Insolvency within the supply chain in the construction industry and what to do about it – Part Two

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Part Two

 

Introduction

As part of this series, last week we looked at what we mean by “insolvency” as defined by the Insolvency Act 1986. We also took a brief look at some of the changes that have been introduced by the new Corporate Insolvency and Governance Act 2020 (the “CIG Act”) and the implications for a project if contractors within the supply chain become insolvent.

This week we take a look at how insolvency is dealt with in the standard form JCT D&B 2016 and the NEC4 construction contracts and also a brief look at how those provisions have been impacted in light of the changes brought about by the CIG Act.

The positions set out below are the positions in the unamended JCT D&B 2016 and the NEC4 contracts and references to “Contractor” are also a reference to “Subcontractor”.

JCT D&B 2016

Clause 8.1 of the JCT D&B 2016 sets out what is meant by insolvency. It involves the start of any of the insolvency procedures e.g.

  • when a company enters into administration within the meaning of Schedule B1 to the IA 1986 (8.1.1);
  • On appointment of an administrative receiver or manager of its property under Chapter I of Part III of that Act, or the appointment of a receiver under Chapter II of that Part (8.1.2);
  • On passing of a resolution for voluntary winding-up without a declaration of solvency under s.89 of that Act (8.1.3); or
  • On making of a winding up order under Part IV or V of that Act (8.1.4).

If the Contractor is insolvent, then the Employer has a right to terminate the contract at any time under clause 8.5. 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. The Contractor must remove plant, equipment etc. and also assigns 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. Once the 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 in e.g. 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 recoverable as a debt.

The Contractor also has a right to terminate for Employer insolvency (clause 8.10) and its obligation to carry out and complete the works is suspended. The Contractor must prepare a final account within two months and the Employer must pay any amounts due within 28 days of submission of the final account.

NEC4

Under clause 91.1 (and the same numbered clause in the sub-contract), Reasons R1 to R10 are types of insolvency procedures applying to both parties and they entitle both the Employer and the Contractor to terminate. They include if a party has:

  • Had a winding-up order made against it (R5),
  • Had a provisional liquidator appointed to it (R6),
  • Passed a resolution for winding-up (other than in order to amalgamate or reconstruct) (R7),
  • Had an administration order made against it (R8),
  • Had a receiver, receiver and manager, or administrative receiver appointed over the whole or substantial part of its undertaking or assets (R9) or
  • Made an arrangement with its creditors (R10).

If the Employer terminates for Contractor insolvency, the Employer can employ another contractor to complete the works (in common with the JCT) and use the plant and material to which he has title. Like the JCT contract, the Employer can also ask the Contractor to assign the benefit to him of any subcontract or other contract relating to the performance of the contract. The Employer will owe the Contractor the amount that is due for works that have been completed in accordance with the relevant Option e.g. Fixed Price or Target Cost and the defined costs for plant and materials. The Employer is also entitled to deduct an amount that he anticipates he may have to pay another subcontractor to complete the works.

If the Contractor terminates for Employer insolvency, the Contractor vacates the site and takes away its equipment. It is entitled to be paid any amounts assessed to be due under the relevant Option, the defined cost of plant and materials, any retentions and any direct fee percentage (applied to the difference between the price for work done to date and the total price for the works).

The effect of the CIG Act on contractual insolvency provisions

Section 14 of the CIG Act is the main section of the Act that will have an impact on construction contracts and this deals with the protection of supplies of goods and services under the section “Termination clauses in supply contracts”. The changes under this section are permanent and apply where “where a company becomes subject to a relevant insolvency procedure” which will also now include the two new processes of moratorium on enforcement action by creditors and the new restructuring plan process.

As we have seen above, under the JCT D&B 2016 and the NEC4, “insolvency” of one of the parties (as defined under those contracts) allows the other party to terminate the contract.

The Employer’s right to terminate under the JCT contract will not be affected by the CIG Act 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.

The Contractor’s right under clause 8.1, however, will no longer have any effect under the CIG Act 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. Under new s.233B(3) of the IA 1986, provisions that provide for this no longer have any effect. The Contractor would have to look to other provisions of the contract e.g. clause 8.9 that allows the Contractor to terminate for non-payment. However, the timing of this is key because if the non-payment is as a result of the Employer already commencing an insolvency procedure, the Contractor will not have a right to terminate. It will need to terminate prior to this.

Under the NEC4 contract, the same principle applies i.e. the Employer may still terminate for Contractor insolvency, but the Contractor may not terminate for Employer insolvency.

If a Contractor is not able to terminate and is obliged to carry on supplying after the relevant insolvency procedure has been commenced in relation to the Employer, the obligation to pay will be treated as an expense of the procedure so that payment will be received for those services being provided, but not necessarily any pre-insolvency arrears.

There are however, exemptions to this and a Contractor may still terminate if the Employer’s liquidator or administrator consents to the termination, the Employer agrees where it is subject to a moratorium, company voluntary arrangement or a restructuring plan procedure or a court decides that it would cause the Contractor too much hardship to carry on with the contract. There is also a temporary exemption for Contractors who are small and have turnovers below a certain threshold.

Conclusion

Both the JCT and NEC4 forms of construction contract allow a party to terminate if the other party is insolvent. What constitutes “insolvency” under the NEC4 is wider than under the JCT. However, under the JCT, the obligation to pay the Contractor stops until the works have been completed and defects have been rectified. This express right is not contained within the NEC4.

With the coming into force of the CIG Act, the right for a Contractor to terminate because the Employer has entered into a relevant insolvency procedure is no longer available. This may lead to Contractors exercising their rights of suspension and termination at an earlier point in time than they otherwise would to avoid being caught out where an Employer is subject to a relevant insolvency procedure and being tied into continuing performance.

Whether or not any amendments are required to the standard form contracts remains to be seen as the relevant clauses affected by the CIG Act may simply fall away and to the extent that they are still effective, they will remain. Contractors in particular will have to decide if they wish to draft in options that take effect before an insolvency procedure is commenced. Contractors may also choose to adjudicate at an earlier stage.

In the next article we will take a look at at what practical and legal steps an Employer or Contractor can take to guard against insolvency before engaging a Contractor or Subcontractor.

Please note that this article does not constitute advice. For advice on insolvency in the construction supply chain and further information on any of the issues addressed in this article, please contact Elizabeth Vago below.