Employers or main-contractors experiencing trading difficulties - what does that mean for you?

Together we are Forbes

Article

03 July, 2020

There is undeniably a risk that COVID-19 will have a detrimental impact on the Construction Sector. It has recently been forecasted that the Construction industry will see over 10% of businesses failing in the next year. This will leave a trail of insolvent construction sector debt totalling £1.5bn this year and could see levels of bad corporate debt in 2021 rising beyond £3bn.

The Government has taken steps to attempt to minimise the number of failing businesses, with measures designed to ensure that businesses can maximise their chances of survival. These new insolvency measures, some temporary and some permanent changes, have been introduced through the Corporate Insolvency and Governance Act 2020 ("the Act") that came into force on 26 June 2020.

This article looks at the knock-on impact for contractors where employers or main contractors are experiencing significant trading difficulties.

The focus of this commentary is on the following three changes introduced by the Act:

  • a new moratorium;
  • a prohibition on the termination of supply contracts; and
  • a temporary restriction of winding up petitions.

The above measures all have the potential to have a significant impact on contractor cash flow.

Moratorium

A moratorium allows breathing space for directors to continue to run a company under the supervision of an Insolvency Practitioner for an initial period of 20 business days. That period can be extended by a further 20 days without creditor consent or up to 12 months with consent or Court approval. During this period the company benefits from a payment holiday from pre-moratorium debts. In practice this is a payment holiday from paying debtors. The Company will still have to pay;

  • the Insolvency Practitioner's Fees;
  • for goods or services supplied during the moratorium;
  • rent during the moratorium;
  • wages, salary and redundancy payments; and
  • debts or other liabilities for financial services.

The aim of the moratorium is that it will allow the business the opportunity to take steps to improve its financial position by restructuring or seeking investment without the pressure of having to keep up payments to trade debtors.

If you are owed money by a company that enters a moratorium you are unable to:

  • commence insolvency proceedings;
  • enforce security;
  • commence legal proceedings without court consent; and
  • no security can be taken over property.

In the worst-case scenario, there will be no attempts by the Company to make payment for 12 months which depending on the scale of the project could have a significant impact on your cash flow.

Prohibition on Termination

Your contracts will typically have provision for either party to terminate the contract by reason of the other's insolvency. In standard form JCTs that is contained at Section 8 and within NEC 3 & 4 at clause 91.1.

This standard contractual right will be severely limited and rendered ineffective by the changes which have introduced a new Section 233B of the Insolvency Act 1986. This means that there is a prohibition of the termination of supply contracts has been introduced which will apply regardless of the terms of the contract.

So what does this mean for you…

By invoking your right to terminate the contract you would be relieved of your obligations under the contract. Particularly the obligation to continue to undertake the works. You are then also entitled to claim your direct loss and damage caused by the termination.

If your right to terminate no longer applies, you are contractually obliged to continue to undertake the works as agreed. You are also prohibited under s233B(7) of the Insolvency Act 1986 from making payment of monies you are owed a condition of your continued performance.

This prohibition applies unless:

  • the Company in the moratorium consents to the termination of the contract'; or
  • you make an application to Court and the Court is satisfied that the continuation of the contract would cause you hardship and grants permission for the termination of the contract

It is unlikely that the Company is going to agree to terminate the contract if further work is required and if they do not consent you are obliged to do the work. We are yet to see what the Court's interpretation of "hardship" will be.

It is going to be interesting to see how this works in practice and whether contractors will be inclined to attempt to rely on the contractual provisions and terminate the contract irrespective of these changes.

There is a temporary exclusion to this new provision where you are a small supplier. That is where you meet two out of the following three criteria: (1) have a turnover of £10.2m or under, (2) have a balance sheet no more than £5.1m, or (3) have no more than 50 employees.

Restriction of Winding-up Petitions

Until 30 September 2020 there is a temporary restriction of winding-up petitions where the unpaid debt is due to COVID-19. The restriction applies unless the creditor has reasonable grounds for believing that:

  • coronavirus has not had a financial effect on the debtor, or
  • the debtor would have been unable to pay its debts even if coronavirus had not had a financial effect on the debtor.

The meaning of "financial effect", appears to be a low threshold. Coronavirus has a "financial effect" on a debtor if the debtor's financial position worsens in consequence of, or for reasons relating to, coronavirus

Similarly, no petition for the winding up of a company can be presented on the ground that the Company has failed to satisfy a statutory demand if the relevant statutory demand was served during the period between 1 March 2020 and ending with 30 September 2020.

Again, this limits your ability to pursue your debtors for failure to pay invoices.

Our Advice

We have three tips to mitigate the impact of the above changes:

  • Contract with companies that you are used to working with and you know, that applies both up and down the chain. Unknown and untested companies are a risk;
  • Ensure you undertake a credit check and due diligence on the financial status of the party you are contracting with. Do not be afraid of asking questions;
  • Be careful of being overly reliant on the timing for incoming payments. How much wriggle room do you have? Do not stretch yourselves too thin.

For more information contact Stephen McArdle in our Dispute Resolution department via email or phone on 0333 207 1142. Alternatively send any question through to Forbes Solicitors via our online Contact Form.

Contact Us

Get in touch to see how our experts could help you.

Call0800 689 3206

CallRequest a call back

EmailSend us an email

Contacting Us

Monday to Friday:
09:00 to 17:00

Saturday and Sunday:
Closed