Corporate Insolvency and Governance Act 2020

The Corporate Insolvency and Governance Act 2020 (“CIGA”) received royal assent on 25th June 2020 and its provisions came into force the very next day, with some having retrospective effect from March 2020 when the first national lockdown began. The Act was created as a response to the devastating impact the Covid-19 pandemic had on businesses all over the UK and whilst much of the Act was temporary, it also brought about permanent changes to Insolvency law including the A1 Moratorium which now sits in Part A1 of the Insolvency Act 1986.

The A1 Moratorium provides businesses facing financial difficulties an initial 20 working day “breather” to allow them to formulate a viable rescue plan to avoid insolvency. The moratorium period can be extended by another 20 working days without creditor consent, subject to certain conditions and up to a year with creditor consent. During this time, creditors cannot take action to enforce their debts unless they fall under the non-payment holiday pre-moratorium debts category(1) which includes but is not limited to debts arising from contracts with financial institutions. There is a risk that entering an A1 Moratorium may trigger a default clause in an existing financial services agreement and any debt therein might immediately become repayable as it falls outside of the non-payment holiday category. But this will depend on the drafting of the default clause and whether the A1 Moratorium is listed as an event of default, which is something to be mindful of when considering a moratorium.

Throughout the moratorium period, a monitor who is a registered insolvency practitioner will be appointed to review the company’s affairs and it is their job to decide whether the moratorium will lead to the business being rescued as a going concern. It is easy to apply for, in that it only requires a court application by the directors of the company, and this is free of charge. The most poignant aspect of the A1 Moratorium however, and what differentiates it from the other UK insolvency procedures is the fact that the directors are still able to run the company whilst the moratorium is in session.

The A1 Moratorium provides businesses facing financial difficulties an initial 20 working day “breather” to allow them to formulate a viable rescue plan to avoid insolvency.

Directors are still able to run the company whilst the moratorium is in session.

What has CIGA done for the construction industry?

Whilst it may have been the intention of CIGA to bring about a solution to businesses in financial distress, CIGA has somewhat muddied the waters for the construction industry with the permanent introduction of section 233B. The purpose of this section is to protect the supply of goods and services to a company when it enters into insolvency proceedings and it does this in two ways, firstly by stripping away the supplier’s ability to exercise its contractual right to terminate on the grounds of insolvency, whether that be automatic termination or termination on notice (ipso facto provision)(2) and secondly, prohibiting suppliers from stopping the supply of goods and services in a bid for payment, meaning suppliers could be left out of pocket. Ultimately though, how CIGA will take effect will depend on whether you are the supplier or the receiver of goods and services to a construction contract.

How CIGA will take effect will depend on whether you are the supplier or the receiver of goods and services to a construction contract.

Insolvency of a Supplier

If we take a situation where a supplier becomes insolvent, for example a main contractor to an employer or sub-contractor to a main contractor, CIGA’s termination provisions will not apply because the supplier is not the party receiving goods and services.

This means, in theory at least, that ipso facto provisions will apply and termination by the employer is still possible via the contract. However, this is where we meet a catch-22 situation because at present, unamended standard form contracts including JCT Design & Build 2016(3), NEC 3/NEC 4(4) and FIDIC(5) contain termination clauses which fail to list the A1 Moratorium as one of the recognised insolvency procedures, meaning if a supplier enters into an A1 Moratorium it will not trigger the contract’s termination clause and the employer can no longer rely on insolvency as a ground to exit. Consequently, if an employer wants to terminate the contract it immediately becomes a higher burden to do so.

The crux of the issue for an employer in this situation is the wording of the termination clause and by making bespoke amendments to expressly include the A1 Moratorium as a recognised insolvency procedure, an employer will avoid this issue altogether.

Unfortunately, this does not solve the problem for employers in existing contracts with unamended termination clauses as section 233B applies to all relevant contracts, irrespective of when they were entered into as long as insolvency proceedings began after 26 June 2020, when CIGA came into force.

The crux of the issue for an employer in this situation is the wording of the termination clause...

Insolvency of the Employer

If on the other hand the employer becomes the insolvent party and subsequently enters into an A1 Moratorium, section 233B’s termination provisions will activate as they are the party receiving goods and services. The supplier, a contractor to their employer or sub-contractor to a main contractor will not be able to terminate the contract on the grounds of insolvency, or crucially, terminate on any other ground that existed prior to the employer entering into the A1 Moratorium, unless they meet any of the following conditions:

The appointed administrator or liquidator agrees to the contract being terminated
The employer who is subject to the insolvency procedure, in this case an A1 Moratorium agrees.
Permission is granted by the court as the contract, if continued will cause “hardship” to the supplier. Hardship is not a defined term in this respect, but government guidance suggests hardship could be when the solvency of the supplier is under threat.(6)

What about step-in rights?

Contracts including a collateral warranty which contain step in rights for the employer or funder will also be affected. If the ability of a main or sub-contractor to terminate the contract on the grounds of insolvency, or any other ground that existed prior to the employer entering an A1 Moratorium are suspended because of section 233B, the process of termination via the step-in option cannot begin. The process usually starts by a contractor, or sub-contractor notifying the employer of their intention to terminate on the grounds of their employer’s insolvency which provides the funder the option to then step into the shoes of the insolvent party to allow for successful completion of the project. This option is effectively ‘on hold’ during the A1 Moratorium.

Section 233B v Section 112 – The battle of the statutes

Section 233B CIGA has also created ambiguity between itself and section 112 Construction Act 1996(7). The well-established section 112 makes provision for a supplier to stop supplying goods and services for non-payment by an employer, striking at the very heart of Section 233B(5) which prohibits a supplier from doing “anything” that attempts to strongarm the insolvent party into making payment of any outstanding amounts a condition of their continued and future supply.

Unlike termination provisions in section 233B which take precedence over ipso facto provisions in unamended standard form contracts when a supplier is the insolvent party, it is not yet clear if section 112 or section 233B will prevail when an employer is the insolvent party and a supplier decides to stop their supply until payment is made. This is something to watch out for and perhaps will be made clear in future case law.

Section 233B CIGA has also created ambiguity between itself and section 112 Construction Act 1996.

Conclusion

Whether you are the employer or a supplier to a construction contract, CIGA has made termination on the grounds of insolvency near impossible and going forward the best way to avoid this is by making bespoke amendments to include the A1 Moratorium in the contract’s termination provisions (at least until contracts are revised to include it within their unamended standard forms).

For those in existing unamended contracts, the A1 Moratorium should be approached with extreme caution, if not avoided altogether. It is imperative that both construction and financial agreements are read carefully, as the A1 Moratorium could exacerbate an already distressed financial situation.

Overall, there is undoubtedly much clarification needed on the issues CIGA has created for the construction industry, but the one thing that is clear at present is it being more of a hindrance than a help!

The A1 Moratorium should be approached with extreme caution, if not avoided altogether.

References

(1)sA18(3) Insolvency Act 1986 contains full list of non-holiday pre-moratorium debts

(2)s233B Insolvency Act 1986

(3)Clause 8.1 - defines Insolvency of the unamended standard form with specific reference to if a company enters: Administration (Schedule B1 to the IA 1896), Administrative receiver or receiver is appointed to manage the property of the company under parts II or III of the Act, The company passes a resolution for a voluntary winding up, without a declaration of solvency under s89 IA 1986; or A winding up order is made in respect of the company under parts IV or V of the Act.

(4)Clause 91.1, reasons R1 to R10 set out the types of insolvency procedures which entitle the other party to terminate the contract. These include: The making of a winding up order against it, The appointment of a provisional liquidator, The passing of a resolution for voluntary winding up (other than for the purposes of amalgamating debts), The making of an administrative order against it, or appointment of an administrator or the making of an arrangement with its creditors.

(5)FIDIC 1999 Silver book subclause 15.2(e), FIDIC Red and Yellow Book subclause 15.2(e)

(6)Prohibition of termination clauses - GOV.UK (www.gov.uk)

(7)S112 Housing Grants, Construction and Regeneration Act 1996.