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Contract clinic: ‘Our main contractor is insolvent. Can we stop work?’

In our latest Contract Clinic column, Jonathan Booton explains why new legislation makes it harder for subcontractors to walk off site.

The question

We are a subcontractor on a UK project and the main contractor we are supplying has become insolvent. Can we stop work and terminate the contract?

The answer

A key piece of legislation you should be aware of is the Corporate Insolvency and Governance Act 2020, introduced by the government because of the pandemic.

Much of the act has now expired, but the addition of Section 233B to the Insolvency Act 1986 remains. This provides that, if a company goes into a formal insolvency process, a supplier to that company is not entitled to stop supplying goods or services under their contract, simply because of the insolvency process. The aim was to protect the supply of goods and services to a company when it goes into insolvency proceedings.

The Corporate Insolvency and Governance Act 2020 applies only to termination clauses in a contract for the supply of goods and services which affect the ‘supplier’. So, it applies to whoever is supplying goods or services.

Most standard form construction contracts, such as JCT, NEC and FIDIC, contain provisions allowing a party to terminate the contract on the insolvency of a party or an insolvency event. For example, this appears under Clause 8.1.4 of the JCT Design and Build Contract 2016 and Section 9 of the NEC3 engineering and construction contract.

“The Insolvency Act 1986 provides that, if a company goes into a formal insolvency process, a supplier to that company is not entitled to stop supplying goods or services under their contract.”

But Section 233B of the Insolvency Act 1986 affects the supplier’s rights in several ways: 

  • The supplier cannot terminate the contract or the supply; 
  • The supplier cannot do “any other thing” when insolvency arises, such as making it a condition of continued supply that outstanding charges are paid;
  • The supplier cannot rely on pre-insolvency termination events; and
  • The supplier must continue to supply even if payment has not been made for goods or services already delivered. 

These provisions make it very difficult for you to terminate the contract or cease supplying the main contractor. However, there are circumstances where termination may arise under Section 233B of the Insolvency Act 1986. These are:

  • if any subsequent administrator or liquidator agrees;
  • where the contractor is subject to a company voluntary arrangement and they agree; or
  • by court order, the court being satisfied that the continuation of the contract would cause the supplier ‘hardship’.

The supplier may also terminate if its right to terminate arises after the insolvency procedure begins, for example, non-payment for goods or services supplied.

Additionally, you have the statutory right to suspend work for non-payment (under Section 112 of the Construction Act 1996).

Section 233B of the Insolvency Act 1986 only covers contractual rights and not statutory rights. Yet, it is likely that relying on your statutory rights to suspend work (under Section 112) would fall within the scope of doing some “thing”, which has the effect of making further supply conditional on payment.

Note that the 2020 act does not affect the rights of an employer to terminate for insolvency of a contractor. Similarly, the rights of a contractor to terminate for the insolvency of a subcontractor (supplier). In these circumstances (subject to the contract), employer or contractor would be able to terminate for insolvency.

Step-in rights

Another option is to try working with the employer directly. The employer may be able to trigger a unilateral ‘right to step in’ with your contract, if such a right exists.

Step-in rights under a collateral warranty may be caught by the Corporate Insolvency and Governance Act 2020. Step-in rights usually arise in specific situations. A supplier has grounds to terminate its appointment by the contractor for insolvency and allow the employer to step into the shoes of the contractor.

The step-in rights typically provide that, before terminating the appointment, the supplier will first have to serve a notice on the employer, notifying them it intends to terminate. This gives the employer the option of stepping in and replacing the contractor.

However, the 2020 act stops contractual termination, in an applicable contract, when a party enters insolvency proceedings. This could also cover any contractual rights that may have arisen before insolvency. This is assuming that the right to terminate was not exercised before the contractor’s insolvency process was commenced.

It is unlikely that the supplier will have time (before the moratorium is in place) to issue the relevant notice to start the step-in process.

Jonathan Booton is an associate at Beale & Company Solicitors

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Comments

  1. Not an easy article to follow, not helped by colloquialism where specific, distinct actions are contemplated; suspending performance of the work/services, abandoning the site and/or terminating the contract. It seems that 3 separate Acts overlap in application and (I assume) take precedence over contractual terms. Clearer conclusion (if there is one) would have been informative.
    Irrespective of expressed step in rights; would it not be the case that an employer might subsequently and mutually agree with the supplier and the insolvent contractor to step in and have the works/services continue?

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