Construction contracts: the impact of CIGA on termination and suspension rights

Construction contracts are notorious for their length. But, even then, they may not tell the whole story.

There are statutory rights and obligations which overlay, and sometimes contradict, the contract terms which have been agreed.

The Housing Grants, Construction and Regeneration Act 1996 (“Construction Act 1996”) has done that for years.

Those working within the construction sector are well-used to the massive impact that legislation has had on construction contracts. Now, we have to get to grips with the Corporate Insolvency and Governance Act 2020 (“CIGA 2020”).

CIGA introduced, with effect from 26 June 2020, a new section 233B of the Insolvency Act 1986 (IA 1986).

The aim of section 233B is to protect the supply of goods and services to a company when it goes into insolvency proceedings by prohibiting the supplier from exercising its right to terminate, among other things, in these circumstances.

Here insolvency law expert Michael Thomson answers six key questions about the impact of CIGA on contracts within the construction sector supply chain.

1. What is the effect of section 233B?

In summary, section 233B prevents a supplier:

• terminating a contract simply because the client has entered insolvency proceedings. Any contractual right to terminate in these circumstances “ceases to have effect”;
• exercising its contractual right to terminate for a pre-insolvency breach if the right to do so has not been exercised before the commencement of insolvency proceedings;
• making it a condition of future supply during the insolvency period (that is, after the client has entered insolvency proceedings), that it is paid any outstanding amounts for supplies made before the client entered into insolvency.

Section 233B does not apply if it is the supplier that has entered into insolvency proceedings. In these circumstances, the client can exercise any of its contractual rights that are triggered by the supplier’s insolvency.

2. When does section 233B apply?

Section 233B applies:

• where a client becomes subject to a “relevant insolvency procedure”;
• to all contracts for goods or services, unless exempt;
• in respect of all relevant contracts, regardless of when the contract was entered into, as long as the client entered into insolvency proceedings on or after 26 June 2020.

3. Are there any circumstances in which the supplier can terminate under section 233B?

A supplier is entitled to terminate the contract or the supply of goods or services if:

• an administrator, administrative receiver, liquidator or provisional liquidator appointed over the insolvent client agrees;
• where the client is subject to a moratorium, company voluntary arrangement or restructuring plan, the client agrees; or
• the court grants permission, being satisfied that the continuation of the contract would cause the supplier hardship. “Supplier hardship” is not defined, although the government’s Guidance: Prohibition of termination clauses indicates that “hardship” is likely to mean the possible insolvency of the supplier if it is forced to continue to supply.

In addition, a supplier may exercise a right of termination that arises during the insolvency period, including a right of termination arising in respect of non-payment.

4. How does CIGA 2020 work with the Construction Act 1996?

CIGA 2020 applies to all contracts for the supply of goods or (non-financial) services, subject to limited exceptions.

The Construction Act 1996 applies to “construction contracts”, as defined in section 104 of it. A construction contract is widely defined and includes contracts with construction professionals.

There are therefore many contracts for the supply of goods or services that fall within the ambit of both CIGA 2020 and the Construction Act 1996.  This raises the following issues.

5. Does section 233B(3) prevent a supplier from exercising its right to suspend for non-payment under section 112 of the Construction Act 1996?

Both bespoke and standard form contracts used in the construction industry typically include a contractual right to suspend performance, in whole or in part, for non-payment.

Construction contracts do not need to include a contractual term to this effect as section 112 entitles a supplier to suspend performance of any or all of its contractual obligations under the relevant construction contract in the event of non-payment by the other party.

Section 233B(3) provides that a:

”... provision of a contract for the supply of goods or services … ceases to have effect … if the supplier would be entitled to terminate the contract or the supply, or to do any other thing, because the [client] becomes subject to the relevant insolvency procedure.”

It seems clear that, in the normal course, a contractual provision entitling a supplier to suspend performance of its contractual obligations for non-payment as a result of the client becoming insolvent would fall squarely within section 233B.

However, a statutory right to suspend for non-payment under section 112 does not. Accordingly, section 233B(3) does not prevent a supplier from exercising its right to suspend for non-payment under section 112.

This right may need to be exercised before the client enters insolvency proceedings for the reasons we discuss in the following paragraph.

6. Does section 233B(7) prevent a supplier from exercising its right to suspend for non-payment under section 112 of the Construction Act 1996?

Section 233B(7) is drafted differently from section 233B(3). It does not refer to contractual provisions. It provides:

”The supplier shall not make it a condition of any supply of goods and services after the time when the company becomes subject to the relevant insolvency procedure, or do anything which has the effect of making it a condition of such a supply, that any outstanding charges in respect of a supply made to the company before that time are paid.”

Once the client has entered into insolvency proceedings, if the supplier exercises its statutory right to suspend performance (of its obligation to deliver goods or services under the construction contract) for non-payment of goods delivered before the insolvency period, this would appear to be “doing something” that has the effect of making payment of these outstanding amounts a condition of future supply.

Section 112 entitles a supplier to suspend for non-payment in these circumstances; section 233B(7), on its face at least, prevents it.

There is no express statement in CIGA 2020 or the explanatory notes as to which is to prevail.

Therefore, failing further clarification via further legislation, we await the issue coming before the courts in order to balance the two sets of provisions in CIGA 2020 and the Construction Act 1996.

If you have any further questions, please do not hesitate to contact Michael Thomson, head of our restructuring and insolvency practice, or Allana Sweeney.