Corporate Insolvency and Governance Act 2020: Leaving the construction supply chain out of pocket?

Like a plethora of other recent legislation, the Corporate Insolvency and Governance Act 2020 (“CIGA”) was enacted to assist companies suffering financial hardship due to the Covid-19 pandemic. Yet, without proper consideration of the measures introduced by CIGA, parties within the construction supply chain might themselves become distressed.

Overview of CIGA

Among other things, CIGA introduced two new restructuring and insolvency processes: a free standing moratorium, and a restructuring plan for companies in financial difficulty. While the details of these processes are beyond the scope of this blog, the key take-away is that construction contracts which either contain a list of insolvency processes and/or make reference to section 113 of the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”) should be amended to cater for these new insolvency processes.

More impactful for the construction industry, CIGA prevents suppliers of goods or services (a “Supplier”) from terminating a contract (whether automatically or by notice) because its client (a “Client”) has entered an insolvency procedure (e.g. administration, liquidation, moratorium, etc.).  Specifically, any contractual right to terminate for the Client’s insolvency ceases to operate.  Additionally, a Supplier is prevented from exercising any contractual right it might have to terminate for a pre-insolvency breach if such right is not exercised prior to commencement of the insolvency procedure. Furthermore, a Supplier cannot do “any other thing” as a result of the Client entering an insolvency procedure. Finally, a Supplier is prevented from making payment of any outstanding amounts a condition precedent to the Supplier providing any continued supply of goods or services.

Impact of CIGA on the construction sector

The amendments in respect of termination rights relate to the insolvency of a Client as opposed to a Supplier. Thus, CIGA does not alter an Employer’s options if faced with the insolvency of its main contractor, or a main contractor’s options if faced with the insolvency of its sub-contractor.

Rather, it will be main contractors and/or sub-contractors who will be impacted where an Employer or the main contractor (as the case may be) enters into an insolvency procedure.

For example, where a main contractor enter administration, the situation would now be as follows:

1. Subject to the contract provisions, the Employer’s ability to terminate the contract remains.
2. Provisions within any sub-contract allowing for termination due to the main contractor’s insolvency cease to operate.
3. The sub-contractors must continue to perform their contractual obligations or risk being in breach of their sub-contracts.
4. The sub-contractors cannot make the continued supply of their goods or services conditional upon payment by the main contractor of any outstanding monies due to the sub-contractors. Nor can the sub-contractors do anything that has such an affect. Hence, the sub-contractors must continue to supply their goods or services notwithstanding that they might be owed substantial sums by the main contractor.

The changes introduced by CIGA do not mean that the main contractor does not still owe money to the sub-contractors; rather, the sub-contractors are unable to terminate their sub-contracts for non-payment of such monies after the main contractor enters into an insolvency procedure.

Supplier’s right to suspend for non-payment

There is little doubt that any contractual right of suspension for non-payment would fall within the changes introduced by CIGA and thus be unenforceable.

As for a Supplier’s statutory right of suspension under section 112 of the Construction Act, unfortunately at this point in time, the position is unclear. It may be that statutory suspension falls foul of CIGA since exercise of a statutory right to suspend for non-payment might be seen as doing “any other thing” as a result of the Client’s insolvency and having the effect of making payment of outstanding amounts a condition of future supply. Yet, the statutory right to suspend derives from a Client’s failure to pay rather than a Client’s insolvency; therefore, arguably CIGA should not impact this statutory right. Until the Courts are required to decide the point, it is likely best for parties to err on the side of caution.

What should suppliers do?

First, any post insolvency non-payment does not fall within the provisions of CIGA, thereby enabling a Supplier to terminate for non-payment during the insolvency period.

Additionally, there are circumstances in which a Supplier can terminate notwithstanding the new provisions. These include agreement with the Client’s insolvency practitioner, a temporary exclusion for certain small suppliers, or the Court granting permission based on it being satisfied that continuation of the contract would cause the Supplier hardship.

Rather than wait until the worst happens, if there is any threat that a Client might become insolvent, Suppliers may be forced to consider terminating for minor breaches in order to protect themselves once the Client becomes insolvent. However, here again Suppliers must exercise care. Under many standard form contracts/sub-contracts, the procedure for termination requires serving of two (2) notices: what is currently unclear is the position if only the first notice has been served prior to a Client entering into an insolvency procedure.

For Suppliers who have yet to enter into a contract, options to mitigate the impacts of CIGA include:

1. reducing payment periods to provide a greater frequency of payment and thus a lower outstanding balance due;
2. amending contracts to take account of the new provisions within CIGA. For example, the current definition of insolvency within both JCT and NEC contracts does not include the new moratorium or restructuring plan. Furthermore, any contract that defines insolvency by reference to section 113 of the Construction Act does not capture these new insolvency procedures;
3. negotiating enhanced termination rights for non-payment during any insolvency period to allow termination of a contract at an earlier stage. For example, within JCT contracts termination for non-payment requires the service of two separate notices – Suppliers should consider negotiating more straightforward termination provisions should the Client experience an insolvency event.

For those Suppliers with existing contracts, it may be worth seeking to incorporate such changes through the use of a deed of variation.

Conclusion

The key message is that Suppliers must stay aware of the solvency status of their Clients and not allow a build-up of potential termination rights. Rather, if a Client appears to be struggling, Suppliers need to carefully consider whether to terminate sooner rather than later.  Such actions must be balanced against any potential for wrongful and/or repudiatory breach by the Supplier which itself is a serious matter.

Overall, whilst the intention of CIGA might have been just for struggling Clients, CIGA has the potential of plunging the construction industry back to pre-Construction Act days when Suppliers where left out of pocket.

If you have any queries about this matter, please contact Brenna Baye or any member of the Construction or Restructuring & Insolvency teams.

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