The focus on Modern Methods of Construction, or MMC, sharpened throughout the COVID-19 pandemic, with many wondering whether the outbreak and the consequential delays to existing construction projects would propel MMC forward as the future of construction.
But there has not been as much focus on a more immediate change and challenge for MMC brought about by the new Corporate Insolvency and Governance Act 2020 (CIGA) which came into force in late June this year. Intended to protect the UK manufacturing industry in a tough economic environment, it has caught some in the construction sector unawares and left others wondering how it fits with the Construction Act.
CIGA in brief
CIGA brings about the biggest change to insolvency legislation in 20 years.
From a construction industry point of view, the main things to be aware of are that:
- it has introduced two new restructuring "tools", and
- it disapplies a supplier's right to terminate under its contract terms if the company it is supplying to enters into insolvency proceedings (with limited exceptions).
Significantly, it applies retrospectively to contracts already in place.
The new insolvency proceedings
The two new restructuring "tools" introduced by CIGA are:
- a new moratorium on enforcement action, and
- a new "restructuring plan" process.
The moratorium is a new standalone insolvency procedure which enables a company in financial difficulty to obtain some “breathing space” (i.e. protection from creditor action) to restructure its liabilities - similar to the US's "Chapter 11".
The new restructuring plan process is a flexible restructuring compromise allowing companies in financial difficulty (or their creditors, shareholders or members) to apply to the court to restructure their debt.
Although these new options may assist financially struggling contractors and MMC suppliers in rescuing their businesses, it is the loss of the right to terminate a supply contract for customer insolvency which is of more interest.
The right to terminate an MMC supply contract
Broadly speaking, the CIGA restrictions on terminating a contract apply when a supplier is providing goods or services to a company, and that company enters into insolvency proceedings (with limited exceptions).
In this case, assuming CIGA applies, the supplier cannot:
- terminate the contract due to the company entering into insolvency proceedings (whether termination arises automatically, or whether the supplier has to exercise a right to terminate, under the contract's terms)
- terminate the contract because of a contractual right that arose before the company’s insolvency (unless the supplier terminates before the company enters into insolvency proceedings)
- say that it will only continue to supply the goods and services if the company pays all or any outstanding amounts for supplies made before the company's insolvency proceedings.
So, for contractors on projects involving MMC and for suppliers of MMC products, if the company they are supplying to enters into insolvency proceedings then they cannot terminate the contract (save for the exception below), they will rank as an unsecured creditor for any unpaid invoices and will still need to continue to supply to that company - although they are entitled to payment for that ongoing supply and their creditor status for the ongoing supply will move up the creditor chain.
Termination may still be possible in certain circumstances - CIGA does allow termination eg if the administrator or liquidator consents or if the court grants permission but this is new territory for everyone concerned.
To illustrate an example. A supplier has manufactured a product, delivered it to site, raised the invoice only to find that the main contractor to whom they are supplying has entered into the moratorium. The supplier cannot terminate their contract with the contractor, they will rank as an unsecured creditor for the goods already supplied and unpaid for, and they are obliged to continue to supply further goods under the contract albeit with payment. Seems tough on the supplier, doesn't it?
"Aha", you may cry. What about my protection under the Construction Act and the right to suspend for non-payment? The answer at the moment is that no one is entirely sure. Our view is that the right to suspend is lost once the contractor enters into the moratorium or administration but we await a court decision to ratify that.
What can MMC product suppliers do to protect themselves?
For contractors on projects involving MMC and suppliers of MMC products, some key things to think about may be:
- updating their contracts so that the definition of or references to "insolvency" include the two new CIGA insolvency proceedings
- reducing payment periods to reduce financial exposure, particularly if the supply contract is short but high value
- asking for advance payments on larger items supplied (although the company may request an advance payment bond)
- using project bank accounts or escrow accounts, to protect the pot of money allocated to the supply contract
- considering the termination rights in their contract, to allow for earlier termination where possible (e.g. if the other party's credit rating drops below an agreed threshold)
- in the event of payment problems, reviewing the contract early so that any termination rights can be considered early and before the company enters into insolvency proceedings (at which point CIGA's restrictions on termination will apply)
- exploring credit insurance.
Of course, whether any of these or other steps can be taken will very much depend on the circumstances, such as the nature and value of the supply, and the bargaining power of and commercial relationship between the parties to the contract.
It may be that the main thing that contractors and suppliers can do is keep an eye open for any warning signs around a company's solvency, and to seek advice quickly if they have any concerns.
For more information see CIGA 2020 and construction contracts: no termination or suspension for insolvency, or contact our Construction Team.
Co-authored by Asa Buchanan, Associate.