I started my legal career in the wake of Sir Michael Latham’s seminal report ‘Constructing the Team’ and the enactment of the Housing Grants, Construction and Regeneration Act 1996 (HGCRA).  So when I read section 14 of the newly enacted Corporate Insolvency and Governance Act 2020 (CIGA), which adds section 233B Protection of Supplies of Goods and Services into the Insolvency Act 1986, my initial reaction was to ask how this would impact “the very life blood of the enterprise” – cash flow in the construction industry1?

I have teamed up with my learned colleague Iain Suttie to write a series of 3 short articles on the new section 233B and what it might mean for construction contracts.  What is clear is that the new legislation was not drafted with construction contracts and the HGCRA in mind, so at times our analysis felt like fitting square pegs into round holes.  Sadly, with the industry in considerable stress at present, it may not be long until we see how Courts will apply the new provisions.

The new provisions in outline

Our insolvency colleagues have posted an excellent critique of the new legislation, and for our Construction Notes readers, we can summarise the key points as follows:

  • New section 233B concerns the supply of goods and services to a company subject to a “relevant insolvency procedure” listed in s233B(2).  The broad reference to contracts for the supply of goods and services will cover most forms of engineering, procurement and construction contracts (construction contracts);
  • Prior to a relevant insolvency procedure, the supplier can exercise any of its usual rights to recover sums due to it from its customer (main contractor, owner etc).
  • However, once the customer is subject to the insolvency procedure, any contractual provision that is triggered upon such insolvency procedure will “cease to have effect”.  This includes, but is not limited to, termination (s233B(3)).
  • Further, the supplier may not exercise during the insolvency period any contractual entitlement to terminate that arose before the start of the insolvency period (s233B(4)).
  • The supplier also may not make supply during the insolvency period conditional upon payment of pre-insolvency debt.  This includes imposing any conditions upon new supply (for example, refusing to supply until all arrears have been paid), or doing “any other thing” which has the same effect (s233B(7)).
  • However, s233B does not preclude the supplier exercising its right to terminate for non-payment for goods and services supplied during the insolvency period.

In short, therefore, the usual contractual remedies that are automatically available upon the insolvency of a customer will no longer apply.  Further, if the supplier has not taken steps to protect its position against an outstanding debt before the insolvency procedure is triggered, it will be prevented from exercising its contractual rights in respect of that breach for the duration of the insolvency period.

Applying these rules to construction contracts

It is clear that much of this will cut through over 20 years of construction industry practice and legislation, and substantially enshrined in standard form contracts such as FIDIC, NEC and JCT,  designed to protect the cash flow of those down the contractual chain.  So what is the supplier left with?

  • It appears that the new provisions will not curtail any right that the supplier has to terminate the contract for convenience/at will:  such a right would fall outside the scope of 233B(3) and (4) as, by definition, termination for convenience clauses are not linked to a counterparty’s insolvency or prior default (although such matters might form part of the reasons for deciding to terminate for convenience).  That said, termination for convenience provisions are more commonly drafted for the benefit of the recipient of the goods or services, rather than the supplier, unless it’s a long-term supply agreement or framework agreement, so in reality this may not be a readily available option for the supplier.
  • It would also seem that the supplier would be able to exercise its right to terminate under common law for a repudiatory breach of contract, as sections 233B(3) and (4) are drafted so as to only refer to the operation of contractual provisions.  Of course, the supplier would need to establish that the customer’s conduct falls within the legal criteria for repudiatory breach.  It’s worth noting that under English law a failure to pay, even if it’s a failure to pay more than one instalment, is unlikely on its own to amount to a repudiatory breach of contract.  Further, where it is possible to establish a repudiatory breach, the supplier would need to elect to terminate in short time, otherwise it could be seen to be affirming the contract and thereby have lost its right to terminate.
  • The prohibition on termination in s233B(4) is expressed only to apply where both the event giving rise to the entitlement to terminate occurs, and the entitlement to terminate arises, before the start of the insolvency event.  However many construction contracts provide for a mandatory cure period before termination, and it will be important to understand therefore exactly when the entitlement to terminate arises for the purposes of s233B(4).  This may not always be straightforward.  To take FIDIC 1999 Silver Book as an example, SC16.2 (b) provides that the Contractor’s entitlement to terminate arises if the Employer has failed to pay within 42 days of the stipulated payment deadline. But it then goes on to state that Contractor may only terminate after giving 14 days’ notice to the Employer.  When we apply this to s233B(4), it is not clear whether the Contractor is permitted to terminate in circumstances where the insolvency event occurs after the 42 day period (when the entitlement to terminate is expressed to arise), but before the expiry of the required 14 days’ termination notice.  Contrast this with the 2017 edition of the Silver Book, the JCT forms2 and the NEC Engineering and Construction Contract3 where the entitlement to terminate is expressed to arise after the expiry of the cure period.  If the termination right only crystallises after the start of the insolvency period, it will not be exercisable during that period.
  • And what about the supplier’s statutory right to suspend (not terminate) for non-payment under construction contracts under s 112 of the HGCRA?  Here Iain and I were not able to land on a clear answer.  Certainly, as a statutory right it would fall outside the scope of s233B(3) and (4) which are clearly expressed to preclude only contractual rights.  However, s233B(7) states that the supplier is not permitted to “do anything” that would have the effect of making it a condition of supply during the insolvency period that pre-existing debts be paid.  Unlike s233B(3) and (4), s233B(7) does not refer solely to contractual provisions, so it would apply to rights arising at law.  As such, if a supplier attempted to exercise against an insolvent contractor its statutory right to suspend for late payment of sums due prior to the insolvency event, which would essentially have the effect of making it a condition of supply during the insolvency period that the prior debt is paid, it may fall foul of s233B(7).

The counter-argument is that exercising a pre-existing statutory right to suspend should not constitute “do[ing] anything [after the company has become subject to an insolvency procedure] which has the effect of making it a condition of … supply” for the purposes of s233B(7). Reasons for this include:

  • The exercise of a pre-existing statutory right is not the same as making something a condition after an insolvency procedure occurs. The “condition” (that is, the right) already exists.
  • Given this, the wording of s233B(7) can be construed so that it does not impliedly restrict the right to suspend under the HGCRA.
  • It could well be harsh for a supplier (not least, a small business) to be unable to exercise the right to suspend. For instance, CIGA would not allow the supplier to seek any relief under s233B(5), as would be the case if its rights were affected by either s233(3) or s233B(4). The difference in application of s233B(5) may be telling.
  • It may be that s233B(7) is essentially aimed at preventing suppliers seeking to exercise leverage over insolvent companies by imposing different payment terms on them. That is also quite different from the exercise of a pre-existing statutory right.

In next week’s blog, we will look at how s233B operates in the context of related step-in and termination provisions in a chain of contracts between Owner/Employer, Main Contractor and Supplier.  In our last blog we will provide tips for suppliers to protect themselves against the constraints of this new legislation and touch on its application to supply chains containing international parties.

[1]       Lord Denning MR, Dawnays Ltd v FG Minter [1971] 2 All ER 1389
[2]       See, for example, clause 8.9 in each of the Standard Form of Building Contract Without Quantities and the Design and Build Contract (2016 editions).
[3]       Clause 91.4 of the NEC4 Engineering and Construction Contract (June 2017 edition).

 

Emma Schaafsma

Emma Schaafsma
Partner
+44 20 7466 2597

Iain Suttie

Iain Suttie
Senior Associate
+44 20 7466 2292