2020 has evolved in a way no-one could have predicted, and there is still much uncertainty as to what the future looks like (particularly as a result of Government stimulus payments and rent freezes varying or coming to an end, and newly announced insolvency law reforms that will affect businesses with liabilities of less than $1 million). While the outlook is not entirely pessimistic, suppliers should be preparing themselves for all scenarios. This means suppliers should now be considering options where their customers are not in a financial position to meet contractual payments, or in more drastic circumstances, face potential insolvency. We have set out below some options should you wish to be relieved of your obligations to continue to supply customers, or what to do if such debts are incurred and your customer cannot pay.

Termination for insolvency  

Historically, contracts (particularly supply agreements) would often include provisions that would permit a party to terminate in the event of the insolvency of the counterparty. What was considered to be an insolvency event was usually defined in the contract (i.e. it could simply be 'not being able to pay debts when they fall due', or more specifically upon the 'appointment of external administrators'). However from 1 July 2018 legislative changes were introduced to limit the ability of a party to terminate an agreement in such circumstances. Where a contract triggers a termination right upon the entry of a party into or commencing certain insolvency or restructuring procedures, the ipso facto stay prevents the non-defaulting party exercising such termination or other rights. There were a variety of reasons for this, one being that it would allow the insolvent company to continue to trade with its contracts in place and hopefully assist in the company being salvaged once debts were restructured.

These laws apply to contracts entered into on and from July 2018. If a contract was entered into before that date and contains such a right, then the termination option would still apply now. We often see contracts entered into post-1 July 2018 which still contain such a termination right on insolvency, but the ability to utilise it is likely now compromised.

As at the time of publication of this issue, the Treasurer had just recently substantial insolvency reforms in response to COVID-19, including the introduction of a debt restructuring process and liquidation path for smaller businesses with debts under $1 million which is intended to be simpler and more efficient than existing structures. These reforms are expected to commence on 1 January 2021 and Gadens will provide updates when further information is available.

Other options

Termination for convenience: If you want to terminate arrangements with your customer you may be fortunate and find that your contract contains a right to terminate for convenience. Terminating a contract for convenience is often not as simple as it may appear, so we recommend that you seek legal advice before exercising (or purporting to exercise) such a right.

Termination for breach: When a customer is teetering on the verge of insolvency they may have delayed payments to you in breach of contractual payment terms. Such a situation may provide you with the opportunity to terminate for breach of contract. Again it is very important to seek legal advice as termination rights can be particularly drafted (with a specific legal consequence) and may not be as straightforward as they appear. Someone in your organisation may have agreed to a variation to the contract to provide for a longer period to meet payments and in those circumstances you may not be able to make a case for breach of contract.

Reliance on contract terms: If you are not in a position to terminate the agreement itself, consider what your obligations are as a supplier to maintain ongoing supply. For example, the provision could state that you 'may' provide the goods or services meaning that it is optional, or there may be no minimum requirements. When entering into a supply agreement you should always seek that title to the goods does not pass until those goods have been paid for in full. Again we suggest seeking legal advice so that appropriate provisions are included in the agreement and to ensure you have registered any security interest on the PPSR appropriately and on time. Timing is critical as delays could result in the registrations being ineffective which could jeopardise your ability to recover what is owed.

Statutory demands: Assuming that your customer owes you a certain amount of money, ordinarily you would likely have issued a statutory demand. Please be aware that until 31 December 2020 the minimum threshold to issue a statutory demand has been increased to $20,000 (from $2,000) and the time to respond to a statutory demand has been increased to six months (from 21 days). If you wanted to commence proceedings for unpaid invoices you would now need to bring debt recovery proceedings through the Courts (subject to Court hearing procedures and availability, which have also been impacted).

Next steps

  • Firstly, where appropriate, you should seek payment upfront and not extend payment terms.
  • Keep open lines of communication with your customer.
  • Consider if a short-term price reduction will keep your customer in business.
  • Consider ability to register a security interest on the PPSR to ensure your interest in the goods is noted (e.g. where you retain title in the goods until payment is received). The timing of this is critical and generally must be done at the outset.
  • Speak to a legal advisor before varying, terminating or purporting to terminate a contract.
  • Keep up to date with constant changes at State and Federal level in response to COVID-19.   

This article was published as part of Gadens' featured publication, FMCG Express | October Edition.