Michael Gerard of Michael Gerard Solicitors explains how businesses can protect themselves against insolvency in the aftermath of Covid-19
Unfortunately, the construction industry is always particularly vulnerable during times of recession. And, while it may be very different in origin to the last global recession of 2007, a significant Covid-inspired economic downturn seems inevitable – both across the UK and the world.
Along with recession comes an inevitable and unwelcome rise in the number of insolvencies. Unfortunately, it is those businesses that are aligned to the construction industry that are likely to be among most vulnerable in the economic storm to come. That’s why it’s essential for all businesses, from contractors through to suppliers, to prepare and ensure that protective measures are in place. A good place to start is ensuring vigilance in managing contracts and cash-flows.
Key issues around insolvency and termination under JCT contracts
The main JCT forms have a section dedicated to termination, with one ground being insolvency. The JCT also defines what insolvency means, giving definitions for the legal entities of a company, a partnership and an individual. Essentially, insolvency is when a party enters into a formal procedure, like administration within the meaning of Schedule B1 to the Insolvency Act 1986. It can also refer to the passing of a resolution for voluntary winding-up without a declaration of solvency under section 89 of Insolvency Act 1986.
Where one party to the contract has become insolvent (within the meaning of the insolvency definition), the other party may, at any time give notice to the insolvent party to terminate the contractor’s employment under the contract. Although this may appear to be straightforward, it is vital that the notice complies with the conditions of the contract, including how the notice is served.
Where an employer terminates the contractor’s employment:
- No further payments are due to the contractor until the work is completed.
- The employer may employ others to have the works carried out and completed at which point, the employer sets out what it has cost to complete, including any damages caused by the termination.
- Alternatively, the employer may elect not to have the works carried out and completed, and where this happens, there is a process to work out the final account.
Common law, contracts and insolvency
At common law, insolvency in isolation is not a breach of contract, but the effect can result in the party becoming insolvent to wrongly repudiate the contract, thus allowing the other party to accept the repudiatory breach and bring the contract to an end. For example, where a contractor has failed to supply physical resources for the project for several days (because it cannot afford to pay for those resources), it could be said that the contractor has abandoned the works.
Sections 122(1)(f) and 123(1) of the Insolvency Act 1986 defines insolvency as where a company is unable to pay its debts when they fall due for payment, which is in contrast to the JCT suite of contracts which defines insolvency as when a party has entered some form of formal insolvency procedure.
Cash flow is king
We all know that projections and forecasts are important, but ultimately, it comes down to cash in the bank. So how does a supplier of goods and/or services maintain a consistent flow of cash? In a nutshell, it is to do with ensuring the payment terms are favourable and that mitigation measures are in place.
This includes:
- Ensure the valuations are as frequent as possible. Under standard forms of contract, like the JCT, there is the option of having the valuation periods geared to milestones or periods of time. Usually, the valuations will be periods of time (monthly), and this continues post practical completion. However, there is nothing to stop a contractor negotiating fortnightly valuations, with perhaps a small discount as an incentive for the employer.
- Ensure that the period of time between the end date of the valuation and the final date for payment is as close together as possible. Under standard forms of contract, this period is around 17 days, but again, the timeframe can be shorter if the parties agree – perhaps a small discount offered could persuade the client to agree to a quicker final date for payment?
- When a payment is late (and one day is late), do not hesitate to threat suspending performance of the works. However, a notice of the intention to suspend must be issued prior to suspension. This notice is often enough to ‘remind’ the debtor to make payment. But don’t hesitate to suspend performance if payment is late, as you could be throwing good money after bad should the employer cease trading.
- Incorporate a paid-when-paid clause for insolvency events for downstream payments. This will protect the business in case of an upstream insolvency.
- Consider including a ‘Romalpa’ clause (retention of title). However, even with a Romalpa clause, it may not be enough to recover goods supplied if those goods are annexed to the structure.
- Collateral warranties are particularly useful for third party funders and future purchasers of buildings where there are defects in the structure, but the developer may have ceased trading. Collateral warranties can also be good news for contractors and consultants if the warranty includes step-in rights and payment of outstanding sums.
- Third-Party (Rights Against Insurers) Act 2020 legislation enables claimants to bring proceedings against insurers of defaulting insolvent companies. This is particularly useful where latent defects arise, but the contractor has ceased trading.
- Ensure that the contract includes a termination clause for party insolvency that also sets out what happens post-termination.
The remainder of 2020 and the following year will be a challenge for the construction industry, amongst many others. However, with the right fiscal and commercial management systems and policies in place, businesses will be placing themselves in a stronger position.
So, anyone who doubts the robustness of their standard terms of contract, should review them now. It could make the difference between survival and disaster as the industry embarks on an uncertain financial future.
Michael Gerard
Founding partner
Michael Gerard Solicitors
LinkedIn: Michael Gerard
