined in EMIR)13 are excluded (including commodity derivatives).
Transfers of gas/electricity capacity and transmission rights
The terms of such contracts would need to be considered specifically, but some may fall within the following category of exempted ‘futures or forwards contracts’ (see definition above).
Set-off and netting arrangements (as defined in the Banking Act 2009) are excluded from the moratorium and restrictions on termination. The same is true of financial collateral arrangements.
Impact on termination under foreign law contracts
The Bill’s provisions on insolvency termination clauses do not distinguish between contracts governed by the laws of England and Wales (or another UK jurisdiction) and foreign law contracts. That said, it would be a matter for the foreign governing law to determine how it would treat the restrictions on insolvency termination clauses (where they apply to a contract). Some governing laws may not recognise the restrictions and treat a contract as terminated, even where this would conflict with the position under English law governing the insolvency procedure to which the company is subject.
Commodity and financial markets have so far benefited from a well-entrenched legal regime under English law, which secures the ability to manage counterparty risk exposures effectively through the use of insolvency termination clauses. This appears largely set to continue.
Firms active in these markets are likely to welcome the relatively broad set of exclusions of entities and contract from the scope of application of the moratorium and restrictions on insolvency termination clauses.
- Available at publications.parliament.uk/.
- Available at www.gov.uk/.
- The provisions governing the moratorium as it would apply in Great Britain are dealt with in sections 1, 2 and 3 of the Bill. These provisions introduce several new Chapters into the Insolvency Act 1986.
- There are exceptions for security under financial collateral arrangements as defined under the relevant UK regulations.
- For most companies, 1 per cent of their debts and liabilities to unsecured creditors to the extent those debts and liabilities can be ascertained.
- The relevant UK insolvency procedures include liquidation, administration, moratoriums, voluntary arrangements, provisional liquidation and administrative receivership.
- Under sections 233 and 233A of the Insolvency Act 1986.
- Reed Smith acted for several trade associations in engaging with the UK government, following which amendments were made to add additional exclusions, including some discussed in this alert.
- Directive 2014/59/EU.
- Regulation 2017/565/EU.
- Regulation (EU) No 2015/ 2365.
- See Article 2(6) of Regulation 2017/565/EU, which repeats the definition of commodity in Article 2(1) of Regulation 1287/2006/EC.
- See Article 2(5) of Regulation (EU) No, 648/2012.
Client Alert 2020-353