CONSTRUCTION JOURNAL

Insolvency update: the latest UK cases and statutes

The new Corporate Governance and Insolvency Act 2020 introduces some of the biggest changes to insolvency legislation in the UK in 20 years

Author: Shy Jackson

25 August 2020

It is a regrettable fact that insolvency occurs too often in the construction industry. The COVID-19 pandemic may make matters worse, but it is not a new issue. One of the drivers for the introduction of the payment and adjudication regimes over 20 years ago in the Housing Grants, Construction and Regeneration Act 1996 was to reduce insolvencies. Based on the Monthly insolvency statistics, July 2020, the number of insolvencies in the construction sector remains higher than in other sectors, despite a reduction from the higher numbers earlier this year.

It is useful to bear that in mind when looking at 2 recent key decisions from the Supreme Court, as well as the new Corporate Insolvency and Governance Act 2020 (CIGA). CIGA introduces some of biggest changes to insolvency legislation in the past 20 years – previously set out in the Insolvency Act 1986 and Companies Act 2006 – as well as including some temporary provisions to deal with the impact of COVID-19.    

Adjudication and directors in the Supreme Court

On 17 June 2020, the long-awaited Supreme Court decision in Bresco Electrical Services Ltd v Michael J Lonsdale (Electrical) Ltd [2020] UKSC 25 was handed down. In the Court of Appeal it was held that an adjudicator had jurisdiction to decide a dispute referred by an insolvent company but that an injunction should be granted to stop such an adjudication as it was an “exercise in futility” due to the conflict with insolvency legislation.

The Supreme Court agreed that an adjudicator had jurisdiction to determine the dispute but decided against the injunction continuing. This was because the Supreme Court took the opposite view to the Court of Appeal, on the basis that adjudication was compatible with the insolvency regime and served a useful purpose, being a well-established form of ADR that often led to a speedy, cost-effective and final resolution of the dispute. This decision makes it easier for insolvent companies to commence adjudication and increases the risks for the responding parties.

A month later, on 15 July 2020, the Supreme Court handed down the judgment in Sevilleja v Marex Financial Ltd [2020] UKSC 31. The Supreme Court reversed the decision by the Court of Appeal, which in turn reversed the decision by the trial judge.  

The claim concerned an allegation that the owner of 2 companies, which were about to be the subject of a judgment requiring payment of over $7m, transferred $10m held by the 2 companies to avoid payment. He then put the companies into liquidation in the British Virgin Islands and the claimant was concerned that the liquidator took no steps to recover these funds.

The claimant then started a personal action against the director and the key issue was the rule against reflective loss – preventing a creditor of a company from taking action against a director who stripped the assets of a company where the company also has an action against that director – even if the company does not take any steps to make such a claim.

The Supreme Court unanimously allowed the appeal and, while there was no complete agreement on the operation of the rule against reflective loss, it was agreed that the rule did not apply to claims brought by creditors who are not shareholders of a company. This will make it easier for creditors to make direct claims against directors in their personal capacity when it is alleged they have removed assets from companies.

“This will make it easier for creditors to make direct claims against directors in their personal capacity when it is alleged they have removed assets from companies”
Corporate Insolvency and Governance Act 2020

The new provisions in CIGA came into force on 26 June 2020. The act contains a mix of measures, some of which have been developed over the past few years and some that have been introduced due to COVID-19.

One of the key changes is prohibiting all suppliers of goods and services from terminating contracts or stopping supplies due to insolvency. This may mean that some the clauses in standard forms that allow contractors to terminate for employer insolvency and sub-contractors to terminate for contractor insolvency may no longer be relied upon, subject to limited exceptions. This only applies to termination by the supplier – that is, upstream – not when the supplier is insolvent.

CIGA also prevents a supplier doing "any other thing" as a result of the main contractor or employer entering into an insolvency procedure. It is unclear what this is meant to cover, but it will likely prevent a supplier taking steps such as suspending or delaying delivery, or attaching conditions to delivery. This is also likely to mean that clauses that allow entry to site and collection of materials after termination for insolvency will no longer be effective and the terms of any payment securities, such as parent company guarantee, will need to be reviewed to ensure they are effective.

In relation to termination, it will not be possible to rely on termination clauses once an insolvent counterparty has entered into an insolvency procedure. It will, however, still be possible to rely on rights of termination for default or non-payment that occur before the insolvency process. This may lead to parties introducing rights to terminate at an earlier stage when there are indications of an imminent insolvency such as presentation of winding up petitions or the launching of a CVA proposal.

Otherwise, once an insolvency has occurred, the supplier can only terminate in limited circumstances, including when it can show that continued supply would cause "hardship" to the supplier. CIGA does not define hardship and it is an area the courts will have to give guidance on. Another exception is for small suppliers, who are temporarily exempted until 30 September 2020.

CIGA also provides for insolvent companies – or those likely to become insolvent – to obtain a 20-business-day moratorium by making an application to the court to allow them time to restructure or seek new investment. The directors will remain in charge of running the business on a day-to-day basis and the period can be extended in certain conditions. The moratorium will be made public and creditors will be able to challenge the actions of the directors on the grounds that their interests have been unfairly harmed, but it will bind secured and unsecured creditors and, in simple terms, prevent formal legal proceedings – but probably not adjudication.

In relation to COVID-19, CIGA includes temporary provisions to restrict statutory demands and winding up petitions issued against companies during the period beginning 27 April 2020 – it has retrospective effect – until 30 September 2020, where the debt is unpaid for reasons relating to COVID-19. The 2 exceptions are where COVID-19 has not had a financial effect on the debtor, or where the debtor would have been unable to pay, even if coronavirus had not had a financial effect on the debtor.

To understand the full impact of the changes, the Act should be considered in further detail. The new provisions need to be considered whenever an insolvency situation arises.

“One of the key changes brought about by CIGA is prohibiting all suppliers of goods and services from terminating contracts or stopping supplies due to insolvency”

shy.jackson@pinsentmasons.com

Related competencies include: Client care, Corporate recovery and insolvency

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