IT suppliers and insolvent businesses: New regulations to protect "essential supplies"

New legislation came into force on 1 October 2015 which affects the rights of suppliers of IT services against insolvent customers. Any suppliers (or anyone seeking to acquire an IT business) caught within the new definition will need to be aware of what these changes mean.

For many years, insolvency legislation has provided that insolvency office-holders can require statutory suppliers of ‘essential supplies’ (water, electricity, gas and communication services) to keep providing them in certain formal insolvency scenarios (subject to safeguards). Additionally, the supplier cannot require past unpaid charges to be paid as a condition of future supply. The protection of essential supplies has now been extended to reflect the importance of IT services to businesses in distress.

“Wi-Fi is the new water”: widening the category of “essential suppliers”

The new legislation recognises that businesses now require a continued supply of IT services as much as a supply of utilities in order to continue in business. On 1 October 2015, IT suppliers were brought into the ‘essential supplies’ regime via the Insolvency (Protection of Essential Supplies) Order 2015. The changes also widen the category of suppliers to include private suppliers of gas, electricity, water and communication services (and to on-sellers, such as landlords charging tenants for electricity and other supplies).

“Communication services” was already included as a supply but is now extended to include a “supply of goods and services… for the purpose of enabling or facilitating anything to be done by electronic means“. The goods and services expressly included are:

• point of sale terminals;
• computer hardware and software;
• information, advice and technical assistance in connection with the use of information technology;
• data storage and processing; and
• website hosting

The new definition of communication services is wide and is expected to cover most IT supplies to businesses. Consequently, the IT supplier will be unable to require past unpaid charges to be paid in an insolvency scenario.

Termination clauses in utilities contracts may be invalid if triggered by insolvency

New provisions shall apply to contracts entered into on or after 1 October 2015 for the supply of essential goods and services to a company. Any “insolvency-related terms” within supply contracts shall cease to have effect if the company enters administration or a CVA (but not liquidation or other insolvency processes), the intention being to prevent the supplier from:

• terminating the supply contract; or
• altering the terms of the supply contract or compelling higher payments.

To counterbalance the impact upon suppliers, there are some safeguards as the legislation overrides contractual rights. In particular, the supplier will be able to:

• terminate with the consent of the insolvency office-holder;
• seek a personal guarantee from the office-holder at any time (this is currently also provided for in the insolvency legislation) – the supplier will be able to terminate if such guarantee is not provided within 14 days;
• apply to the court to terminate their contract on the grounds of ‘hardship’ (we anticipate cases being referred to the courts, although proving ‘hardship’ may present too high a threshold for larger suppliers); or
• terminate if charges post-administration or CVA are not paid within 28 days of the due date.

As it is not common for insolvency practitioners to give personal guarantees, we anticipate that suppliers will only be asked to continue the service where the underlying business of the insolvent customer is expected to continue or continued trading will enhance the realisations in the estate. Even if a guarantee is not provided, under insolvency law the post-insolvency charges for any period after administration will usually constitute an expense of the administration, giving them ‘super-priority’ for payment ahead of the administrators’ own remuneration.  In many cases this will provide enough comfort to the supplier for the supply to continue.

What practical steps should IT suppliers take to protect their position?

In many instances, the designation of certain IT supplies as essential reflects the reality: the businesses receiving those supplies could not viably continue without them. Others, however, may not immediately recognise that they are providing services that would be deemed ‘essential supplies’. IT suppliers should carefully consider whether they will be caught by the new legislation, as this could affect their risk exposure to businesses that become insolvent.

The following practical steps will assist suppliers caught by the new legislation, but could apply more widely to IT suppliers to reduce their exposure to insolvent businesses:

1. Prior to insolvency of an existing customer:

Keep abreast of unpaid invoices and engage with defaulting customers at an early stage.

2. If a customer has already entered an insolvency process:

Contact the office-holder as soon as possible to:

• confirm whether the supply should continue (or be terminated by consent); and
• ask the office-holder to personally guarantee payment of future charges, although there may be resistance to this as post-administration charges should constitute an administration expense that gives super-priority.

3. When entering into new contracts:

• Ensure that early termination rights activate before the onset of insolvency. The new legislation is only applicable once a customer enters a formal procedure.
• If contracts cover both ‘essential’ and ‘non-essential’ services, it may be prudent to distinguish the services (and payment provisions) where the ‘essential supply’ is only part of a wider contract.