UK ban on terminating contracts for insolvency – commodities

The Corporate Governance and Insolvency Bill 2020 (the Bill) was introduced into the House of Commons today and will make far-reaching changes to English insolvency law. It was also announced that all stages of the Bill will be heard on Wednesday 3 June.

The immediate reason for the introduction of the Bill lies in the UK government’s desire to minimise the economic consequences of COVID-19, however, many of the changes will have a longer-lasting impact.

This article focuses on the provisions of the Bill which relate to ipso facto clauses and considers how they will affect commodities trading.

We will shortly be publishing an Insights article on how those same provisions will affect lenders and on the Bill more generally.

Ipso facto clauses

The Bill will make so-called ipso facto clauses in certain contracts unenforceable.

The expression has been used to describe a provision in a contract which enables one party to terminate it on the other party entering insolvency proceedings.

Such clauses represent an important right for a supplier of goods and services, but they have an impact on commodities trading contracts.

Most commodity trading contracts contain an ipso facto clause in the form of an event of default or early termination right which is triggered by one of the parties entering insolvency proceedings.

Earlier proposals

The introduction of such a provision into English insolvency law has been contemplated for several years.

In 2016, The Insolvency Service launched a consultation on the reform of corporate insolvency. One of the reforms proposed was the introduction of a moratorium for distressed businesses to enable them to obtain protection against legal action while considering options for rescue.

The proposals took further shape in 2018 when the Department for Business, Energy & Industrial Strategy (BEIS) published its response to The Insolvency Service’s consultation and announced its intention to introduce legislation to prevent the enforcement of ipso facto clauses.

Exclusions

BEIS acknowledged that if ipso facto clauses were rendered unenforceable, some finance providers might withdraw their products and services at the first sign of financial difficultly and this would put borrowers in a worse financial position than if the ban had not become law.

BEIS acknowledged that certain types of financial products and services therefore deserved to be excluded from the new provision.

Key question

The key question for the wholesale commodities industry is whether the wide exemptions in favour of financial services providers announced by BEIS in 2018 have been included in the Bill and broadened to include wholesale commodities trading and financing contracts. The Bill contains exclusions based on the type of contracting entity and type of contract. So the exclusion can apply to a contract if the supplier or distressed company as recipient of services under that contract is on the excluded list or if the contract itself is of a type that falls within the excluded list.

Excluded entities

Under the Bill, if the supplier or recipient of services is an insurer, bank, investment bank or investment firm, electronic money institution, payment institution, an operator of a payment system, an infrastructure provider, a recognised investment exchange, a recognised clearing house (CCP), a recognised central securities depositary (CSD) or a securitisation company, an ipso facto clause will be enforceable.

The Bill also excludes any overseas entities whose functions correspond with any of the above.

Wholesale commodities companies falling outside the above list (such as commodity trading firms who are exempt from the requirement to become authorised) are not excluded from scope. The effect of this is that a party may still be required to deliver or perform under certain contracts, even if its counterparty is insolvent, unless the relevant contracts are of a type that is excluded.

Operators of multilateral trading facilities (MTFs) and organised trading facilities (OTFs) are not expressly included in the list but would be covered as they are either market operators (so regulated as recognised investment exchanges or equivalent EU regulated markets or other overseas firms) or investment firms.

There is also a temporary exclusion for contracts for the supply of goods or services by small suppliers. This applies where the recipient company becomes subject to a relevant insolvency procedure up to the later of 30 June 2020 and one month after the relevant section of the Bill comes into force.

Excluded contracts

The Bill excludes financial contracts. The phrase is widely defined by reference to different types of contract.

With respect to commodities, this includes:

• contracts for the purchase, sale or loan of a commodity or group or index of commodities for future delivery;
• an option on a commodity or group or index of commodities;
• a repurchase or reverse repurchase transaction on a commodity, group or index;
• futures or forwards contracts (including those 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);
• swap agreements;
• spot contracts;
• securities financing transactions as defined in the Securities Financing Transactions Regulation (SFTR); and
• derivatives as defined under EMIR.

For the purposes of this exclusion, where the types of contracts listed make reference to commodities, this has been expanded to include certain specified types of units, emissions allowances, and green certificates recognised under UK legislation and emissions allowances that are units recognised for compliance with the EU Emissions Trading Scheme (EU ETS).

The following do not appear to be included within this list:

• emissions allowances and other environmental products not specified in the list (such as voluntary emissions reduction units or any form of allowance or certificate that the UK may issue in the future); and
• transactions of a type that would fall within the definition of a securities financing transaction under the SFTR but benefit from an exclusion under that regulation (such as those subject to the industrial and operational purposes carve out), and do not qualify as repurchase or reverse repurchase transaction.

Other contracts included in the definition comprise: contracts for the provision of financial services comprising lending contracts (including the factoring and financing of commercial transactions), financial leasing or providing guarantees or commitments; securities contracts; inter-bank borrowing agreements where the term of the borrowing is three months or less; and a master agreement for any of the contracts or agreements on the excluded list. This list also excludes capital market arrangements and contracts forming part of a public-private partnership.

In addition, the Bill clarifies that it will not affect the protections provided by the following types of existing arrangements and legislation:

• set-off and netting arrangements (within the meaning of ss. 48(1)(c) and (d) of the Banking Act 2009) are excluded from the effect of the termination clauses provisions and the company moratorium in the Bill also will not affect the operation of set-off or netting;
• Part 7 of the Companies Act 1989 (financial markets and insolvency);
• The Financial Markets and Insolvency Regulations 1996 (S.I. 1996/1469);
• The Financial Markets and Insolvency (Settlement Finality) Regulations 1999 (S.I. 1999/2979); and
• The Financial Collateral Arrangements (No.2) Regulations 2003 (S.I. 2003/3226).

Conclusion

The Bill is lengthy and complex and its operation is something which will require careful consideration.