It is always critical, in order to preserve value or protect your position, to take swift action in an insolvency scenario. Over the last couple of years – with Brexit, the COVID-19 pandemic and, more recently, the impact of the war in Ukraine – the headwinds facing the construction industry have gathered speed, with labour shortages and increased raw material costs, and sometimes severe supply-chain delays and dislocation.
In addition, the sector is grappling with ESG issues, and trying to find ways of using technology to increase efficiencies and profitability. Collectively, these issues are having an impact, and any changes in costs on fixed-price contracts (often with very thin margins) are likely to lead to an increase in insolvencies in the sector.
Further, the impact of legislative changes brought about by the Building Safety Act 2022 (BSA), following the Grenfell Tower tragedy, will lead to additional strains on the industry.
Extending the scope of claims
In particular, the amendments to the Defective Premises Act 1972 and the Limitation Act 1980 serve to extend the scope of claims that can be brought, and extend the limitation period for bringing such claims – retrospectively (30 years) and prospectively (15 years) in some instances.
This introduces the potential for a host of claims in relation to historic projects, which would otherwise have been time-barred. This will result in projects having a longer liability 'tail' than has previously been the case, which may in turn put pressure on the pricing of construction work and the necessary insurances.
It remains to be seen how the professional indemnity market will respond to covering such risks.
New insolvency laws
While the industry is all too familiar with the challenges of insolvency, companies and their boards might not be aware that, following the introduction of new insolvency legislation in June 2020, suppliers can now be required to continue to supply an insolvent counterparty, or that a Restructuring Plan could result in amounts owed to you being reduced – or even wiped out – if the requisite conditions are met for a 'cramdown' to occur.
- Ipso facto
These are clauses in a contract that allow a party to terminate the contract as a result of the other party's insolvency. The Corporate and Insolvency Governance Act 2020 (CIGA) introduced a prohibition of the operation of such clauses for any contract for the supply of goods or services that will capture a main contractor supplying services to an employer, as well as a subcontractor working for a contractor. The legislation also prohibits the supplier from making payment of historic arrears (those relating to the pre-insolvency period) a condition of continued supply. There are certain carve-outs where the ongoing supply would cause hardship to the supplier, but these will be limited in nature.
As a consequence of these changes, parties will need to consider in more detail alternative provisions for termination that could be triggered independent to the actual insolvency. For example, 'termination at will' or 'termination for convenience' clauses, which provide the right to terminate the contract without the need to prove a breach. Careful consideration should be given as to the potential consequences of such provisions.
Alternatively, if standard clauses are used, close attention should be paid during the life of the contract, so that if there are breaches and concerns around the counterparty's viability, a termination notice is given for things such as non-payment or breaches of other terms prior to any insolvency occurring.
- Restructuring Plan
Also introduced by CIGA, the Restructuring Plan allows any company that "has encountered or is likely to encounter financial difficulties" to make an application to court to propose a Restructuring Plan that can seek to compromise debt and/or equity in the company. Dissenting classes can be crammed down so long as (i) one class of creditors with a genuine economic interest has voted in favour of the Restructuring Plan and (ii) any dissenting class is no worse off than they would be in the 'relevant alternative'.
If the court accepts that such a relevant alternative is an insolvency process where there would be no distributions made to unsecured creditors, it may be that the entirety of the debt owed to you by a counterparty is extinguished. As well as being aware of the risk of being on the 'other side' of a Restructuring Plan, it is, of course, also a tool that companies can consider themselves if they are facing financial difficulties.
Unfortunately, an increase in restructuring and insolvency in the sector appears to be inevitable. For businesses to come through these challenges, clear communication and strong relationships are vital. So much can be detected from ongoing communication with counterparties and often a resolution can be found should the worst happen. Likewise, if you are the company facing distress, early communication with key stakeholders is critical and prudent boards should be looking at what restructuring options might be available to them as they navigate their way out of this difficult period.
Note: a cramdown is the imposition of a bankruptcy reorganisation plan by a court, despite any objections by certain classes of creditors. A cramdown is often used as part of the Chapter 13 bankruptcy filing and involves the debtor changing the terms of a contract with a creditor with the help of the court. This provision reduces the amount owed to the creditor to reflect the fair market value of the collateral used to secure the original debt. (From Investopedia).
Originally published by Construction News on the 25th of August, 2022.
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