Ipso facto restrictions – radical but complex
Insolvency Bitesize - October 2020
An ipso facto clause is one which allows a party to a contract to terminate or modify the contract, or for such events to happen automatically, by reason of the insolvency of the counterparty. These types of clauses are very common in commercial contracts and can typically be triggered irrespective of whether the insolvent counterparty is actually performing their obligations.
The treatment under English insolvency afforded to such termination rights has developed:
- monopolies: when the Insolvency Act 1986 was first passed, s233 looked to prevent utility suppliers from abusing their monopoly by requiring outstanding amounts be paid before continuing supply on insolvency but stopped short of restricting the exercise of insolvency termination rights;
- essential utility and IT supplies: in 2015, the scope of s233 was extended to include, in particular, IT-related suppliers and a new s233A was inserted into the 1986 Act. This, for the first time, imposed restrictions on exercising insolvency-related termination rights in essential utility and IT-related supply contracts; and
- goods and services: in June 2020, the Corporate Insolvency and Governance Act 2020 inserted a new s233B into the 1986 Act. This applies to all contracts for the supply of goods or services, subject to key carve-outs, and restricts more broadly the exercise of termination rights.
None of these provisions, however, apply to loans, securities, bonds or derivatives (among other financial products).
The table below highlights the key similarities and differences between the provisions.
|SECTION 233||SECTION 233A||SECTION 233B|
|Applicable insolvency procedures||Standalone Moratorium||X||X||✓|
|Part 26A restructuring scheme||X||X||✓|
|Types of supply contracts||Utilities, communications and IT-related||Utilities, communication and IT-related||All goods or services (subject to exceptions)|
|Restricts exercise of insolvency-related termination rights?||X||✓||✓|
|Restricts exercise of non-insolvency-related termination rights (triggered other than because of entry into insolvency process)?||X||X||✓|
|Restricts exercise of non-termination rights (e.g. raising prices) (triggered other than because of entry into insolvency process)?||X||X||X|
|Supplier able to require a personal guarantee as condition of future supply?||✓||✓||X
However, the interplay of these three statutory provisions can be confusing and will depend, among other matters, on the type of insolvency procedure, the type and date of the supply contract or even the type of customer or supplier.
This flow chart shows – at a high level – how to identify which provision or provisions may apply to a particular term in a contract. In practice, their application will require careful scrutiny to understand the rights of the IP and/or the supplier.