As previously reported, the Corporate Insolvency and Governance Act 2020 (CIGA) had made some permanent and temporary changes to the insolvency regime.
Here we focus on the impact of CIGA on construction contracts and, in particular, how the new provisions affect construction contracts and the Construction Act.
What is CIGA?
CIGA came into force on 26 June 2020. It reforms the insolvency framework in a number of fundamental ways, including new measures to provide businesses with breathing space so that they can continue trading through the coronavirus pandemic. For example, there is a temporary suspension on the issue of statutory demands and winding up petitions, except in certain limited circumstances. However, there are also permanent measures introduced such as the ban on the exercise of contractual termination provisions (with limited exceptions).
Of particular importance to the construction industry is section 14 of CIGA, which applies to all contracts for the supply of goods or services (save in respect of certain suppliers, and certain types of contracts for the supply of goods or services, which are not considered further here). Section 14 introduces a new section 233B to the Insolvency Act 1986 (IA86).
How does the ban on the exercise of contractual termination clauses introduced by CIGA affect construction contracts?
Most construction contracts contain provisions enabling a party to terminate the contract if the other party is insolvent (Clause 91 of NEC4 and Clause 8.5 and 8.10 of JCT/SBCC).
The relevant provisions of section 233B of IA86 introduced by CIGA are summarised below. It is important to remember that these provisions are one way and affect only the rights of the "supplier" ie the contractor/consultant as against the client, or the sub-contractor as against the contractor. The employer's right to terminate is not affected.
In summary:
- CIGA essentially renders nugatory any contractual provisions that would enable a contractor to terminate as a result of the client (or contactor from the point of view of a sub-contractor) becoming subject to a "relevant insolvency procedure". This would also capture automatic termination provisions (s233B(3) IA86)
- a provision which allows the contractor to do "any other thing" in such circumstances also ceases to have effect (s233B (3) IA86)
- a relevant insolvency procedure includes all of the existing insolvency procedures, as well as the new Part A1 moratorium procedure
- suppliers (ie contractors) are also prevented from exercising contractual termination rights if the relevant right to terminate arose (but was not exercised) prior to the client entering the relevant insolvency procedure - ie, once the client is in an insolvency procedure, the contractor cannot exercise any pre-existing termination rights (whether or not it related to the client's insolvency) unless the client or the insolvency officeholder consents, or the court orders on the basis of the supplier's "hardship"
- suppliers (ie contractors) are prevented from "doing any other thing" which has the effect of making further supply of goods and services conditional on payment of outstanding charges (s233B(7)). This means that a contractor is not allowed to impose conditions to the effect that the continued supply of goods or services depends on the settling of any outstanding payments
If the prohibition of termination bites, termination in such circumstances requires:
- the consent of the insolvency practitioner
- the consent of the client
- the permission of the court to terminate on the grounds that "hardship" would otherwise be experienced by the contractor contractor (although there is currently no guidance on the meaning of "hardship").
There is a temporary exclusion from the effects of s233B IA86 for certain small suppliers, which the Government has recently extended to 30 March 2021. A small supplier must meet two of three criteria: turnover not more than £10.2 million; balance sheet total not more than £5.1 million; and not more than 50 employ.
Does this apply to all termination clauses?
As mentioned above, CIGA applies only to termination clauses in a contract for the supply of goods and services which affect the supplier/contractor. CIGA does not apply to any rights of an employer as against its contractors, or to a contractor as against its sub-contractors and suppliers. There is also a temporary exclusion until 30 March 2021 for certain small suppliers.
What if the termination event arises after an insolvency event?
If an event entitling a contractor to terminate arises after the insolvency procedure, for example non-payment, the termination provision will remain effective and the contractor will be able to terminate during the insolvency period.
How does this work alongside section 112 of the Construction Act?
Again, we see the difficulties of the insolvency regime and the Construction Act - this time section 112 and the right to suspend for non-payment.
Section 112 enables the contractor to suspend performance on 7 days' notice to the client. Whilst a contractual right to suspend would become ineffective under s233B(3) as it is likely to amount to doing "any other thing", it is unlikely that a statutory right to suspend is caught by s 233B(3).
However, it would seem that this statutory right would need to be exercised before the insolvency procedure was commenced to avoid being caught under s233B(7). It is likely that exercising a right to suspend (eg by giving notice) would amount to doing "something" which has the effect of making further supply conditional on payment.
What about step-in rights under a collateral warranty?
There is some debate as to the effect of the CIGA on step-in rights. Many projects provide for step-in rights to protect an employer or a funder when faced with contractor insolvency to allow an employer or funder to step-in and so protect the supply chain. The rights are then documented in a separate collateral warranty or in specific third-party rights clauses within the construction contract or sub-contract.
These provisions usually require a contractor or sub-contractor to give notice to the funder/employer prior to exercising any contractual right of termination so as to give the funder/employer the chance to step in. As CIGA prevents the exercise of a contractual termination right by a contractor or sub-contractor on the basis of a recipient counter-party entering an insolvency procedure, it is likely that there will be no opportunity for a contractor or sub-contractor to issue the relevant notice triggering the commencement of the step-in process while the moratorium is in place unless there is an additional right to terminate arises after the insolvency procedure. However, this will not prevent the employer/funder electing to step-in where it has a separate right to do so.
