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Construction suppliers beware: New corporate insolvency law requires ongoing performance

Builders

The introduction of the Corporate Insolvency and Governance Act 2020 (“CIGA“) in June 2020 was one of the many preventative measures taken by the UK Government in an attempt to safeguard the economy in the wake of the global Covid-19 pandemic.

Its primary purpose is to provide breathing space to businesses during the pandemic as well as to support continued trading.

CIGA, which introduced significant changes to contracts for the supply of goods and services, has significant implications for businesses that supply construction and engineering services.

In this column I outline what those implications are, and what construction businesses can do to protect themselves.

What are the changes to contract law introduced by CIGA, and how does it affect construction businesses?

CIGA introduces a new section 233B into the Insolvency Act 1986. This makes two important changes to contracts for the supply of goods and services.

Firstly, suppliers of goods and services are prevented from exercising certain rights of termination against a company that is going through a relevant insolvency procedure. Secondly, suppliers must continue to supply goods and services even if they have not been paid for goods and services already delivered.

In the context of a construction contract, a supplier is likely to the contractor, a sub-contractor, or a consultant under a professional appointment.

In practice, this means that there is no longer an automatic right for a supplier to terminate a contract in the event of a client becoming insolvent. Rather, there is now a legal expectation that suppliers will continue to deliver.

This means that the supplier will need to continue providing goods and services even if it has not been paid for those already provided at the point the company enters into a relevant insolvency procedure. However, in the context of construction and engineering contracts, if the company defaults on payment during the insolvency period, there is protection afforded to the supplier through its statutory right to suspend works (for non-payment) under section 112 of the Construction Act.

How can suppliers protect themselves?

Potentially, CIGA is a piece of legislation that could wreak significant harm on the construction industry supply chain.

On one level, as a piece of emergency legislation, it made sense at a time when robust, reliable supply chains are essential to, for example, the provision of vital supplies to the NHS.

However, whilst it aims to assist ongoing trading (through securing supply chains) during the Covid-19 pandemic, it is difficult to ignore the possible consequences this may have on cash flow and the strain that this may place on suppliers in the construction sector.

For many years now, this sector has had the benefit of the Construction Act.  One of the main objectives of the Act was to improve cash flow (once famously described by Lord Denning as ‘the life blood of the industry’) through the construction supply chain with the aim of reducing the number of insolvencies in the sector.

The Construction Act sought to achieve this by introducing processes such as adjudication, rights to interim payments and the right to suspend works.

It appears that the practical effect of the changes introduced by CIGA are now in direct conflict with the processes provided by the Construction Act, continuing a growing trend of conflict between insolvency and construction legislation. The effect this will have on the construction and engineering sector as a whole remains to be seen but it is clear that suppliers will need to be even more on their guard than ever.

In this context, there are several practical issues that parties to construction and engineering contracts will need to consider carefully.

  • Is the definition of Insolvency (whether as set out in the standard contracts or in a bespoke form) suitable – or even correct – in light of CIGA?
  • The timing of exercising a right to terminate is even more important than ever. A party must not attempt to exercise a right to terminate before that right has crystallised under the relevant contract. The consequences of doing so incorrectly could be hugely damaging and professional advice should always be sought.
  • Suppliers may seek to negotiate shorter payment periods.
  • Might this more precarious landscape prompt wider use of mechanisms such as project bank accounts to provide greater levels of comfort for the supply chain?

I would urge construction businesses concerned about the impact of CIGA on their cash flow and financial sustainability to seek immediate legal advice.

Refusing to perform could expose firms to potential claims from liquidators – so it’s certainly worth seeking specialist legal advice to ensure you minimise your risk and exposure to future claims.

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Construction suppliers beware: New corporate insolvency law requires ongoing performance

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