Termination of building contracts under the new Corporate Insolvency and Governance Act – avoid being locked in
Significant changes to corporate insolvency law were introduced on 26 June 2020 when the Corporate Insolvency and Governance Act 2020 (CIGA) was enacted. It represents the government's latest attempt to assist companies affected by the financial repercussions of Covid-19.
Section 14 of CIGA limits the exercise of termination, or other 'ipso facto' rights, within supply contracts following a customer's insolvency. This article focusses on the implications of this restriction for the construction industry.
For the purposes of this article, a company supplying goods or services under a contract shall be referred to as "Supplier", whilst a recipient company shall be referred to as "Customer".
Restriction of 'Ipso Facto' rights
The popular standard form building contracts include express provisions which say that, in the event that the Customer (e.g. Employer) becomes insolvent, then the Supplier (i.e. Contractor), will automatically accrue the right to terminate the contract.
However, under section 14 of CIGA, suppliers cannot exercise contractual rights to terminate or "do any other thing" (an Ipso Facto Right) during the Customer's insolvency period if:
- The right arose as a result of the Customer entering into a "relevant insolvency procedure" (defined by CIGA); or
- The right arose (for any reason) before the start of the Customer's insolvency period, but the accrued right was not exercised.
Effectively unless any of CIGA's exemptions apply (see below), if the Customer goes bust then CIGA will 'denude' any contractual provision which would otherwise have entitled the Supplier to terminate or "do any other thing" following the Customer's insolvency. The Supplier will then potentially become 'locked-into' a supply contract with the insolvent Customer. CIGA also prohibits the Supplier from making its continued performance (i.e. supply) under the contract contingent on the Customer's payment of pre-insolvency period debts.
The potential ramifications of CIGA for the construction industry are therefore extremely significant.
When can the Supplier still exercise an Ipso Facto Right?
Under CIGA, a Supplier may still exercise an Ipso Facto Right if:
- The right arose during the insolvency period and was not exercisable due to the Customer's insolvency;
- The Customer or the insolvency office holder consents to the exercise of the right;
- The Supplier applies to the Court and the Court agrees that continuing the contract with the insolvent Supplier would cause the Customer "financial hardship" (not defined by CIGA);
- The Customer and/or Supplier is a provider of financial services (subject to exceptions in CIGA); or
- The Supplier is a "small entity" as defined by CIGA (this is only available until 30 September 2020).
By way of example, a contractor that has entered into a JCT 2016 Design & Build Contract (D&B) with an employer which has since become insolvent will now be prevented from exercising its right to terminate due to the employer's insolvency under clause 8.10.
However, it may still be possible for suppliers (e.g. contractors) to avoid being 'locked into' contracts under certain circumstances. CIGA does not appear to prevent a contractor from terminating under D&B clause 8.9 as a result of non-payment by the employer. A contractor therefore ought to be able to terminate and avoid being 'locked-in'. However, there may be a significant period of lag between an employer entering insolvency and any failure by the employer to make a payment of a sum that has subsequently fallen due.
In addition, CIGA does not appear to 'denude' s122 of the Construction Act (s122), under which a Supplier has a statutory right to suspend performance when a due payment has not been paid by the Customer after seven days' notice. This is because whilst CIGA restricts contractual rights, the right to suspend under s122 is a statutory right. In addition, the Supplier's s122 right arguably arises as a result of non-payment by the Customer, not the Customer's insolvency (although both may occur simultaneously). The industry awaits any guidance from the Courts on this point with great interest.
Suppliers should be alert to signs that customers may be struggling so that they can exercise any Ipso Facto Rights before the Customer becomes insolvent and therefore before the Customer secures protection under CIGA. Early indicators may include high staff turnover and lack of responsiveness or progress.
If the Customer becomes insolvent, the Supplier should consider whether they are able to benefit from one of the statutory exceptions outlined above. However, the Supplier considering the "financial hardship" exception should keep in mind that an application to the Court could lead to problems with its own suppliers if they hear of the application and begin to fear that the Supplier itself may be under threat of insolvency due to the Customer's financial problems.
As CIGA provisions will override any incompatible clauses, suppliers must review their existing supply contracts and also consider the impact of CIGA when negotiating future contracts. It may be possible to negotiate additional protections into future supply contracts to avoid some of the problems referred to above, for example by introducing clauses that enable the Supplier to terminate a future contract in the event that certain 'early warning' events of future insolvency by the Customer occur, or potentially introducing a right for the Supplier to terminate 'at will'.