Insolvency within the supply chain in the construction industry and what to do about it – Part One
The following statement appeared in Construction News (2 June 2020):
The article went on to say that this could increase as productivity levels have been low during the lockdown period relating to Covid-19 and cashflow is drying up in the supply chain. There are also companies that went into the lockdown with low reserves and ongoing disputes that have suffered.
However, in an article which appeared in Construction News on 2 July 2020, it stated that due to government intervention, the number of administrations had halved, but warned that this may just be temporary.
Insolvency is therefore a major issue currently within the construction sector that has been exacerbated by the recent pandemic.
As we expect the number of construction companies going into administration will be an issue in the coming months, we will be publishing a series of bite-sized articles over the coming weeks looking at the issue of contractor and sub-contractor insolvency and how an employer or a main contractor can best protect itself either before it happens or once it has happened.
This week we look at what we mean by insolvency and what the potential implications are for a project if a contractor becomes insolvent.
References to “contractor” are also a reference to “subcontractor”.
A. What do we mean by insolvency?
Corporate insolvency is contained in the Insolvency Act 1986 (IA). As well as the IA 1986, there is also a more detailed set of rules, the Insolvency (England and Wales) Rules 216 (SI 2016/1024) to supplement the IA 1986.
The IA does not define “insolvency” itself, but it does embody the concept in the phrase “unable to pay its debts”. The criteria for establishing whether or not a company is “unable to pay its debts” is set out in s.123 of IA 1986 and they include:
- Failing to pay with a statutory demand for a debt of over £750.
- Failing to satisfy enforcement of a judgment debt.
- A court being satisfied that a company is unable to pay its debts as they fall due (the “cash flow” test).
- A court being satisfied that the liabilities of the company (including contingent and prospective liabilities) exceed the assets of the company (“balance sheet” test).
The government recently brought in some changes to the insolvency regime through the Corporate Insolvency and Governance Act 2020 (the “CIG Act”), partly to assist companies struggling with the impact of Covid-19 and also to introduce some long awaited changes.
The CIG Act came into force on 26 June 2020 and protects companies from certain actions its creditors might otherwise take, currently set to last until at least 30 September 2020 but that may be extended further. Some of the changes are as follows:
- New moratorium on enforcement actions by creditors – if the company is not subject to a winding up petition, then directors can obtain a moratorium. This will end automatically if the company enters into any of the insolvency procedures, but should give a company some breathing space. It could be useful to supply chain members until productivity increases and cashflows begin to improve.
- New restructuring plan process – construction companies could put forward a proposal to re-structure their liabilities. This will need creditor and court approval.
- Disapplication of supplier termination of contract provisions for insolvency – this is likely to be useful to main contractors and employers who find themselves in financial difficulty. It prevents suppliers from terminating contracts due to a company’s insolvency. They are obliged to carry on supplying goods and services to a technically insolvent company.
The following temporary changes could be of use in the construction arena:
- Temporary suspension of the offences of wrongful trading – The Act temporarily suspends wrongful trading until 30 September 2020 (retrospectively from 1 March 2020), the “relevant period”. This gives directors some breathing space to trade without the risk of incurring liability if a company becomes technically insolvent. A court may assume that a director is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period in connection with any action brought against a director for wrongful trading. Once the suspension has been lifted however, directors will need to show that they have minimised losses to creditors.
As this article only gives a brief overview of the changes, should you require further information on insolvency procedures and the changes being introduced by the CIG Act, please contact us and we will refer you to one of our insolvency specialists.
B. What are the implications for a Project if the Contractor becomes insolvent?
There are obviously a number of problems that an employer or a contractor will find themselves faced with if a contractor in the supply chain becomes insolvent during the course of a project. Not least, it may spell the end of a project and large financial losses for the employer or contractor.
Some of the consequences may include the following:
- Vested materials or works manufactured off-site that do not comply with the required specification;
- Unfinished work;
- Programme implications such as:
- delay to completion;
- non-payment of liquidated damages; and
- wasted time spent having to deal with the consequences of the insolvency and replace the contractor.
- Cost implications in relation to:
- having to find a replacement contractor;
- Additional funding interest charges due to time overrun;
- Inaccurate valuation/overpayment and insufficient monies available to complete.
- Worthless warranties and guarantees; and
- Limited recourse in the event of a dispute with the insolvent contractor.
As can be seen, some of the changes that have been introduced by the new CIG Act 2020 will be of assistance to employers and contractors in the short term at least, and the changes are welcomed. However, insolvency may still be a problem in the long term and the impact can have serious consequences for a project and may even mean that projects will need to be abandoned.
In the next article we will take a look at how the standard form JCT D&B 2016 contract and the NEC4 deals with insolvency.
Please note that this article does not constitute advice. For advice on insolvency in the construction supply chain and any of the issues addressed in this article, please contact Elizabeth Vago, Construction, Engineering, Infrastructure and Energy partner, at Spencer West LLP [email protected].