Bar on terminating contracts on insolvency grounds

• United Kingdom

• Construction and engineering
• Litigation and dispute management
• Restructuring and insolvency

26-06-2020

The Corporate Insolvency and Governance Act 2020 (the “Act”), which is now in force, is introducing a number of changes to current insolvency rules, including imposing a permanent ban on supplying parties invoking contractual termination rights where their counter-party has become subject to a relevant insolvency procedure.

Typically construction contracts include mutual termination clauses which can be invoked by a party where the other has entered into an insolvency process.  These mutual termination clauses are widely used in construction contracts at tier 1 and subcontractor levels. The problem with such clauses is that, once invoked, a successful restructuring of the insolvent company is less likely and there is a consequential effect across the supply chain.

The Act therefore offers protection to troubled parties by improving their chances of a successful restructuring by maintaining their key contracts.  However, suppliers will now, more than ever be looking closely at their termination rights and those who have forewarning of their counter-party’s financial distress may now seek to protect themselves by terminating contracts more readily if a right to terminate (other than a relevant insolvency trigger) arises. 

What does the Act provide?

The Act prevents termination or variation of a contract where goods and/or services are supplied to a company, and the company enters formal insolvency proceedings, where the supplier would otherwise be entitled to terminate as a result of that company entering into a relevant insolvency procedure or on the basis of a right to terminate which accrued prior to the insolvency process, (whether or not that ground of termination was insolvency related).

The limited exception to this rule will be where:

i)             the office-holder or the company (depending on the relevant insolvency process) consents; or

ii)            the Court is satisfied that the continuation of the contract would cause the supplier hardship and grants permission for the termination of the contract.

Industry standard form contracts

The vast majority of construction contracts include mutual termination provisions which are designed to protect parties from incurring additional losses which may not be recoverable from the party in financial distress.

The JCT Design and Build Contract and JCT Standard Building Contract (with or without quantities) 2016 at clauses 8.5.1 and 8.10.1 provide mutual termination rights for the Employer and the Contractor in the event that either of the parties becomes insolvent (as defined in the contract).  Similarly, the Engineering and Construction Contract of the NEC 4 suite at clause 91.1 offers similar mutual termination rights. The JCT and NEC 4 equivalent sub-contracts also offer similar termination rights to the Contractor and Sub-Contractor.  

Accordingly, the Act will in the most part render such clauses unenforceable to the party supplying goods and services; although it will remain possible to terminate on the basis of insolvency (i.e. inability to pay debts) provided that the counter-party is not in formal insolvency proceedings.

Impact of the Act

The Act should have a positive impact in terms of assisting the rescue of viable businesses and strengthening the UK’s rescue culture for companies in financial difficulty.   However, it may also result in suppliers seeking to terminate contracts more readily if a right to terminate arises and there is a real risk that the counter-party may enter an insolvency process in the near future.