The Corporate Insolvency and Governance Act 2020 ("CIGA") came into force on 26 June 2020 with the main objective of giving businesses "breathing space" in order to continue trading in light of the COVID-19 pandemic. It was progressed quickly through parliament and includes a number of temporary measures aimed at immediately reducing the number of companies entering insolvency procedures. It also includes a range of permanent measures which had been previously considered as part of an overhaul of UK insolvency law and which represent the most significant changes to the regime in over 20 years.
Suspension of winding-up petitions
One of the temporary measures which is having an immediate impact on all sectors of the UK economy, including construction, is the restriction on the presentation of winding up petitions. Before CIGA was published it was thought this measure would focus on protecting tenants from enforcement action by landlords for unpaid rent, but the Act is far wider than that. During the restricted period (originally up to 30 September 2020 and since extended to 31 December 2020) no statutory demands or winding up petitions can be presented by any creditor unless the creditor has reasonable grounds for believing either (i) that coronavirus has not had a financial effect on the company; or (ii) the facts by reference to which the relevant ground to wind up the company applies would have arisen even if coronavirus had not had a financial effect on the company.
The test for establishing if coronavirus has had a 'financial effect' on a company is considered to have a low threshold and reports suggest that in practice there have been no more than a handful of winding up petitions granted during the restricted period. For the construction industry where companies can be heavily reliant on cashflow, businesses should, therefore, be aware that this option is currently unlikely to be available to force payment of debts. Also, in the run up to the end of the restricted period (as above, currently 31 December 2020) creditors may store up winding up petitions leading to a sudden wave of multiple liquidations when the restriction finally ends.
Perhaps the most significant impact on the construction industry from CIGA will be the introduction of section 233B to the Insolvency Act 1986 – a permanent measure preventing the use of termination clauses in the event of insolvency.
Who is affected?
The CIGA provisions on termination apply to "suppliers of goods and services". In a construction context this will mean contractors and suppliers on the insolvency of those immediately above them in the supply chain. It does not apply the other way around to employers/main contractors on the insolvency of one of their suppliers. Therefore, a main contractor can still rely on a contractual termination clause if a subcontractor enters insolvency.
There is a temporary exemption that CIGA does not apply to a "small entity" supplier which as with the restriction on winding up petitions, currently lasts until 31 December 2020. A "small entity" is one which satisfies at least two of: (i) has a turnover of less than £10.2 million, (ii) has a balance sheet total of less than £5.1 million, and/or (iii) has fewer than 50 employees.
What is the impact of section 233B?
The new measure means that any term of a supply contract which either: 1) provides for its automatic termination; or 2) gives a right to suppliers to terminate; or 3) enables the supplier to "do any other thing" (e.g. increase costs), all as a result of the insolvency of the instructing company will cease to have effect. The aim being to improve the prospects of rescuing insolvent businesses.
Termination on insolvency provisions are commonly found in standard form construction contracts, including JCT; SBCC; and NEC:
Can you terminate on insolvency for pre-insolvency events?
The legislation also prevents suppliers from exercising their termination rights once the employer is subject to insolvency proceedings, even if the event triggering termination (e.g. non-payment) occurred prior to the employer becoming insolvent.
Payment conditional on continued supply
Suppliers are also prohibited from making the continuation of work post-insolvency conditional on the employer paying for outstanding charges incurred pre-insolvency. However, if the supplier continues to provide services to the employer after they enter into insolvency proceedings, the employer will be obliged to pay for those services as sums fall due. In administration for example, any costs relating to supplies made under contracts that the administrator opts to continue will be expenses of the administration which will rank as a priority ahead of the administrators' own remuneration. If payment is not forthcoming, then the supplier can terminate for non-payment without falling foul of section 233B. Nevertheless, it is important for suppliers to seek advice when faced with an insolvent employer to best protect their position.
What insolvency proceedings trigger section 233B?
The new measures under section 233B apply where a company has become 'subject to a relevant insolvency procedure'. This includes administration, liquidation, CVAs and the new moratorium procedure.
The 'moratorium' is an additional insolvency tool introduced by CIGA. Companies can apply for this 20-day protection period to enable them to pursue a rescue plan and during which they are entitled to payment holidays in respect of certain debts and litigation cannot be commenced, continued or enforced against them.
The standard form construction contracts do not currently take into account the new moratorium. Therefore, employers seeking to terminate contracts with suppliers when the latter enters into a moratorium may be unable to do so if the definition of 'insolvency' under the contract does not extend to this new insolvency tool.
Does section 233B prevent suppliers relying on their statutory right to suspend performance for non-payment?
Section 112 of the Housing Grants, Construction and Regeneration Act 1996 (the "Construction Act") grants parties a right to suspend performance for non-payment. Suspension of work for non-payment is generally incorporated as an express clause in standard form construction contracts, but if not, the term can be implied.
Where an employer is not subject to a relevant insolvency procedure, CIGA should not prevent a supplier from exercising the right to suspend under the Construction Act. However, where an employer does become subject to a relevant procedure, the supplier's statutory right to suspend work for non-payment would we think be limited by the measures in CIGA. Exercising this right on the employer's insolvency may be viewed as doing "any other thing" due to the insolvency (contrary to section 233B(3)), or, in certain circumstances, an attempt to make payment of pre-insolvency debts conditional on continuing supply post-insolvency (contrary to section 233B(7)). Without further guidance from the Government, it will be left to the courts to decide how section 112 of the Construction Act should operate in an insolvency situation against the backdrop of CIGA.
What protections are there for suppliers?
Suppliers should try and engage with an insolvent employer and any appointed office holder as soon as possible to establish what their plans are for the insolvency and the contract. If there is no intention to continue the contract, either the office holder (where the company is in a formal process) or the company itself (such as when the company is subject to a CVA or moratorium) can consent to the contract being terminated. A supplier can also apply to court for the contract to be terminated on the basis that its continuation would cause the supplier hardship. It remains to be seen how the courts will interpret "hardship", however, the Government's Guidance on prohibition of termination clauses indicates that 'hardship' can mean where the supplier's own solvency is threatened. This may set the bar high for suppliers applying to the court to terminate contracts with employers, albeit the courts may take additional factors into account.
Key risks for suppliers
Given the increased shift in risk to suppliers in insolvency situations, they should keep the following in mind:
- If a supplier, attempts to rely on an insolvency termination clause when in fact it has been rendered ineffective by CIGA, and subsequently ceases to perform its contractual obligations, the supplier could be faced with a claim for wrongful termination and potential exposure to damages.
- Increased financial checks on employers may become the norm, or even a contractual obligation, to allow for suppliers to exercise their termination rights (where possible) before employers become insolvent.
- Suppliers may be required to make a decision to terminate under the contract far earlier than usual, particularly where a contract requires service of a 'warning notice', for example under Clause 8.4.1 of the JCT Design and Build Contract 2016. If a warning notice is served pre-insolvency, but the second notice bringing the contract to an end is issued post-insolvency, then it seems likely that the termination will be prohibited by CIGA.
- Depending on the terms of the main contract, where the employer terminates its contract with an insolvent contractor, sub-contractors may still be restricted by CIGA and be required to seek permission from either the insolvency practitioner, the company or the courts in order to terminate its sub-contract.
- Suppliers may seek to amend contracts to allow termination prior to the employer becoming insolvent, but where they are perceived to be in 'financial difficulty'. However, including a broad provision such as this could have unintended consequences for the supplier if made mutual.
There are various question marks over CIGA in so far as it relates to construction contracts. Short of further Government guidance, we may have to wait for disputes to be brought before the courts before those questions can be answered. In the meantime, it is vital, particularly during these challenging times where insolvency is more prevalent, that all parties to construction contracts are aware of the termination restrictions imposed by CIGA on the insolvency of employers and how they manage the process in the event of an insolvency occurring.