07 Jul 2020

The Corporate Insolvency and Governance Act (CIGA 2020) came into force overnight on Friday 26 June and will have a significant impact on contracts and contract management, in the construction sector, and many others.

CIGA 2020 makes a number of changes to insolvency practices, some of them temporary to manage the impact of the COVID-19 epidemic, and some of them permanent policy changes that have been debated for some time. The permanent changes include the creation of a standalone 'Chapter 11' inspired moratorium on enforcement action in order to buy breathing space to restructure businesses, and a restructuring plan, which adds creditor 'cram-down' rights to what is broadly the existing scheme of arrangement structure. We have previously commented on the new processes here.

CIGA 2020 also brings in an important change in contract law in section 14 (which introduces a new section 233B to the Insolvency Act 1986). As of Friday 26 June, clauses that allow a supplier to terminate a contract for the supply of goods and services are of no effect if the purchaser has entered a formal insolvency process, including the new moratorium, administration, liquidation or a Company Voluntary Arrangement (CVA). Construction contracts, including the main standard forms, normally contain provisions that entitle both parties to terminate if the other becomes insolvent. These clauses will now only have effect if the supplier becomes insolvent.

The drafting of s14 anticipates many of the ways in which contract drafting may seek to avoid the effect of the provision:

  • A supplier is prohibited from terminating the supply, not just the contract, because the purchaser has become subject to an insolvency procedure
  • A supplier also cannot terminate during an insolvency process because of a contractual right which arose before the company’s insolvency. Any such right to terminate would need to be exercised before the insolvency commences. This provision is very broadly drafted and applies to all contractual rights which arise prior to insolvency, not just a failure to pay, which would be the obvious choice. One potentially important effect of this would be to dis-apply any right to terminate for failure to provide payment security if the purchaser becomes insolvent leaving a supplier obliged to supply without the benefit of the payment security it had expected
  • A supplier may terminate for failure to pay, or any other entitlement to terminate, during the period in which the purchaser is in insolvency process. This means that the company, or its administrator, need to ensure that they pay a supplier through the insolvency, albeit that that the supplier has an unpaid debt that arose prior to the start of the process
  • A supplier cannot demand payment of outstanding pre-insolvency debts as a condition of any future supply after the insolvency process has begun or "do anything which has the effect of making it a condition of such supply". This means that where a supplier has entered into a binding framework (where a purchaser has a contractual right to call-off supply) the supplier cannot draft the framework to make the obligation to enter into future call-offs subject to payment of earlier call-offs if the purchaser is subject to an insolvency process. A supplier could seek to get around this with a non-binding framework, but this may not be commercially practical
  • A supplier can terminate if the relevant insolvency practitioner, company or court agrees (depending on the insolvency process in question). The power of the court to permit a termination is exercisable if "the court is satisfied that the continuation of the contract would cause the supplier hardship", This is designed to provide a failsafe, to prevent the irony of a provision designed to promote the rescue of businesses in distress inadvertently leading to other collapses in the supply chain
  • The prohibition on termination of supply also dis-applies clauses that allow a supplier “to do any other thing” as a result of insolvency. This means that a clause in a supply contract that states that a supplier may call on payment security in the event of the purchaser entering an insolvency procedure is dis-applied. However, s14 only applies to a contract for the supply of goods or services so the same provision in a bond or guarantee would be effective
  • It should be of comfort to suppliers that any supplies made during an administration or liquidation will be deemed to be expenses of that process, and will rank ahead of most creditors and the Insolvency Practitioner's own costs. If an administration or liquidation follow within 12 weeks of the end of a moratorium, the supplies made in the moratorium period will also have priority over expenses of that administration or liquidation. So, while the ability to terminate, or make clearing arrears a condition of ongoing supply may be lost, in most cases a supplier will be more likely to be paid for supplies to an insolvent customer than one that is not in such a process.

The effect of these provisions for the construction sector remain to be seen. It will be particularly interesting to see how case law on the "supplier hardship" exemption develops and whether the courts take a supplier or customer friendly approach. These provisions will prevent suppliers to contractors from collapsing supply chains, but will not prevent a purchaser from doing so. This means that if a tier 1 contractor becomes insolvent, the entire supply chain will be waiting on the decision of the developer or owner at the top of the chain as to whether the chain collapses.

It will also change the way in which suppliers deal with payment terms and payment security in contracts, both in negotiation of the terms and during the management of a contract.