Insolvency: the Corporate Insolvency and Governance Act 2020 and how it affects the construction industry

03 July 2020

The Corporate Insolvency and Governance Act 2020 (the CIG Act) received Royal Assent on 25 June 2020 and effects wide ranging changes.

Further to our briefing note 'Corporate Insolvency and Governance Act 2020: How do the new protection of supplies of goods and services provisions work', we focus on the provisions in the CIG Act that are most relevant to the construction industry - those setting out restrictions on termination clauses in supply contracts and a new moratorium process.



Overview

The CIG Act is a mixture of temporary and permanent measures.

Temporary measures

  1. A temporary removal of the threat of statutory demands and winding-up proceedings where the debt is due to COVID-19.
  2. A temporary suspension of wrongful trading liability.
  3. Temporary changes to the holding of AGMs and general meetings.
  4. Temporary extensions to some Companies House filing requirements.

Permanent measures

  1. A new company moratorium - directors of companies that are insolvent or likely to become insolvent can obtain a 20 business day moratorium period to allow time to restructure or seek new investment.
  1. A new re-structuring plan - this expands upon the existing "scheme of arrangement" regime.
  1. Prohibition on supplier termination clauses in supply contracts.

In this review, we focus on the restriction on termination clauses in supply contracts and the new moratorium provision.

Restriction on termination clauses in supply contracts

Section 14 of the CIG Act inserts new provisions into the Insolvency Act 1986 relating to contracts for the supply of goods and services. Detailed information is set out in our briefing note, but summarising the key features:

Summary

1. Where a company (the customer) has become subject to a relevant insolvency procedure and the contract is in scope (because an exclusion does not apply), any provision in the contract that says:

  • the contract or the supply would terminate or anything else would take place, because the customer becomes subject to the relevant insolvency procedure; or
  • the supplier would be entitled to terminate the contract or supply of goods or services or do anything else, because the customer becomes subject to the relevant insolvency procedure, will cease to have effect.

2. If the supplier has a contractual right to terminate (for any reason) and that entitlement arose before the start of the insolvency period of the customer, the supplier cannot exercise that entitlement before the end of the insolvency period, as defined in the CIG Act.

Restrictions apply upstream

These provisions restrict the rights of a supplier against an insolvent customer (company); they do not apply to the insolvency of the supplier. In those circumstances, the customer will be entitled to terminate if the supplier is insolvent, if this is provided for in the contract between the two parties.

If that is the case, in what circumstances can the supplier terminate?

Ground one: where the relevant insolvency office holder consents to that termination.

Ground two: where the customer consents to the termination.

Ground three: with the court's permission, where the court is satisfied that the continuation of the contract would cause the supplier hardship.

If the default by the customer occurs after the commencement of the insolvency procedure, termination by the supplier on non-insolvency grounds (e.g. non-payment) is still possible in principle, subject to the terms of the contract. However, a supplier cannot make it a condition of future supply, that outstanding amounts for supplies made before the insolvency procedure started have to be paid first.

Temporary exclusion for small suppliers

There is a temporary exclusion for suppliers who are 'small entities as defined in the CIG Act between the day when s14 comes into force and 30 September 2020. So, for example, where the supplier is not in its first financial year, it will be a small entity if two of the following conditions are met (in its most recent financial year):

  • Condition 1: the supplier's turnover was not more than £10.2 million;
  • Condition 2: the supplier's balance sheet total was not more than £5.1 million; or
  • Condition 3: the number of the supplier's employees was not more than 50.

Adjustments to these figures apply for companies in their first financial year and where the most recent financial year is not a full 12 months.

Permanent exclusion - financial services

There is a permanent exclusion in relation to contracts where either the insolvent company (customer) or supplier is one of the following.

  • An insurer.
  • A bank.
  • An electronic money institution.
  • An investment bank/firm.
  • A payment institution.
  • An operator of a payment system or infrastructure provider or infrastructure company.
  • A recognised investment exchange, clearing house or central securities depository.
  • A securitisation company.
  • An entity involved in activities in the areas set out above outside the UK.

The CIG Act provides specific meanings for all of the above.

The CIG Act also sets out a range of "contracts involving financial services" that are also excluded from these restrictions. These include lending, financial leasing, the provision of guarantees, securities contracts, commodities contracts, futures or forwards contracts plus any set-off or netting arrangements (as defined in the Banking Act 2009).

New moratorium provisions - permanent

Detailed information is set out in the CIG Act but summarising the key features of the moratorium:

  • it applies to an "eligible company" (as defined in the CIG Act);
  • directors of an 'eligible company' can obtain a moratorium for the company by filing certain papers at court, but if the company is subject to an outstanding winding up petition, court permission is required subject to a temporary dispensation period until 30 September 2020;
  • an overseas eligible company can only apply for a moratorium if it is not subject to an outstanding winding-up petition and the directors must make a formal court application; the moratorium period can be extended as long as certain conditions are met; and
  • the moratorium is overseen by a monitor who is an insolvency practitioner but the directors remain in charge of the business.

During the moratorium, except in very limited circumstances[1], the company cannot be placed into insolvency proceedings unless they are commenced at the directors' instigation.

Other restrictions apply including a prohibition on any legal process against the company including proceedings or execution, subject to exceptions including employment disputes and where the process has the permission of the court.

Key considerations for the construction industry

1. What about the existing termination clauses in the standard form contracts?

To the extent that contracts (completed or still in negotiation) include clauses that fall within the new provisions, those clauses will now simply be ineffective in terms of rights that can be exercised by the supplier against the customer e.g. the contractor against the employer. If a clause in a live contract is ineffective, the supplier can still terminate on one of the grounds mentioned above (see section headed 'If that is the case, in what circumstances can the supplier terminate?'), but as each ground requires an element of consent, in practice, that may not be easily attainable and could involve significant cost.

NEC4 - the core clauses in the Engineering and Construction Contract (ECC) include termination provisions in Section 9. Clause 91.1 effectively provides that either party may terminate on the insolvency of the other party. Under the CIG Act, to the extent that Clause 91 gives such rights to the contractor (as supplier), those clauses will now be ineffective.

The rights for the employer to terminate on the insolvency of the contractor remain, subject to the specific provisions of the ECC.

JCT 2016 - taking the Design and Build Contract as an example:

Clause 8.5 provides a right for the Employer to terminate the contract if the Contractor is insolvent. This is not affected by the CIG Act.

Clause 8.10 provides for the Contractor to suspend services and/or terminate the contract if the Employer is insolvent. As the Contractor is the supplier for the purposes of the CIG Act, these clauses will now be ineffective.

2. Does the restriction on termination clauses affect the right to suspend for non-payment?

This needs consideration in each instance as the s14 CIG Act restrictions[2] extend beyond the right to terminate to "or any other thing [that] would take place" which could in principle include the right to suspend for non-payment.

3. How does the new moratorium affect the right to adjudicate?

As set out above, when the new CIG Act moratorium is in place, restrictions will apply including a prohibition on any legal process against the company. In those circumstances, does the moratorium affect the right to adjudicate under s108 of the Housing Grants, Construction and Regeneration Act 1996 (as amended)[4]?

A statutory moratorium in administration already exists under the provisions of the Insolvency Act 1986 - amongst other restrictions during that moratorium, paragraph 43 of Schedule B1 states as set out below. The provisions also apply to an interim moratorium in administration.

(6) No legal process (including legal proceedings, execution, distress and diligence) may be instituted or continued against the company or property of the company, except -

  1. with the consent of the administrator, or
  2. with the permission of the court.[5]

This is important in understanding the effect of the moratorium provisions under the new CIG Act as the words emboldened above from the Insolvency Act 1986 in relation to the statutory moratorium in administration are broadly the same as the words relating to the new moratorium process added by the CIG Act.

It is clear from the approach of the courts to adjudication enforcement proceedings that the courts have been and remain keen to enforce adjudication decisions wherever possible, even where a statutory moratorium in administration is in place. In those circumstances, the "unique" nature of adjudication and the need to balance the interests of the claimant and those of the creditors will be considered by the court[6] - in appropriate cases, the court's discretion can in principle be exercised to enforce the adjudicator's decision, notwithstanding a statutory moratorium.

Whilst each case will turn on its facts, the courts are likely to take a similar approach in relation to the new moratorium process provided for in the CIG Act.

Practical points

  • The publisher of the standard form contracts such as JCT and NEC, may well decide that amendments are not currently necessary as ipso facto clauses rendered ineffective by the CIG Act will simply fall away. To the extent that clauses are not prohibited, they will remain effective.
  • Review existing contracts to identify "new" risks arising from the CIG Act - if you are the supplier, you need to make provision for and take into account the fact that any contractual right to terminate or other right (which in each case is triggered by an insolvency event), will no longer be effective if the customer becomes insolvent.
  • Options need to be considered at an earlier stage i.e. before an insolvency event occurs, when choices about whether to e.g. terminate will no longer be available to a supplier of goods or services.
  • The changes may mean that adjudications are started by contractors at a much earlier point to minimise their risks of being prevented from progressing with the adjudication or enforcing an adjudicator's decision.
  • Bear in mind the provisions are upstream i.e. they restrict the right of the supplier not the customer on the customer's insolvency. On a large project, a main contractor may be a supplier under its contract with the employer but also a customer under a contract with a sub-contractor.
  • The new CIG Act needs to be taken into consideration during the negotiation of contracts, bearing in mind that the supplier's rights will become severely restricted on the customer's insolvency.

[1] For example, a public interest winding up petition presented by the Secretary of State.
[2]http://www.legislation.gov.uk/ukpga/2020/12/section/14/enacted
[3]http://www.legislation.gov.uk/ukpga/1996/53/section/112
[4]http://www.legislation.gov.uk/ukpga/1996/53/section/108
[5]para. 43, Schedule B1 of the Insolvency Act 1986
[6] Obiter Coulson J in South Coast Construction Ltd v Iverson Road Ltd [2017] EWHC 61 (TCC)


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