The Corporate Insolvency and Governance Act 2020 and its Impact on the Construction Industry
The construction sector is the industry grouping with the highest number of insolvencies in the 12 months ended Q1 2020, according to statistics published by the Insolvency Service on 30 April 2020.
Proposals to change the Insolvency Act 1986 and Companies Act 2006 have made their way through Parliament in the form of the Corporate Insolvency and Governance Bill, and on 25 June 2020 they received Royal Assent and became law in the form of the Corporate Insolvency and Governance Act 2020. Most of the Act is effective from 26 June 2020.
The new Act sets out the most comprehensive changes to UK insolvency law in a generation, including temporary measures responding to the turmoil caused by the COVID-19 pandemic.
Traditionally, the UK construction industry involves long (and often complex) supply chain and subcontracting arrangements. As a result, the temporary COVID-19 motivated changes introduced by the Act will impact all companies involved in construction, whether directly (e.g. those in financial distress as a result of the COVID-19 pandemic) or indirectly (e.g. those contracting with others that find themselves in such distress).
In this article, Daniel Shaw (in consultation with Rob Downey FCCA, licensed insolvency practitioner and Director at EY) considers three key aspects of the new Act likely to impact the construction industry heavily in their own right, before considering how these aspects might affect adjudication in particular.
The three key aspects of the Act discussed below are:
- a new moratorium;
- a restriction on winding-up petitions; and
- a suspension of express contractual rights upon insolvency.
The New Moratorium
The Act provides for a new moratorium against the commencement or continuation of any legal proceedings (other than those involving employees) without the permission of the court. This new moratorium is standalone, and not reliant upon any other insolvency process having been initiated.
The moratorium is effected by a company’s directors filing a notice at court, and provides the company with up to 40 business days of protection.
During the currency of the moratorium, the company is entitled to a payment holiday for almost all pre-moratorium debts. Exclusions are limited, and are mainly concerned with debts owed to employees and financiers. Accordingly, any debts owed to suppliers or subcontractors will likely be subject to the moratorium, and those owed money by the company will be unable to commence any proceedings to recover the debts.
During the currency of the moratorium, the directors of the company retain management control. As a result, they are able to continue trading, although a third-party insolvency practitioner (or practitioners – there can be more than one) will be appointed as a moratorium monitor to ensure that the moratorium is likely to result in the rescue of the company, and is not being abused. This monitor’s consent will be required for the company to make many payments.
The directors can seek the protection of the moratorium even if a winding up petition has already been presented, although they must make an application to the court (rather than simply filing the moratorium notice). Once the moratorium comes into effect, and for its duration, insolvency proceedings cannot be commenced against the company.
The documents that must be filed with the court include:
a. a notice of wishing to obtain a moratorium;
b. a statement from the directors that the company is, or is likely to become, unable to pay its debts; and
c. a statement from the proposed moratorium monitor that the company is an eligible company (see definition below) and that in the monitor’s view it is likely that a moratorium would result in the rescue of the company as a going concern.
Any goods and services supplied to the company during the moratorium will be payable as moratorium expenses. This goes beyond the monitor’s expenses, and wages/salaries/redundancy payments, and includes liabilities incurred by the company in the ordinary course of doing business. As a result:
in-moratorium costs will, therefore, be effectively prioritised over any costs incurred prior to the moratorium;
the company may incur in-moratorium costs that serve to reduce the amount that unsecured creditors receive for pre-moratorium debts;
in-moratorium costs may themselves never be paid (or paid in full), if the company’s reserves do not suffice.
However, the company is unable to obtain credit of more than £500 without first giving notice that a moratorium is in force.
Even where the company is able, and the directors willing, to pay down pre-moratorium debts, it cannot pay more than £5,000 and 1% of the total value of liabilities owed to unsecured creditors at the date the moratorium began without the consent of the monitor or the permission of the court.
The initial moratorium period is 20 business days, but can be unilaterally extended by the directors to 40 business days upon the directors filing a notice at court. The notice can only be filed in the last five days of the initial period. There are other ways to extend the period (e.g. by creditor consent, or by application to the court) for longer.
There are restrictions on the companies that are able to benefit from the moratorium, most of which (e.g. banks, insurance companies) would not apply to most employers or contractors. However, any company that has been in any insolvency process within the previous 12 months is ineligible.
The Restriction on Winding-Up Petitions
Under the provisions of the new Act, a winding up petition cannot be presented between 27 April 2020 and 30 September 2020:
in relation to a company subject to the moratorium discussed above; or
based upon a statutory demand dated between 1 March and 30 June 2020.
For statutory demands served before 1 March 2020, a winding up petition cannot be served unless the creditor has reasonable grounds to believe that:
the COVID-19 pandemic has not had a “financial effect” on the company (i.e. the company’s financial position worsens in consequence of, or for reasons related to, COVID-19). This is a low threshold; or
the company would have become insolvent notwithstanding any financial effect the company has felt from the COVID-19 pandemic. This will likely prove a difficult test to apply.
These restrictions apply whether the non-payment was caused or contributed to by COVID-19 or not.
Originally, the motivation from this was to prevent commercial landlords aggressively hounding their tenants for rent payments, but the provisions are applicable to any and all companies (not only those with commercial tenancies) and any and all creditors (not only commercial landlords).
The Effect Insolvency Upon Contractual Rights
Under the new Act, any supply contract clause that provides for termination, or any other step (whether automatically or at a supplier’s option) if the counterparty to that contract enters into insolvency, will be ineffective and unenforceable if:
the new moratorium referred to above arises;
the company enters into administration or an administrative receiver is appointed;
the company enters into liquidation or a provisional liquidator is appointed; or
an order summoning a meeting relating to compromise or arrangement is made under s.901C(1) of the Companies Act 2006.
Furthermore, the new Act also precludes the supplier exercising any pre-existing (but un-exercised) right to terminate, and the supplier will not be able to withhold their supply to the company pending the payment of pre-insolvency debts.
The Act does, however, provide two important exceptions. The first relates to small suppliers. These are companies that meet at least two of the following criteria:
turnover £10.2m or less;
balance sheet of not more than £5.1m;
not more than 50 employees.
Small suppliers are temporarily excepted until 30 September 2020.
The second exception is where the obligation to continue supply causes the supplier ‘hardship’. This is not a term that is defined in the proposals, and so it is not currently possible to say what it means, or what criteria might be used to assess it.
The right to statutory adjudication, and the subsequent prevalence and popularity of construction adjudication more generally, resulted from concerns about the construction industry’s approach to (amongst other things) cashflow. Pursuant to s.111(1) of the Housing Grants, Construction and Regeneration Act 1996, a party to a construction contract is entitled to payment of a notified sum, even if the notified sum is incorrect. If a notified sum is not paid, a party can refer the non-payment to adjudication pursuant to s.108, and if an adjudicator decides that the notified sum must be paid, the payee is ordinarily able to enforce the adjudicator’s decision in the TCC. Thanks to the efficiency of the process, parties are often able to obtain judgment in a small number of weeks, rather than having to wait many months for a case to progress to trial through the courts.
The new Act would probably not prevent an adjudication being started, even if the new moratorium applied, since adjudication is unlikely to constitute legal proceedings for the purposes of the new Act (although legal proceedings is not actually defined in the Act) However, the new Act would prevent enforcement proceedings being subsequently brought in the TCC against a company subject to the new moratorium, and so the directors of a company could avoid being compelled to comply with the adjudicator’s decision and pay a notified sum simply by filing a notice at court.
As a result, the new moratorium might be abused as a get-out-of-adjudication-free card by companies in the construction industry keen to avoid paying a notified sum (in circumstances, for example, where those companies simply failed to serve a valid and timeous pay less notice), without having to simultaneously accept the negative consequences of entering into insolvency in order to obtain the protection.
The new Act also clashes with ss. 111(10) and 112 of the Housing Grants, Construction and Regeneration Act 1998:
by s.111(10), the obligation to pay a notified sum does not apply if a contract states that the payer need not pay the notified sum if the payee becomes insolvent, and the payee does become insolvent. Under the new Act, such a provision is ineffective and unenforceable in a supplier contract since it provides for a step to occur automatically upon the payee’s insolvency. Accordingly, a payer may be required to pay a notified sum that is clearly not due to the payee (but for having become the notified sum), with no prospect of recovering it (because the payee is insolvent) or with no opportunity to recover it quickly (because the payee has the protection of the new moratorium);
by s.112 of the Housing Grants, Construction and Regeneration Act 1998, non-payment of a notified sum entitles the payee to suspend performance. Under the new Act, such a provision would be ineffective and unenforceable in a supplier contract if the reason for the non-payment of the notified sum was the payer’s insolvency. Thus, the payee would be obliged to continue performance for an insolvent company that had already failed to make payment of a potentially significant notified sum.
The new Act therefore seemingly puts at risk some of the cashflow safeguards set out in the Housing Grants, Construction and Regeneration Act 1998 in a way that is likely to be detrimental to the construction industry. Contractors, sub-contractors, and suppliers, may be forced to incur new, and/or carry existing, liabilities for the benefit of a company higher up the contractual chain that is either insolvent (and that therefore cannot and may never be able to make payment) or is taking advantage of the new moratorium (and that therefore may simply be unwilling to make payment).
Whilst the very significant and far-reaching changes to the law set out in the new Act may assist keystone employers/main contractors in mitigating the impact of COVID-19 and avoiding being leveraged into failure, it appears to do so with a risk of detriment to sub-contractors and suppliers further down the chain by imposing a considerable fetter on payees’ rights and on freedom of contract. Suppliers/subcontractors are forced to keep incurring costs/liabilities despite the likelihood of being unable to recover payment, and in some circumstances lose the cashflow security that adjudication offers.
Thus, under the new Act, the suppliers/subcontractors that are least able to do so may be required to suffer financially in the hope that both they and the company that is insolvent (or subject to the new moratorium) might survive long enough for payment to be made.
Written by Daniel Shaw.