Knowledge & News

Working with companies in financial trouble – ipso facto clauses may be terminated

19 June 2020

What’s changing?

Businesses like safeguards when they enter into any venture with a third party. For example, they like to have the option of exiting an arrangement with a business that has run into financial difficulties – so that they can avoid any related obligations and risks. UK contracts therefore often include a mechanism to allow termination of an agreement if a party enters into an insolvency process (e.g. administration). However, an imminent change to UK law means that this will not always be an option in the future.

Under the proposed insolvency legislation, these so-called “ipso facto clauses” will no longer be enforceable in contracts relating to the supply of goods and services – for these agreements, parties will not be able to terminate for the sole reason that the other party has entered an insolvency process. This restriction also applies to any other contractual terms which specify contingencies triggered by insolvency processes.

Why?

This change is part of an ongoing drive to help companies in financial trouble who still stand a good chance of surviving following an insolvency process. A company’s prospects are diminished when its suppliers cancel contracts for the sole reason that an insolvency process exists (and without any regard to whether the company intends to fulfil its contractual obligations including continuing payments to the supplier). The UK government is keen to ensure that this is not a factor in determining a company’s fate – even with the potential negative effects for suppliers.

How will the changes affect Intellectual Property?

This is likely to affect many dealings with intellectual property. We frequently see agreements involving the sharing or creation of IP alongside other provisions which could demonstrate an agreement to supply goods or services. Even for self-contained IP licences, there is a question mark as to whether ipso facto clauses will become unusable – whilst these agreements are not expressly referred to in the proposed new legislation, the government has previously made clear that it wants this change to apply to contractual licences such as for the use of software or patents.

Any other options?

Not all is necessarily lost for those seeking to terminate in these circumstances. The parties might actually be able to agree to end a relevant contract. Alternatively, the UK Court might allow termination if the supplier can show that it will suffer hardship if the agreement continues. This latter option will require an application to the UK Court (and the incurring of legal costs) and will not be relevant to everyone. However, it may justify the continued inclusion of ipso facto clauses in certain suppliers’ agreements going forward.

Aside from the above considerations, keep in mind that any subsequent breach of other contractual terms by the company may trigger a justifiable reason to terminate at that point. However, when considering this option, the supplier cannot try to rely on a breach which had occurred (and was overlooked) in the past.

Take home message

The ongoing financial health of a business partner is a key consideration for any company when working with others. Unfortunately, this concern is increasingly relevant given the economic ramifications of Covid-19. The new ipso facto restriction is expected to become law shortly (with a temporary exclusion for small suppliers to cater for difficulties during the Covid-19 pandemic). It is therefore something that businesses need to be aware of when negotiating contracts which are governed by UK law. It is important to consider the effect of a planned agreement in advance, as well as the circumstances of all parties, so that appropriate contractual terms are used. These might include potential alternatives for termination which, whilst not falling foul of the ipso facto restriction, help to offer a way out if a company’s financial health is in ominous decline. You should be comfortable with who gets to use your IP and the level of control you have over this use.

Authors

John de Rohan-Truba

John de Rohan-Truba Managing Associate London (UK) Solicitor (UK)

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