On 25 June 2020, the Corporate Insolvency and Governance Act 2020 introduced some of the most transformative changes seen in insolvency since the Insolvency Act 1986.
For the construction industry, the Corporate Insolvency and Governance Act 2020 (‘the Act’) presents hurdles for contractors in terms of their ability to operate contractual termination clauses in the unfortunate event that their employer becomes insolvent.
What are the new changes to insolvency law?
The key points to be aware of are that the new provisions:
- stop a contractor from exercising a contractual right to terminate where an employer has entered into a formal insolvency procedure (within the meaning of the Act);
- stop a sub-contractor from exercising a contractual right to terminate a contract where a contractor has entered into a formal insolvency procedure (within the meaning of the Act);
- prevents contractors and sub-contractors (as suppliers of goods and services) from withholding works on the basis that unpaid invoices for work done made before the start of the insolvency period are paid first. Therefore, contractors/sub-contractors under the Act are obligated to continue works despite non-payment; and
- prevents the pursuit of unpaid invoices by way of a winding up petition based on:
- service of a statutory demand between 1 March 2020 and 31 March 2021; or
- service of a winding up petition based on a statutory demand before 1 March 2020, so long as it can be shown that the pandemic has not had a “financial effect” on the company or that the company would have become insolvent regardless of the pandemic.
The impact on contractors
For contractors, the new provisions can lead to a degree of uncertainty about what they can do if:
- their employer become insolvent;
- their ability to serve statutory demands/winding up petitions if employers do not pay their bills;
- they are experiencing cash flow problems as a result of COVID-19 and receive statutory demands/winding up petitions;
- they enter into an insolvency procedure themselves and what their continuing contractual obligations are; and
- they want to use their statutory rights under Housing Grants, Construction and Regeneration Act 1998 to suspend works due to non-payment of goods/services and/or commence adjudication for non-payment and successfully enforcing the decision.
Can the parties reach a mutual agreement to terminate due to an employer’s insolvency?
One key question raised by contractors is likely to be whether parties can still mutually agree to terminate works due to an employer’s insolvency. The answer appears to be yes, but only on the basis that:-
- The insolvency practitioner agrees; or
- The insolvent party agrees.
It is likely that consent from an insolvency practitioner or insolvent party will be hard to come by, given the current economic climate, the strong onus and commitment by the UK government to restart the economy and insolvency practitioner’s duties to creditors.
One argument that could be used by a contractor when seeking to reach a mutual agreement to terminate is that it is not commercially viable (for either party) to continue with the works but this will need to be carefully considered and discussed between the parties.
If it is not possible to reach a mutual agreement to terminate, one final option for a contractor is to seek permission from the court on the basis that it should allow termination as continuing with the works by the contractor would cause ‘hardship’. Presently, the new rules do not provide any definition of ‘hardship’. However, on the face of it, larger contractors may have more of a struggle persuading the court that continuing the works will cause ‘hardship’ compared to smaller companies who may be more significantly impacted.
Supplies of goods and services by small suppliers
For a short window, there is a temporary suspension in the application of the new rules to small suppliers until 30 March 2021.
To count as a ‘small supplier’, they’ll need to tick two of the following criteria:
- A turnover of less than £10.2m;
- A balance sheet total of less than £5.1m; and
- Less than 50 employees
What does this mean for the future of the construction industry?
Some of the temporary changes to the insolvency rules brought about as a result of the Act were originally due to expire on 30 September 2020., but these changes were extended until 31 December 2020.
Unsurprisingly, these changes have now been extended for a second time until 31 March 2021. As a result:
- I’s not possible to issue a winding up petition based on a statutory demand served between 1 March 2020 and 31 March 2021; and
- The prohibition on presenting winding-up petitions or making winding-up orders is extended until 31 March 2021.
Given the ever changing nature of the restrictions as a result of the COVID-19 pandemic, and the challenges that these restrictions present, it remains to be seen whether these changes extended a third time.
In the meantime, contractors should remain vigilant as to their employer’s financial position. It also makes sense to ensure that construction contracts entered into going forward include appropriate drafting to ensure that, as far as possible, the consequences of insolvency and the new rules from the Act are addressed and properly covered off.
We’re here to help
If you have concerns around the implications the new insolvency rules may have on your business then our construction disputes team can help – contact Kate Onions or Adam Watson for advice and support.
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