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What does your construction contract say about insolvency?

Frances Antoniak, Fintan Wolohan and Nicola Deedes discuss the importance of scrutinising your contract to understand your position and protections when it comes to insolvency.

FOR the past 10 years, the construction sector has been susceptible to insolvencies at all levels, from tier one contractors down to specialist sub-contractors. In particular, the past few years have seen the construction industry blindsided by a perfect storm of factors outside of its control (the Covid-19 pandemic, the war in Ukraine and Brexit to name a few) and this has inevitably resulted in record numbers of contractors becoming insolvent.

When insolvency occurs, it’s vital to act quickly – but knowing how to act starts with understanding what your construction contract says. Here, we’ve looked at the approach to insolvency in the standard building contracts most commonly used in the UK – namely the JCT, NEC, and FIDIC – focussing on the JCT D&B 2016 (JCT), NEC4 ECC (NEC4) and FIDIC Yellow Book (FIDIC).

It’s worth noting from the outset that in the contracts, provision is made for the event of the insolvency of either the contractor or the employer – but in practice it tends to be the contractor who unfortunately becomes insolvent and goes into an insolvency process.
Furthermore, the standard forms provide for insolvency in the context of a company, a partnership and an individual – but we’ve concentrated on the position where the insolvent party is a company or partnership.

What do you mean by ‘insolvency’
The first place to start is to see how your contract defines ‘insolvency’. The JCT defines a party as ‘Insolvent’ by referring to the legislation of England and Wales (see 8.1). This isn’t necessarily straightforward to understand, or to ascertain, and so it is advisable to seek professional advice regarding the precise status of the potentially insolvent party and trigger event under the contract. For example, a company doesn’t ‘enter administration within the meaning of Schedule B1 to the Insolvency Act 1986’ (see 8.1.1) until the administrators have been appointed, not at the point where a notice of intention to appoint administrators has been filed.

The unamended NEC4 is broader and includes insolvency events as reasons for termination (in R1 – R10, see 91.1) to include a company: having a winding up order made against it (R5); having an administration order made against it or having an administrator appointed over it (R8); and making an arrangement with its creditors (R10), making it broader than the JCT’s 8.1.

As for the FIDIC, this is similarly drafted to NEC4 but also includes a catch all provision to include ‘any event which is analogous to or has a similar effect to any of these acts or events under applicable Laws’ (at 15.2.1(g) in the case of contractor and 16.2.1(h) for the employer).

So, when faced with a potentially insolvent party, it’s essential to understand whether the party in question has in fact met the definition of insolvent under the relevant contract.

For example, a party in financial difficulty that choses to enter into an arrangement with its creditors (a ‘company voluntary arrangement’ or CVA is one such arrangement) when contracting under NEC4 or FIDIC would not be able to avoid the contractual ramifications of insolvency.

Steps to take on insolvency
If you do establish that the other party is insolvent under the terms of your contract with them, what next?

Under the JCT, if either party is ‘Insolvent’, the contractor’s employment may be terminated at any time by notice, provided it’s given in accordance with the contract’s notice provisions. Such a termination shall take effect on receipt of the relevant notice.

Another important point to note is that from the date the contractor becomes ‘insolvent’, regardless of whether the employer has given a notice of termination, the contractor’s obligation to carry out the works are suspended (see and no further sums will fall owing to the contractor (see 8.7.3), subject to a final account balancing discussed below.

The NEC4 also provides for termination, stating that either party may terminate if the other party has ‘done’ one of the insolvency events listed at clause 91.1 (such as having a provisional liquidator appointed to it (R6)). Once the project manager issues the termination certificate the termination is effective immediately and the contractor does no further work necessary to provide the works (see 90.4).

The FIDIC provides that a notice of termination can be issued in the instance of the insolvent events defined in those previously mentioned clauses 15.2.1(g) and16.2.1(h), applying to either the contractor or the employer as appropriate. The contract is terminated immediately on the date the notice is received (see 15.2.2).

If you want to terminate, for all three of the contracts mentioned above, you’ll need to issue a notice or certificate. In doing so, check you have crossed all the Is and dotted all the Ts, because non-compliant notices have been held in court to be inadequate, which would then put you on the backfoot (needing to re-issue) and in breach of the contract. Similarly, trying to terminate but not using the right grounds under the contract can create further problems for you by limiting your rights to complete the works.

To add a further layer of complexity, the economic impact of Covid-19 resulted in several lasting changes to UK insolvency law under the corporate Insolvency and Governance Act 2020 (CIGA). In short, where you’re supplying services to the insolvent party, the insolvency events set out in your contract that trigger your entitlement to terminate may also trigger the provisions of CIGA, which (broadly speaking) acts to prevent suppliers from terminating a contract and ceasing to supply for reasons of insolvency (known as the ‘ipso facto’ provisions).

While CIGA isn’t an absolute bar on termination and is unlikely to apply where an employer (ie the party being supplied with services) is looking to terminate its contract with an insolvent contractor, care needs to be taken before serving a notice.

How can the employer complete the works?
Recognising that the project cannot be left unfinished, the JCT, NEC4 and FIDIC all provide that upon termination of the contractor’s employment for insolvency, the employer may employ others to carry out and complete the works, using the plant and machinery on site (JCT 8.7(1), NEC4 92.1 and FIDIC 15.2.4).

The contractor must also remove all goods from the site, provide copies of design documents, and, at the request of the employer, the benefit of any supply agreements for the execution of any work shall be assigned (JCT 8.7, NEC4 92.2 and FIDIC 15.2.3).

It’s worth checking the applicable contract for the employer’s rights in relation to assignment, for example, the JCT acknowledges that such an assignment may be restricted to the extent that the contractor may lawfully be required to do so while the FIDIC limits this right as the contractor only needs to comply with the employer’s ‘reasonable instructions’.

Assignment could be helpful in facilitating the completion of the works by subcontractors already engaged onsite, as they’re already mobilised and familiar with the project.

The employer should, however, keep in mind that the insolvency of a contractor will, practically speaking, lead to a significant amount of upheaval, making a smooth transition (including access to documents and the site) difficult.

The administrator or liquidator is unlikely to have had any prior involvement with the insolvent contractor and will therefore spend the first few weeks simply getting up to speed. In an administration and other insolvency processes, there is also moratorium on legal proceedings against insolvent company.

What to do about money owing after an insolvency?
After a party becomes insolvent, it’s only to be expected that the parties check they can recover what monies they can to protect themselves, and the contracts recognise this.

Under the JCT there is a separate final account procedure to determine the balance of the account between the employer and the insolvent contractor following completion of the works (at 8.7.4). Continued good record-keeping is therefore essential when administering a JCT contract after a contractor’s insolvency, because depending on when the contractor became insolvent it can be some time before this final tallying takes place.

The NEC4 assesses the amount due at the time of termination, the contractor is paid for work that it has done and costs it has reasonably incurred in the expectation of completing the works up to the point of termination, less any amounts due from it and subject to any rights of set-off the client may have (see A1)

Under A3, a further deduction can be made of the forecasted amount of additional costs the client will incur in completing the works due to the termination, such an assessment must be made within 13 weeks of the termination certificate and as the name suggests, is a forecast rather than being based on actual costs.

You should also check the main option used (for example option C: target cost) as this may also impact on sums due following termination.

Under FIDIC, a valuation exercise is undertaken at the point of termination (under 15.3) after which the employer may withhold payment from the contractor and shall be entitled to payment of the additional costs of execution of the works (under 15.4).

From an insolvency law perspective, the relevant legislation includes its own regime for arriving at a ‘final account’ of what is owed and which way. This may have an impact on the application of the contractual mechanism. Seek advice before embarking on the process or in the event you run into difficulties dealing with the administrator or liquidator of an insolvent company.

Other considerations
It’s essential, in the first instance, that the parties understand what their contract says about insolvency, both in terms of the definition used and the consequences laid out.

If these don’t say or cover what you want them to, these should be amended before the contract is entered into. There may be other options available to the parties outside of the ones that we’ve mentioned above, but understanding your core legal rights under the contract are key to understanding your position and your options.

With clarity on the contractual position, it’s important the parties factor in the impact of relevant insolvency law.
Frances Antoniak and Nicola Deedes are associates and Fintan Wolohan is a managing associate at international law firm, Womble Bond Dickinson

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