When Builders Go Bust…Continued!

Despite this and my previous article (Construction Timebomb: Detonation Date 1 March), I have been doing whatever I can in preparing current roundtable discussions we are hosting at Spencer West to cover more positive forward-looking topics – and we are discussing such topics. I do think the future for the second half of this year will be much brighter for the Development and Construction sectors. Written by Jonathan More, Constructions Solicitor at Spencer West LLP

However, we can’t avoid the “here and now” and as all developers will know, it does them no favours whatsoever for the construction industry – that will build, refurbish and fit out and finish their properties – to be on its knees, or for your contractors or their supply chain to be staggering along the cliff edge between a successful business and insolvency.

As was reported in Building Magazine on 18 March, there have been more construction insolvencies in the last year than in hospitality and retail. Grim.

The recent Qandor meeting with the same title as this article suggested there was an appetite for more information on this topic, so here we go.

What does “going bust” mean?

This might seem a stupid question or one with an obvious answer, but it is not quite what it meant pre-COVID-19, but the basics are broadly the same and involves administration and liquidation.

Administration gives a company some time to sort its affairs out as it continues to trade, in some form, under the control of the administrator(s), in an attempt to rescue the company as a growing concern or achieve the best possible result for creditors.

If a company is not rescued through this process, it will be put into liquidation or dissolved. This is the last resort: to liquidate or wind up a company. Liquidation can be “compulsory” (by order of the court; commenced by petition – often a creditor on grounds that the company cannot pay its debts) or “voluntary” (by resolution of the company, for example, by members’ or creditors’ voluntary liquidation).

The new kid on the insolvency block is the Corporate Insolvency and Governance Act 2020 (the 2020 Act), brought in last June both to assist companies struggling with the impact of COVID-19, and also to introduce some other changes that have been in the pipeline for some time. The Act makes some permanent and some temporary changes to the insolvency rules and regulations.

There is no need, for the purposes of this article, to become overly bogged down in technicalities quoting statutory legislation, but permanent changes include:

• New moratorium on enforcement actions by creditors, in essence aimed to provide some breathing space for the “insolvent” company against creditor action

• The disapplication of supplier termination of contract provisions for insolvency i.e. a supplier cannot terminate a contract or do “any other thing” (e.g. amending payment terms) as a result of a company’s insolvency

• New restructuring plan process (Part 26A restructuring plan)

Temporary changes include (some of which will have ended by the date of issue of this article):

• A director’s liability for wrongful trading, which expires on 30 April 2021

• A moratorium on Winding up Petition, which expires on 31 March 2021 and is relevant to all companies seeking payment for admitted debt or debts which have been determined as due by formal dispute proceedings.

This is a particular hindrance to companies properly due money, and who may previously have managed to extract this money from a company under threat of insolvency as it restricts the creditor’s use of winding up petitions, so that creditor must have reasonable grounds to believe that COVID-19 had not had a financial impact on company, or grounds for winding up petition would have applied even if COVID-19 had not had an effect on the company.

• A moratorium on statutory demands which expires on 31 March 2021 (a statutory demand being effectively a quick process by which a company can be held accountable in circumstances where it can be proven that it cannot pay a debt properly due).

Your contract is still important (but…)

Notwithstanding the above, it remains important for those in contracts where there is an insolvency of one of the parties to be aware of the contractual consequences of such insolvency (albeit that some standard contractual options have been impacted by the 2020 Act).

Focussing on the unamended JCT D&B 2016 contract, the standard terms allow a party to terminate if the other party is insolvent.

If the Contractor is insolvent, Employer has a right to terminate the contract at any time. The Contractor loses the right to be paid (until the works are completed and defects are rectified) and its obligation to carry out and complete the works is suspended; it must remove the plant, equipment etc. and assign the benefit of any supply contracts without charge to the Employer.

The Employer may also employ others to complete the works and make good any defects, and once works have been completed and any defects rectified, the Employer prepares a final account to show the balance payable (if any) to the Contractor and the costs the Employer has incurred, e.g. in employing others to complete the works and rectify defects and any other losses or damages suffered by the Employer. If any amounts are owed by the Contractor, this amount will be entitled to be recoverable as a debt .

If the Employer is insolvent, the Contractor had a right to terminate for Employer insolvency but by virtue of the 2020 Act, this is no longer relevant and is not enforceable (reference the prohibition of any supplier of services to terminate a contract where the beneficiary of those services becomes insolvent).

The effect of the CIGA on contractual insolvency provisions

As will be becoming apparent, the 2020 Act will have, and has had, an impact on construction contracts (which fall under the category of supplies of goods and services).

The relevant changes that apply “where a company becomes subject to a relevant insolvency procedure” are permanent and will also now include the two new processes of moratorium on enforcement action by creditors and the new restructuring plan process.

The Employer’s right to terminate under the JCT contract will not be affected by the CIGA as “company” is interpreted to mean the entity receiving any goods or services. However, because the definition of insolvency does not include the two new processes, then without amending the JCT Contract to include this, an Employer will not be entitled to terminate when the Contractor is subject to either of those procedures. So appropriate amendments should be made.

As indicated above, however, the Contractor’s right will no longer have any effect, and there will be no right to terminate the contract or “do any other thing” under the contract if the Employer is subject to a relevant insolvency procedure.

The phrase “do any other thing” here is critical. It is reasonable to assume that if a party benefitting from the supply of goods and services is insolvent, it will not be able to pay for these services. In construction there is a statutory right to suspend works under a contract where a party has not been paid for those services. This is usually encapsulated within the relevant contract but even if not, it is implied by law.

It is difficult to argue that suspending works for non-payment is not an act of doing any other thing; that said, it is a battle of one statutory right against another statutory right so there is a tension there. In the current environment, it seems non-sensical and unworkable to force a contractor or subcontractor to continue to provide services and goods where it is not, or at best is unlikely, to receive payment.

However, it does appear that the 2020 Act has considered this. For example, if the court is satisfied that the contractor or sub-contractor will suffer undue hardship by continuing services due to the CIGA provisions, termination may be permitted. The key word there is “court” – so a relevant contractor will have to “tool up” with lawyers and pay to prove its case.

In addition, certain exceptions apply for excluded companies, certain types of contract and smaller companies.

Of course, a Contractor may still terminate if the Employer’s liquidator or administrator consents to the termination.

This all being said, there is no absolute clarity as to whether or not a Contractor could suspend works for non-payment, but such actions should be treated with care and caution as if it is found that a party has wrongfully stopped its works on a contract it may be subject to the contract being repudiated (which creates a string of potential damages claims against the Contractor, which will be very gratefully received by any insolvency practitioner handling the insolvency process of the Employer).

The result of all of this may all be somewhat counterproductive as Contractors may frontload claims and be more on the front foot in adjudications against an Employer to ensure that no money is left to chance as a project proceeds.

Practical thoughts on how best to ensure the success of projects in the current environment

Pre-contract legal steps

There should be proper due diligence by both parties who are due to sign up to a contract for any construction works, and a real effort for open and transparent collaboration on what is required for the works on the project to succeed. 

This includes:

• careful scrutiny of the Contract Sum Analysis and cash flow schedules, and ensuring that they are not heavy at the front end, with no monies left to finish the job if there is an insolvency;

• retention provisions;

• ensuring the contract and sub-contract obliges sub-contractor to provide/procure:

  • full details of any sub-sub-contractors/suppliers it intends to contract with

  • warranties from any sub-sub-contractors with step-in rights

  • product warranties and guarantees

  • PI insurance

  • Vesting certificates in off-site materials

(it should be noted that an Employer can include drafting in the main contract providing for a right for it to review and approve any subcontracts entered into. Clearly this would be subject to the agreement of the main contractor)

• if you do have a right of review over sub-contracts, or have procured your project to operate on a construction management model, include drafting in the sub-contract to cover:

  • a right to terminate immediately on an insolvency event occurring

  • a system of early warnings regarding events which may delay or increase the cost of the works (not a formal compensation event mechanism but simply a prospective approach to issues which may arise on any project)

  • the right of cross-contract set-off

  • lien over plant/machinery/materials

  • financial standing checks during term of sub-contract

Post-contract legal steps

As indicated, above parties should be aware of increased and earlier adjudication, which is why transparency and collaboration is important as much as possible. It is also why great care should be taken to properly know your contract and ensure both parties comply with it.

If significant problems arise on the project once commenced, promote an environment where these are discussed and solutions are not just “dumped” on one party. No matter the risk balance between parties to a construction contract, it does one party no favours at all if the other party has the majority of the risk but is not able to work its way through significant issues by being left to it.

Yes, it is important that if a party does not comply with its obligations, the other party has rights which protect it from any losses incurred as a result, but surely it is more important for all involved that completion of the project is the focus, rather than fighting for money whilst a project is, for example, mothballed whilst the issues are sorted out.

For more advice on any issues covered in this article, and construction issues generally, please get in touch.