Resolution Ready? New Controls For IT Supplies to Distressed Banks

by DLA Piper
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A current "hot topic" for banking technology contracts is termination rights. 1 October brings new statutory controls, potentially affecting termination rights in many IT contracts. For banks in particular, regulatory led contractual requirements which are designed to protect key IT functions should a bank suffer financial distress are on the horizon. What does this mean for banking technology contracts in practice? 

Overview

Banks, and the suppliers of IT services to banks, will be aware of the Bank of England's power to suspend contractual payment obligations and termination rights. However, further controls are afoot:

  • From 1 October 2015, as a result of new powers being introduced under general corporate insolvency law, the insolvency of a bank will have a significant effect on the rights of suppliers to demand the payment of arrears. Depending on the insolvency regime which the bank enters, the new powers may also affect supplier rights to terminate some specific types of contracts with banks.
  • Last year the Prudential Regulation Authority (PRA) consulted with a view to both ensuring operational continuity for a bank in resolution and on specific proposals for ring-fenced operations. Its proposals include comments about contractual terms.

This briefing considers the effect of these new controls on financially distressed and insolvent banks. It is worth noting that, although not covered in this briefing, similar regimes apply to insolvent investment banks and to building societies.

Current landscape: Bank of England powers

The Bank of England has the power to suspend, in each case for one day, both contractual payment obligations and supplier termination rights which would otherwise have been triggered by the bank's financial distress. The power is exercisable in very particular circumstances, namely when the bank (or part of it) is being transferred either to another bank or into public ownership (a process known as "Stabilisation" and forming one option under the banking Special Resolution Regime). In this scenario, the transferring bank's (former) group is obliged to continue support the transferred operations by providing necessary premises, IT systems etc., in return for "reasonable consideration".

Changes effective 1 October 2015: Insolvency Act changes 

Payment controls - when a bank enters into any form of insolvency procedure

On 1 October 2015, protections in the Insolvency Act 1986 will be expanded to catch IT supplies which fall into the definition of "Essential Supplies":

Essential Supplies means

  • the supply of communications services by any party who carries on a business which includes giving such supplies;
  • the supply of the following goods or services by any party whose business includes making such supplies and where supply is for the purpose of enabling or facilitating anything to be done by electronic means: point of sale terminals; computer hardware and software; information; advice and technical assistance in connection with the use of IT; data storage and processing; website hosting.

 

Legal effect

The supplier of Essential Supplies will no longer, upon a bank's insolvency (or its special banking insolvency procedure or special banking administration procedure "BAP") be able to make it a condition for continued supply that some or all of the bank's pre-insolvency arrears are paid. However the supplier will be allowed to make it a condition of continued supply that the insolvency office holder personally guarantees payment of future charges.

Impact on contracts

In practice many banks already negotiate wider protections into their arrangements and may find that their existing measures are superior to the new statutory protection. IT suppliers will be reviewing their contracts to include the most favourable provisions and will be mindful that, from 1 October 2015, suppliers should contact insolvency office holders as quickly as possible following their appointment in order to mitigate the potential effects of these protections.

Termination controls - when a bank enters administration, BAP or is the subject of an approved voluntary arrangement

Legal effect

From the same date, the Insolvency Act will be altered to radically suspend the ability of the providers of Essential Supplies to exercise their normal termination rights. Instead, any contractual remedy that would normally be triggeredby a bank's relevant insolvency and automatically result in, or entitle, the supplier to terminate the contract (or, indeed, to do "any other thing") will be of no effect unless or until certain "protective measures" built into the new statutory mechanism arise or have been complied with.

In short, any contractual termination right of the supplier whose trigger event has already arisen is replaced by a right to terminate only if certain protective measures are satisfied.

Protective Measures

  • To be allowed to terminate a contract:

o    The administrator consents to the termination of the contract; or

o    The court grants permission for the termination of the contract (which it may do only if satisfied that the continuation of the contract would cause the supplier hardship); or

o    Any charges in respect of the supply that are incurred after the relevant insolvency event are not paid within 28 days of the day on which payment was due

  • To be allowed to terminate the supply:

o    The supplier gives written notice to the administrator that the supply will be terminated unless he or she personally guarantees the payment of charges arising after the date of the administration; and

o    he or she fails to provide the guarantee within 14 days of receiving the notice.

Impact on contracts

These new provisions could have a significant effect on the rights and income stream of IT suppliers, particularly those making multiple supplies to a bank on standard terms and conditions, because the ability to terminate could be delayed. Yet conversely, for some larger, more complex supplies the protective measures might have the unintentional effect of allowing the supplier to terminate before its contractual right to terminatewould ordinarily have arisen.

On the horizon: PRA regulatory proposals 

The Insolvency Act changes outlined above apply to utilities, not just essential IT supplies, and to all customers of those services. However banks will be mindful that, in addition, regulatory controls on the horizon will also affect some technology contracts.

The protection of critical shared services

Last year the PRA published[1], proposals which flow from its Fundamental Rule 8: "A firm must prepare for resolution so, if the need arises, it can be resolved in an orderly manner with a minimum disruption of critical services."   Proposed Design Principle 2: Contractual Service Provisions reads:

"contracts [both intra group or with third parties] should not contain clauses that allow the service provider to alter the provision of services solely as a result of [a bank, for our purposes] entering into a period of stress, failing, or entering resolution."

Additional rules for ring-fenced bodies

The PRA has also published near final rules for ring-fenced bodies[2] including a rule requiring "ring-fenced bodies to ensure that the provision of services and facilities from both other group entities and third parties cannot be disrupted through the acts, omissions or insolvency of other group members." For example, it is proposed that:

"A ring-fenced body must ensure the agreement or related arrangement under which it receives services or assesses facilities that it requires in relation to the carrying on of core activities does not permit any other party to terminate, suspend or materially alter the services or facilities or the agreement or arrangement as a result of an act, omission or deterioration in the financial circumstances of another entity in the ring fenced body's group."

Ring-fencing is due to come into effect in 2019 (although at the time of writing a second Bank of England consultation is anticipated).

Both proposals provide helpful guidance as to the regulator's view on certain contract terms. Whilst still in consultation, given that the recommendations are designed to support regulatory obligations which are either already in place or are anticipated, banks would be wise to adhere to their spirit in current negotiations, particularly when negotiating long term IT contracts whose supplies are in-scope. Doing so helps banks to demonstrate that they are "resolution ready".

Summary of controls

A reminder of the key legislation and consultations in this space and how it impacts banks is set out below:

Source

Protected Supply

Relevant financial trigger

Effect

In force?

Banking Act / Special Resolution Regime

Critical functions

Bank is failing or likely to fail.

Depends on SRR route taken. Contract rights may be dis-applied. Other group companies may be expected to provide continued IT (and other) support where the failing bank transfers out of the group.

Insolvency Act s233[3] as applied, with modifications, to banks by the Banking Act

Utilities (which will become the wider Essential Supplies)

Any type of insolvency

Arises automatically.

 

Supplier cannot make it a condition for continued supplies that some / all arrears are paid but can require a personal guarantee.

√ for utilities. From 1 Oct 2015 scope widens to "Essential Supplies" incl. IT.

 

Not retrospective for pre-existing contracts.

Insolvency Act s223A as applied, with modifications to Banks in Banking Act s145. A schedule to the new Statutory Instrument extends s145 to include 223A

Essential Supplies

Administration, Bank Administration (BAP) or Company Voluntary Arrangement only.

Arises automatically.

 

Replaces pre-insolvency contractual termination rights replacing them with statutory protective measures.

1 Oct 2015

 

Not retrospective for pre-existing contracts.

PRA Discussion Paper DP1/14

Critical Shared Services

Stress, failing or resolution.

Contracts should not allow service provision change by virtue of the bank suffering the relevant financial distress

X (but supports fundamental rule 8 which is already in force)

 

Consultation. Operative date for final form unknown.

PRA Consultation Paper CP19/14.

Policy Statement PS10/15

Ring fenced core activities

Any act, omission or deterioration in the financial circumstances of another entity in the group.

Arrangements must not allow the financial distress of another group entity to affect the supply.

 

X

 

Consultation.

Implementation currently planned for 1 Jan 2019.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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