The Corporate Governance and Insolvency Act 2020 – Impact on Construction
The Corporate Governance and Insolvency Bill 2020 gained royal Assent on 25 June 2020 and the Corporate Governance and Insolvency Act 2020 (the “Act”) now brings about a significant change in UK insolvency legislation. You can read more on the wider impact of the Act here.
In short the intention of the Act is to assist companies in financial difficulty by providing measures to allow such entities to continue to trade through those difficulties.
The most significant changes the Act entails will be:
- The introduction of a new moratorium during which no legal proceedings may be taken against the company;
- The prohibition on the operation of termination clauses by suppliers which will take effect on a company entering an insolvency procedure, including the new moratorium.
The potential impact on suppliers being required by law to continue to supply to insolvent parties is fundamental change and one which will have significant repercussions in the construction industry.
Many construction projects are procured using a web of contractors, professional consultants, subcontractors, and materials suppliers. An insolvency within the matrix of contractors and suppliers involved on any project can cause practical and financial issues for one or more of the other parties. The industry has established contractual mechanisms to manage such risks and all in the construction industry are familiar with the mandatory payment mechanisms included (or implied into) construction contracts by the amended Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”). One of the intentions behind the Construction Act was to ensure staged and prompt payment to those contractors and subcontractors towards the bottom of the contractual chain. It is not immediately clear how that intention is reconciled with the motivation behind the Act.
The government commentary on the Act gives a worked example of how the new moratorium and prohibition of termination might work in practice. This is a relatively straightforward example of a simple supply of goods arrangement and is arguably overly optimistic in its outlook. In the government’s example the insolvent customer has no outstanding debts to the supplier at the date the customer enters the insolvency procedure, the customer requests the supplier to continue to supply during the period of the insolvency period which the supplier is willing to do, the supplier is paid for those services and, at the end of the insolvency moratorium the customer exits the process as a viable trading business.
For those in the construction industry it may be more helpful to look more broadly and at arguably more realistic examples in order to asses both the impact of the Act and the relationship with the Construction Act.
One such circumstance would be as follows:
A main contractor, with a turnover in excess of £10.2m and with more than 50 employees working for an employer under an unamended JCT Design and Build Contract 2016.
- The final date for payment of the previous month’s valuation has passed and remains unpaid. The limited company employer is in financial difficulties and then enters the new moratorium.
- Under the proposed provisions of the Act the Contractor cannot terminate the supply under the contract and would be prevented from terminating the contract pursuant to clause 8.10. As the non-payment related to sums which had passed the final date for payment prior to the insolvency process commencing the contractor would be prevented from terminating its employment under clause 8.9.3.
- On a purely contractual basis the contractor is obliged to keep working under the contract whilst the moratorium is in place and unless and until sums falling due as a result of goods and services provided during the moratorium are unpaid after the final date for payment at which point termination does become available to the contractor. Alternatively the contractor can obtain a judgment from the court that continuing to supply would cause the contractor hardship. What is ‘hardship’ is yet to be determined but there is a risk that large companies will be expected to bear greater pain before they will be considered to be suffering hardship.
- Assuming monthly valuations under Alternative B the contractor would be obliged to continue providing goods and services for over a month before having the right to terminate. If the contract provided for staged payments under Alternative A then the contractor could be required to continue working for the entire duration of the current stage unless and until either the contractor could demonstrate ‘hardship’ or the moratorium process ended.
- The contractor continues to supply the goods and services until the final date for payment of goods and services provided during the moratorium has passed and the sum is unpaid. The contractor then serves notice under clause 8.9.1 and 14 days later terminates its employment using the provisions of clause 8.9.3. Shortly thereafter the employer enters liquidation.
In the above example the contractor is owed nearly 3 months’ work and only has a claim as an unsecured creditor against the insolvent employer. The reality is that in such circumstances the contractor will likely receive very little of the amount it is owed.
That is an unsatisfactory position for the contractor. The contractor may have sought to reduce its exposure to additional losses by challenging the obligation to continue to work. The Act permits termination of the supply where the contractor can demonstrate that doing so would cause the contractor ‘hardship’. However, what constitutes ‘hardship’ is not certain and will likely depend heavily on the facts particularly the scale of the obligations and the ability of the contractor to withstand such obligations.
The question therefore arises, can the contractor look to the provisions of the Construction Act to permit it to suspend the performance of the works (and in doing so suspend the supply) to at least reduce the extent of the contractor’s ongoing exposure? The Act does not directly address a contractor’s right to suspend work under S.112 of the Construction Act nor does the current guidance. Therefore whether or not a contractor can look to this provision is an interpretation of the drafting of the Act.
The Act inserts a new section 233B(4) into the Insolvency Act 1986 as follows:
(a) under a provision of a contract for the supply of goods or services to the company the supplier is entitled to terminate the contract or the supply because of an event occurring before the start of the insolvency period, and
(b) the entitlement arises before the start of that period,
the entitlement may not be exercised during that period
Read literally a contractor would still be entitled to suspend services in respect of sums outstanding after the final date for payment and which remained unpaid following a seven day notice to suspend. The contractor would do so on the basis that the right to suspend arose not out of “a provision of the contract” but rather by virtue of a statutory right under S.112 of the Construction Act. There is also scope for debate around whether a suspension of supply under the Construction Act amounts to termination of the supply.
In order to succeed it is likely that the Contractor’s notice to suspend would need to expressly reference S.112 of the Construction Act under which such suspension would be carried out as opposed to any co-existing contractual right such as clause 4.11 of the JCT Design and Build Contract 2016.
Ultimately the interpretation of the relationship between the new S. 233(B) of the Insolvency Act and S.112 of the Construction Act and how those are to be reconciled will, in the absence of further guidance, likely be decided by a decision of a court.
Whilst the above example is in the context of a main contractor and employer relationship the principles set out will apply equally to that of a subcontractor engaged and carrying out work for a main contractor. In the event of the main contractor entering an insolvency process a subcontractor’s position is similar to that of the contractor in the above scenario. The subcontractor would likely be looking to the Construction Act to provide some relief from an ongoing obligation to continue the supply.
However, for those suppliers providing goods and materials and whose contracts do not constitute a Construction Contract for the purposes of the Construction Act the absence of any possibility of a statutory basis to suspend ongoing obligations during the customer’s insolvency period is a greater risk. Such materials suppliers may look to incorporate and rely on terms allowing suspension for non-payment and make use of such provisions prior to the customer entering an insolvency process and obtaining the protection afforded to it by the Act. Consideration should also be given to reducing payment terms to minimise the period of ongoing supply before a right to terminate during the insolvency period may arise.
Those in the construction industry should understand the potential implications of the Act and develop commercial strategies to reduce the risk of being caught supplying goods and services under a contract for an extended period of time without being paid. The alternative would be to terminate in breach of contract and face the consequences of being in repudiatory breach, adding insult to financial injury.
If you would like to talk through the consequences for your business, please email us and one of our team will get in touch.
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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