UK: Termination Rights In The Event Of Insolvency: Where Are We Now With Ipso Facto Clauses; Are They Still A Potent Weapon In A Creditor's Armoury

Introduction

Long term contracts frequently contain clauses which either terminate the contract automatically or entitle a party to terminate the contract in the event of the other party becoming insolvent; so-called 'ipso facto' clauses. The use of such clauses is controversial and in many jurisdictions such clauses are unenforceable because they are seen as allowing one creditor to take priority over other creditors in relation to property that should otherwise form part of the bankruptcy estate. English law did not share this approach but viewed the operation of such clauses as being essentially a matter of contractual construction. That position has now changed with the coming into force of amendments to the Insolvency Act 1986 ('IA 1986') introduced by the Corporate Insolvency & Governance Act 2020 ('CIGA 2020'), which make ipso facto clauses in contracts for the supply of goods and services unenforceable against an insolvent party. The purpose of this article is to examine some of the issues which arise in relation to the construction of ipso facto clauses and to explain the effect of the amendments to the IA 1986.

Ipso facto clauses are generally considered valid under English law. They do not, without more, offend against the public policy that prevents a party contracting out of the pari passu distribution of an insolvent's assets. Nor do they offend against the anti-deprivation rule, which prevents a party from withdrawing assets on bankruptcy, liquidation or administration so as to reduce the value of the insolvent estate to the detriment of creditors. As to the last, the Supreme Court held in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd [2012] 1 AC 383 that the rule would not invalidate clauses which did not amount to an illegitimate intent to evade bankruptcy or insolvency law and had a legitimate commercial basis.

Construction of the contract

The starting point for considering the applicability and effectiveness of an ipso facto clause will therefore be, as is so often the case, the construction of the contract. In this regard, clauses inevitably vary in their complexity, whether it be in the definition of what constitutes a triggering event or as to the procedures, such as the giving of notice, which have to be followed in order for termination to be valid. There are no special rules of construction applicable to ipso facto clauses. The general principles laid down in cases such as Arnold v Britton [2015] AC 1619 and Wood v Capita [2017] AC 1173 apply. In summary, one is looking to ascertain the objective meaning of the language used by the parties to express their agreement. This means looking at the contract as a whole and, depending on the nature, formality and quality of the drafting, giving more or less weight to the wider context of the agreement. However, the consequences of triggering an ipso facto provision are inevitably severe. In addition, the courts have emphasised in a series of recent judgments that the principles which apply to the construction of exclusion clauses and indemnity provisions do not represent special rules applicable only to certain types of clauses but represent principles of construction which are to be used alongside the general principles of construction for the purposes of determining the intention of the parties; cf. Fujitsu Services Ltd. v IBM United Kingdom Ltd [2014] EWHC 752 (TCC) at [24] – [26] and CNM Estates v VeCref I Sarl [2020] EWHC 1605 (Comm) at [14] – [18]. As such, when questions arise as to the construction of an ipso facto clause, a court should be guided by the principle that clear words are necessary to define the circumstances in which the parties intended that the right of termination would accrue.

The first question with any ipso facto clause is whether there has been a triggering event, which gives rise to the right to terminate. Clauses may define when a party is deemed to be insolvent by reference to specific insolvency events and may include a proviso that insolvency events include any similar or equivalent event under any applicable law. But even in the absence of such proviso, the question arises as to which law determines the nature of the event said to constitute insolvency.

Conflicts of law

If the relevant insolvency proceedings take place in the same jurisdiction as the applicable law of the contract, there is no difficulty in answering the question, it is the applicable law of the contract. But in many contracts subject to English law, it is equally possible that the relevant insolvency proceedings will take place in another jurisdiction. Is it still then only the governing law of the contract which determines the nature of the proceedings or should one also look to the law of the country where the event in question is taking place?

The better view must be that the construction of the contract is a matter for English law and, therefore, whether or not the attributes of a foreign proceeding bring it within the scope of the clause is a matter of English law. However determining the nature of the proceeding and whether or not the proceeding is an insolvency proceeding within the foreign jurisdiction is a question for the law governing the proceeding. So, for example, the contract clause may allow a right of termination in the event of 'winding up'. One party is the subject of proceedings in a foreign jurisdiction, which as a matter of translation, are considered to be winding-up proceedings. However, the proceedings in question are in fact used to enable solvent companies to re-structure and it is only in the event that such a restructuring is not possible that the party may then be put into liquidation. The law of the jurisdiction where the proceeding are taking place does not consider the 'winding-up' to be an insolvency proceeding. In these circumstances, even though winding up might otherwise be considered under English law to be an insolvency proceeding, the foreign proceedings should not be sufficient to trigger the right to terminate under an ipso facto clause. By way of analogy, it is noteworthy that in In re Sturgeon Central Asia Balanced Fund Ltd [2020] EWHC 123, the court overturned a recognition order granted ex parte in respect of a Bermudan liquidation because the liquidation in question did not constitute 'foreign proceedings' for the purposes of the CBIR. The essential reason for the court's decision not to recognise the liquidation under the CBIR was that the regulations only applied to the resolution of a debtor's insolvency or financial distress. They did not apply to allow recognition of foreign proceedings for the winding up of a solvent company, which was not in financial distress.

Preventing the operation of an ipso facto clause

If the triggering event has occurred, the next question is whether any conditions precedent to termination, for example in relation to the giving of notice, have been complied with. However, unless the contract provides otherwise, no particular formality will be required as long as there is substantive compliance with the terms of the contractual provisions. So, for example, any notice of termination needs to be in sufficiently clear terms to communicate the decision to terminate; see Newland Shipping & Forwarding Ltd v Toba Trading FZC [2014] EWHC 661 (Comm). The contrast is unilateral contracts, such as options, where strict compliance with the express requirements of any termination clause will be required; see Siemens Hearing Instruments Ltd v Friends Life Ltd [2014] EWCA Civ 382.

If the conditions for termination are met, can the exercise of a termination clause be prevented? On the face of it, if the requirements of the termination clause have been met, then should be enough to bring the contract to an end. But what if the party alleged to be insolvent claims that it is only in such a situation because of the actions of the terminating party or that the terminating party has engineered a situation, which has allowed insolvency proceedings to be commenced notwithstanding that there is no genuine insolvency.

English law does not (at least at present) recognise a general duty of good faith but there are a number of possible principles, which may assist the party alleged to be insolvent.

One line of argument, which has been put forward in connection with other forms of termination clauses is that there is an implied term that the right of termination should not be exercised in an arbitrary, capricious or unreasonable way adopting the reasoning in Braganza v BP Shipping Ltd [2015] 1 WLR 1661. However, a series of cases has found that where one party is given an unqualified right of termination, there is no place to imply a term along Braganza lines; see TAQA Bratani Ltd v Rockrose [2020] EWHC 58 (Comm), Monk v Largo [2016] EWHC 1837 and Cathay Pacific Airways Ltd v Lufthansa Technik AG [2020] EWHC 1789 (Ch).

While arguments based on good faith are unlikely to succeed, there are alternatives that given the right combination of facts may succeed. First simply as a matter of construction, it may be possible to argue that notwithstanding the existence of an insolvency proceeding, there is no genuine insolvency and on the proper construction of the relevant clause there are therefore no sufficient proceedings to trigger a right to terminate. Alternatively, if the events said to trigger the operation of the termination clause have arisen because of interference by the party relying on the clause in the performance of the contract, it may be possible to make good an argument that there has been a breach of one or more of the following implied terms: an implied term that both parties will perform the contract honestly; an implied term that neither party will frustrate the purpose of the contract or an implied term that both parties would cooperate in the performance of the contract and would not seek to prevent the other party's performance of the contract. Whether such terms will be implied depends of course on matters such as whether such terms would be consistent with the express terms of the contract and whether or not the nature and circumstances of the contract are such that the general test for the implication of terms, namely one of necessity, is met; see Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1988 and the discussion in Lewison on The Interpretation of Contracts, 6th ed at §6.05.

In the context of implied terms that one party will not prevent the other from performing the contract, the more general test has been refined further to require: first that the implied term must not be illegal, contrary to public policy or ultra vires the contracting party; second that the term is limited to active prevention of performance (and probably does not extend to passivity in the face of the action of some third party) and third that the act complained of is wrongful either as being a breach of the express or implied terms of the contract or wrongful independently of the contract. These principles were recently re-stated in Jiangsu Guoxin Corporation Ltd v Precious Shipping Public Co. Ltd [2020] EWHC 1030 (Comm) at [20]. It is unlikely that there will often be an issue with the first of these requirements. The issue is more likely to be whether the party opposing termination can satisfy the second and third requirements. Nevertheless, if the circumstances are such that one party had deliberately delayed or refused to make payments under a contract for the purposes of putting the other party in a position where it can no longer resist insolvency proceedings and therefore termination of the contract, the prevention principle or one of the other implied terms mentioned above may provide redress. Again, it will be a question of the particular facts whether that claim for redress sounds in damages (combined with a claim for renunciatory breach) or in the form of injunctive relief to restrain termination of the contract.

Statutory control

The discussion above reflects the contractual means by which a party may challenge the application of an ipso facto clause. However, in certain jurisdictions, such as the United States, legislative controls either limit or exclude the enforcement of a such a clause against an insolvent party. The need for such controls under English law was under discussion prior to the outbreak of the Covid-19 pandemic. However, the dire financial consequences of that outbreak have pushed through the introduction of those controls. The relevant provisions are to be found at sections 14 and 15 and Schedule 12 of the Corporate Insolvency & Governance Act 2020 which amend the Insolvency Act 1986 by introducing section 233B and Schedule 4ZZA. In summary the affect of these provisions is to prevent a supplier relying on an ipso facto clause in a contract for the supply of goods and services once a company has entered into an insolvency procedure as defined in s.233B. The statutory restriction prevents the supplier terminating the contract or exercising any other right which accrues in the event of the debtor company becoming subject to a relevant insolvency procedure.

There are exclusions from the scope of s.233(B) for contracts with certain types of person or certain types of contracts. The exclusions include, for example, contracts with insurers and banks (subject to the qualifications in the Schedule) and contracts including financial services such as commodities contracts. The Schedule also provides an exclusion to ensure that the United Kingdom does not infringe its international obligations in the aviation sector under the Cape Town Convention. Those obligations are set out in the International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 and provide, among other things, for debtors and creditors under relevant agreements to be able to agree in writing the events which constitute default and the remedies for default (see in particular regulations 18 and 21).

Section 15, of CIGA 2020 provides a temporary exemption for small company suppliers, which originally ended on 30 September 2020 but has now been extended until 30 March 2021. A small supplier is defined as being a company which meets two of the following conditions: (1) it has a turnover of no more than £10.2 million, (2) its balance sheet total was not more than £5.1 million and (3) the number of the supplier's employees was not more than 50. In addition a supplier can enforce its ipso facto clause with the consent of the office holder or of the company or the permission of the court.

It should be emphasised that the restrictions on ipso facto clauses introduced by CIGA 2020 are not just temporary measures. They are intended to have long-term effect. They are also likely to give rise to a number of difficult disputes as to the meaning of the provisions. There is, for example, no definition of what is a contract for the supply of goods and services. It may well be difficult in a complex web of project contracts with interlinking rights and obligations to determine whether a contract is a contract for the supply of goods and services or not. What is meant by termination is not defined. Does the restriction apply if the debtor company is otherwise in renunciatory or repudiatory breach of contract? One would anticipate that the answer to this question should be 'no' but that answer is not certain. What is the meaning of 'any other thing'? Does the restriction prevent a supplier enforcing an associated guarantee or relying on a clause which accelerates the payment of all sums due under a contract if one payment instalment is missed? There are certainly at least two major uncertainties.

First, how the provisions of s.233B will operate in the event of foreign insolvency proceedings? Will those proceedings still engage the restrictions on ipso facto clauses imposed by s.233B? Where the foreign insolvency proceedings have been recognised under English law, for example under the Cross Border Insolvency Regulations, the answer would seem likely to be 'yes'. In other situations, the position is far more uncertain bearing in mind the very specific provisions of s.233B(2) defining the types of insolvency procedures which engage the section's protection.

Second, s.233B(4) prevents a party relying on events occurring prior to the start of the insolvency period as a ground for termination once the insolvency period starts. However, the language of the clause suggests that this restriction is only temporary so that if debtor comes out of the insolvency procedure in a state of solvency, the supplier can rely on the prior events to terminate the contract. What is not clear from the language of s.233B is whether the same result is intended to apply to a right of termination in the event of insolvency. If s.233B is suspensory only, then in theory once the relevant insolvency procedure is over, the supplier could terminate the contract based on the prior insolvency. Alternatively, if the ipso facto clause provides for termination on an event of insolvency, there might be an argument that the contract terminates automatically once s.233B ceases to have effect. Such a result would seem to undermine the initial purpose of s.233B especially if the debtor company has come out of the insolvency in a solvent position. It could also be said to be inconsistent with the language of s.233B(2), which speaks of relevant clauses ceasing to have effect once a company becomes subject to a qualifying insolvency procedure. Nevertheless, the position is uncertain and there is certainly scope for argument that the effect of s.233B is suspensory only.

Conclusion

Overall well-drafted ipso facto clauses remain a valuable contractual asset and are likely to become potentially more valuable in times of financial uncertainty. The case law makes clear that if the provisions of the clause are complied with, it will be difficult to say the least to prevent their operation. However, the position under English law has moved on and statutory controls which initialled looked to be some way off, have now been brought in. There are uncertainties in the legislation which will need to be resolved. The tension that exists between the use of such clauses to protect the interests of individual creditors over the interests of the insolvency estate as a whole remains.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.