Guarding against insolvency risks in IT contracts
With tech now more vital than ever for most businesses, the failure of an IT service provider can be catastrophic. As businesses suffer from the knock-on effects of the pandemic and insolvencies look set to increase, it is important for businesses to protect themselves as far as possible in their commercial relationships.
Protection for both the IT service provider and the business comes from the contract they enter into with each other. We take a look at the key points to consider.
IT service providers
The IT service provider needs to ensure that payments are being made regularly to support its operation. Delays can arise where milestone payments are agreed in the contract but milestones cannot be met because the client does not provide information, instructions or meet its obligations.
The contract needs to address this as far as possible by requiring the client to meet deadlines and specifying the tasks to be carried out by each party.
It can also help the service provider to have shorter payment times where payments are linked to milestones, to try and bring money in more quickly. This can also warn the service provider of potential financial difficulties on the behalf of the client as there will be an earlier warning of problems in paying.
The service provider will also benefit from the inclusion of a dispute resolution process to stop the client from withholding payment. The clause should aim to move the dispute along without too much delay for the benefit of both parties.
Another risk for the service provider comes from large items of expenditure made in anticipation of a contract continuing for a substantial period of time. This could be the purchase of equipment or putting infrastructure in place to fulfil the contract. If the client becomes insolvent, it could leave the service provider in difficulty. The solution is to negotiate upfront payments for anything purchased specifically to carry out the client’s job.
Customer priorities are timescales, budget and delivery of the service. Where the project needs to be completed within a certain time frame, this should be included in the contract.
Budget can be managed by agreeing to payment on reaching milestones, rather than a lump sum upfront, which risks losing funds in the event that the IT service provider becomes insolvent.
Consideration should also be given in the contract to the ownership of any intellectual property created by the IT service provider for use by the client. The client may want exclusive ownership of any intellectual property created for it to use, to prevent a competitor from using it.
Escrow can be used to protect the client in the event that the IT service provider becomes insolvent. By placing intellectual property, such as software codes, with an independent third party, they can be safeguarded. The contract should detail exactly what is to be placed in escrow, who will pay the costs and how the retrieval of the escrow items will be dealt with.
Other preparations to safeguard against insolvency of the service provider include mirroring the data they use and create to another server that is controlled by the client and is completely separate from the service provider.
Clients are also advised to have a procedure in place for switching to a new service provider in case difficulties arise. This is a complex process and it will require considerable upfront work to put a contingency plan in place. However, in the event of the loss of the original service provider, it can be the difference between survival and failure of a business.
Insolvency and contract termination
Under the terms of s. 233 of the Insolvency Act 1986, a supplier cannot insist on arrears being paid in an insolvency situation as a condition of the continuation of services where the arrears existed at the start of insolvency.
Similarly, the Corporate Insolvency and Governance Act 2020 allows a moratorium on creditor action initially for a period of 20 days, during which time no legal action can be brought for pre-moratorium debt.
However, provision of services during the insolvency can be conditional upon the insolvency practitioner giving a personal guarantee in respect of payments.
The Insolvency Act contains specific provisions in respect of IT service providers, as follows:
- An IT service provider cannot end the provision of services because a client has entered into administration or a voluntary arrangement.
- Clauses in the contract that are triggered by a client entering into an insolvency procedure and that provide for increased charges will be invalid.
- If an IT service provider could trigger termination of the contract before insolvency proceedings commence but chooses not to do so, they cannot later trigger termination once insolvency proceedings have begun.
The right remains for an IT service provider to terminate a contract before insolvency commences or during the insolvency if it is for a reason other than the insolvency. An example of a valid reason would be failure to pay for services that are being provided during the insolvency.
In the event that the service provider would suffer hardship if they had to continue to provide services, the court may give permission for termination.
The Corporation Insolvency and Governance Act 2020 contains a temporary provision, in force until 31 March 2021, preventing a winding-up petition or statutory demand from being issued where the reason for debt is Covid-19.
It is important that the contract between the parties defines how it will be determined when insolvency begins. A business may be insolvent for some considerable period before insolvency proceedings are entered into.
During the term of the contract, both parties will be advised to monitor the financial wellbeing of the other, so that any financial difficulties do not come as a surprise and insolvency proceedings can be anticipated and appropriate action taken.
At RSW Law we understand the importance of covering every eventuality in a contract between a client and an IT service provider. If you would like advice on negotiating and putting a robust contract in place or guidance about potential insolvency, we will be happy to hear from you.
Our advice is intended to be practical and focussed on our clients’ business interests and success. Our lawyers work in many areas, including financial services, retail, leisure, property and professional services.
If you would like to speak to Tanya Seevaratnam or Chris Ward, our expert commercial dispute resolution and insolvency solicitors, please telephone us on 020 3146 2989, email us at email@example.com or firstname.lastname@example.org or fill in our contact form.
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