Dealing with insolvency in the construction supply chain (UK focus)

Dentons

This round-up collates the information, analysis and guidance relating to insolvency issues shared by our Construction and Restructuring, Insolvency and Bankruptcy teams during the COVID-19 pandemic. For further information on any of the issues below, please get in touch with one of the Key Contacts.


Few construction projects have been left untouched by the effects of the coronavirus (COVID-19) pandemic. The first national lockdown and the need to comply with social distancing regulations reduced workforce capacity, disrupted supply chains and led to many site closures. The result was widespread disruption and, despite government measures such as furloughing, many in the construction industry are still struggling. Some have already succumbed to insolvency. The second Welsh lockdown, the English lockdown starting on 5 November and the continuing tiered approach in Scotland will mean further anxiety, despite government reassurance that construction work can continue and the extension of the furlough scheme.

However, COVID-19-related pressures need not necessarily lead to commercial disaster. The government's early call for collaboration and good contractual behaviour set a positive tone for the industry, as did guidance such as PPN 02/20 calling on public authorities to make payments. Good contractual behaviour includes monitoring the finances (both of your own business and that of your trade partners) and taking prompt action in accordance with your contractual rights and obligations and the COVID-19 guidance. 

A clear head, watching closely for the warning signs of insolvency, understanding the legal and practical options, taking early, prompt action and a willingness to collaborate and compromise could save your business, the project and jobs – and help the wider economy.

What is insolvency?
What is insolvency? A business is insolvent if it is in financial difficulties and unable to pay its debts. Several procedural options are available to distressed businesses and their creditors for dealing with the insolvency. 

In An introduction to English insolvency procedures (and practical action to take), we summarise the two key insolvency options for distressed business in England and Wales: administration and liquidation.

The effects of the procedures and their outcomes are very different and it is therefore important to understand how they operate.

Government measures to help distressed businesses
Changes to insolvency laws The Corporate Insolvency and Governance Act 2020 (CIGA) came into force on 26 June 2020. It introduced emergency measures to protect directors of companies which continue to trade notwithstanding the threat of insolvency, and to prevent, where possible, companies entering into insolvency due to COVID-19.

Crucially, CIGA created a breathing space in the form of a moratorium for struggling companies. You can read more here:

  • COVID-19: Permanent and temporary changes to Corporate Insolvency and Governance laws in the UK (Quick Guide, updated 29 September 2020); 
  • COVID-19: Permanent and temporary changes to Corporate Insolvency and Governance laws in the UK: The moratorium and directors' liability (Long Guide, updated 29 September 2020); and
  • The Global COVID-19 Insolvency Tracker.
On 24 September 2020, the government extended the duration of the original temporary measures under CIGA which had been due to expire on 30 September 2020 (see the announcement here). Consequently:
  • Statutory demands and winding-up petitions will continue to be restricted until 31 December 2020. This follows the announcement earlier in September that the COVID-19 protections from forfeiture for non-payment of rent for business tenancies were to be extended in England to 31 December 2020.
  • Small suppliers will remain exempted from the obligation to supply under the new "Ipso Facto" provisions until 31 March 2021. 
  • The temporary moratorium rules will be extended to 31 March 2021. The modifications to the new moratorium procedure, which relax the entry requirements to it, will also be extended until 31 March 2021. 
  • Companies and other qualifying bodies with obligations to hold Annual General Meetings will continue to have the flexibility to hold these meetings virtually until 31 December 2020.
At present, it does not look like the suspension of liability for wrongful trading provisions contained in the Act are to be extended.

The Scottish Government has confirmed that they will extend the current restrictions on the availability of irritancy (for non-payment of rent) and the protections from eviction relating to residential tenancies until 31 March 2021 (under the Coronavirus (Scotland) Act 2020).

Changes to company laws CIGA relates mainly to insolvency law but also makes some temporary changes to UK company law. Its aim is to give companies greater flexibility to deal with the difficulties caused by COVID-19. 

You can read more here: COVID-19: the company administration aspects of the Corporate Insolvency and Governance Act 2020 (United Kingdom) (updated 30 September 2020).
 
For those involved in structured finance transactions, you can find out more about the effect of CIGA here: Structured Finance and the Corporate Insolvency and Governance Act 2020 (United Kingdom) (updated 29 September 2020).

While attention should be paid to the provisions of the Act, on balance, structured finance transactions should remain largely unaffected as a result of the broad exclusions which exist for such transactions under the Act.

Does CIGA affect construction's statutory right to suspend for non-payment? CIGA has and continues to benefit many, but one issue it raises is whether it affects the right to suspend work under the Housing Grants, Construction and Regeneration Act 1996 (as amended) (the Construction Act).

CIGA includes a measure preventing suppliers from exercising rights to vary their contract. So how do the CIGA provisions interact with the well-established statutory right to suspend performance in the event of non-payment under the Construction Act? Gurbinder Grewal and Tessa Blank discussed that issue here: What effect does the new Insolvency Act have on construction's statutory right to suspend for non-payment?

Minimising the economic impact of COVID-19
Identify financial issues in the supply chain early, collaborate and avoid disputes
Monitor your supply chain for signs of insolvency Disrupted cash flow has been one of the key consequences of COVID-19 for the construction industry. While the government and industry guidance sets out very sensible recommendations, some businesses will continue to be hit harder than others. A single insolvency in the supply chain can soon disrupt the project programme and undermine the goodwill built up between long-standing trading partners.

It is important to spot the warning signs of financial difficulties in the supply chain as early as possible, so that appropriate action can be taken promptly to limit potential damage to the project and other businesses.

In Monitoring your supply chain for signs of insolvency: promote collaboration and keep UK projects on track, we explain why construction disputes proliferate in recessionary times and provide a checklist: the warning signs that a party might be (or be becoming) insolvent. 

Act early: it is difficult (sometimes impossible) to recover money from an insolvent business

Keep up to speed with government and industry guidance The UK government and the governments of each of the devolved administrations are updating their guidance and legislation regularly in response to COVID-19. Keep up to date and adapt business practice accordingly and swiftly. 

Note the guidance issued by the Construction Leadership Council (CLC) including England Lockdown – A Message to the Construction Industry, 2 November 2020 (by Andy Mitchell) which highlights the following:

See also: COVID-19: Contractual Disputes & Collaboration Guidance (14 July 2020) which builds on the CLC COVID-19 Contractual Best Practice Guidance.
Act responsibly and fairly The government issued its "Guidance on responsible contractual behaviour in the performance and enforcement of contracts impacted by the COVID-19 emergency" on 7 May 2020. This guidance encourages public and private contracting parties to act responsibly and fairly to support the response to COVID-19, and protect jobs and the economy. 

You can read our summary here: Government guidance on responsible contractual behaviour.

Review your contracts Many businesses reviewed their contracts at the start of the pandemic to ensure their trading terms were still appropriate. Several months down the line, continue to monitor current projects to ensure that contract terms remain suitable. Take extra care when negotiating new contracts – including the dispute resolution clauses. See The ramifications of amending dispute resolution clauses.
Keep good records In times of economic uncertainty, disputes are, unfortunately, inevitable. One of the best ways of resolving a dispute quickly is to have clear records available to support your claims.
  • Check your systems for keeping records. Are they up to date?
  • Where furloughed staff were responsible for record keeping, are their records up to date? (Take care not to ask furloughed staff to do any work).
  • If redundancies are under consideration, ensure that affected employees' site records are up to date and backed up in the office.
Pay up (and keep up to date with procurement models) The government has called on contracting parties to collaborate with each other and has issued guidance on responsible contractual behaviour to that effect (see above). Good contractual behaviour includes paying your suppliers and supply chain on time in accordance with your contract.

One of the COVID-19 measures introduced by the government was a call for public authorities to fast track payments under its Public Procurement Guidance (PPN) 02/20 (which we wrote about here Contracting authorities – act now to safeguard supplies during the COVID-19 outbreak). PPN 02/20 expired on 30 June 2020. 

PPN 04/20, which became effective on 1 July 2020 and expired on 31 October 2020 (see PPN 04/20: government sets out COVID-19 recovery strategy for contracting authorities (effective from 1 July 2020)), built on and left it open to contracting authorities to apply PPN 02/20 but steered authorities towards the next stage: a "recovery strategy". That next phase involves contracting authorities working proactively with their suppliers to transition to "a new, sustainable, operating model which takes into account strategic and reprioritisation need".

PPN 06/20, which became effective on 24 September 2020, provides a new model for public bodies to take account of social value in the award of central government contracts. It should be applied to all new procurements from 1 January 2021.

PPN 07/20 was introduced on 29 October 2020 and sets out how payment approaches can be taken into account in the procurement of major government contracts. PPN 07/20 updates PPN 04/19: Taking account of a supplier’s approach to payment in the procurement of major contracts which will remain effective until 1 April 2021.

Similar provisions were introduced in Scotland. SPPN 05/2020 set out guidance for public bodies on options for payment to their suppliers to ensure service continuity during COVID-19. It expired on 30 June 2020. SPPN 08/20 is supplementary to SPPN 05/2020. It also sets out guidance for public bodies on options to ensure service continuity during COVID-19 and is under review.

If disputes do arise
Collaborate both inside and outside your business Disagreements are a fact of life and their proliferation in times of economic distress can all too easily push fragile businesses into insolvency. Recognising how disputes can cause a business' economic position to spiral downwards, the government issued guidance on responsible contractual behaviour to encourage collaboration between contracting parties. The CLC has promoted the Conflict Avoidance Pledge (the Pledge) created by the Conflict Avoidance Coalition Steering Group (CACSG). See also the CACSG's useful Contract Avoidance Toolkit on how to implement the Pledge.

Well-designed dispute avoidance procedures encourage communication and compromise, help identify problems early and enable them to be addressed in non-adversarial environments.

However, businesses and their lawyers must not lose sight of the human context if they want to keep trading relationships smooth. In this context, we suggest, in Mind your "Ps" and "Cs" to avoid disputes (UK construction focus), that businesses focus on identifying risks early in the project, set out clear dispute resolution procedures in their contracts, promote collaboration in their culture and encourage personal development in their team and training.

Use alternative dispute resolution The government's COVID-19 guidance strongly encourages contracting parties to seek early resolution of emerging contractual issues using ADR methods such as negotiation, mediation or other fast-track dispute resolution (such as the CIC's and the Royal Institution of Chartered Surveyors' (RICS) Low Value Disputes Model Adjudication Procedure). Parties could also sign up to the Pledge.

If you do become involved in ADR proceedings, remember that people react to the stress caused by disputes in diverse ways. Settlement prospects could be improved by the early use of emotional intelligence/quotient (EQ) in trying to understand better the other party's position. See Engage emotional intelligence.

Adjudication when one party is insolvent...

Can a liquidator use adjudication to resolve a dispute when one party is in liquidation or administration?

Statutory adjudication under the Construction Act is now an established way to resolve a construction dispute. However, recent decisions have highlighted a number of issues to consider before serving a notice of adjudication when one of the parties is insolvent.

One such issue relates to the clash between the statutory adjudication and insolvency regimes. In recent years, the courts had decided that the adjudication regime under the Construction Act was subject to, and incompatible with, the Insolvency (England and Wales) Rules 2016. In effect, liquidators in England and Wales were denied the use of adjudication as a tool to help them take a proper account of insolvent companies' assets.;

This clash of regimes was largely resolved in June 2020 in Bresco Electrical Services Ltd (in liquidation) v. Michael J Lonsdale (Electrical) Ltd [2020] UKSC 25. In Bresco, the Supreme Court provided some respite to contractors in liquidation by finally confirming their unfettered right to refer construction disputes for resolution by adjudication. Our Construction team explains the arguments and the court's decision here: Supreme Court reinstates adjudication as a key tool for liquidators.

Adjudication enforcement in Scotland: the balancing of accounts in bankruptcy While Bresco largely resolves the English/Welsh position on liquidators using adjudication to resolve construction disputes, in Scotland, both the approach to using adjudication when one party is in liquidation and the Scottish courts' powers to order a stay of execution are different.
Tips and checklists
Tips for directors facing financial challenges The temporary, retrospective suspension of the directors' personal financial liability for wrongful trading under CIGA does not act as a blanket defence to a director's breach of duty: the fact that directors must act in the best interests of the company (or, on insolvency, its creditors) will continue to apply.

In COVID-19: Companies facing financial challenges – Top 10 tips for UK boards (United Kingdom) (updated 29 September 2020), our Restructuring Insolvency & Banking team sets out a list of top ten tips for boards to consider when addressing COVID-19-related issues. The tips will help directors navigate the challenges facing businesses while complying with their own legal duties.

Checklist: the warning signs that a party might be insolvent As referenced above, you can find the checklist on the warning signs that a party might be insolvent here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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