Insolvent abuse

Insolvency of any party on a building project is regrettable and something advisers should look to militate against at pre–tender stage. Pre-contract checks on financial position, current workload and resources are essential prerequisites to entering a construction contract: yet, despite such checks, insolvency remains a possibility.

Although insolvency in the industry has fallen slightly over the past year, history shows that, once construction activity picks up, insolvency is likely to increase. Insolvency numbers have been lower because monetary policy has provided financial props and their removal will, in all likelihood, produce an increase. As construction is the sector that frequently produces more insolvencies than any other, detailed consideration should be given to contract termination provisions and what type of security might be sought, for example, performance bonds, parent guarantee, and so on, to provide protection in the event of insolvency.

Insolvency itself is not a breach of contract but its effect frequently means that repudiation follows. Repudiation generally means the contract can be brought to an end regardless of whether or not the contract contains any termination provisions. However, most building contracts contain express provisions dealing with termination events; insolvency being one. 

Although insolvency in the industry has fallen slightly over the past year, history shows that, once construction activity picks up, insolvency is likely to increase

Until 2005 a contractor’s insolvency triggered an automatic termination under the JCT Standard Contract but as this was problematic the position was revised so that the contractor’s employment continues in the event of insolvency, unless it is terminated by the employer.

Despite the JCT Standard Building Contract 2011 (SBC2011) containing a framework for termination by the contractor or employer in a range of specified circumstances it is without prejudice to other rights (clause 8.3.1); such provisions are common to many JCT contracts including the Intermediate Building Contract and the Design and Build Contract. That saving provision raises the question as to whether one should terminate under a contract provision or at common law.

Thomas Feather & Co vs Keighley Corporation (1953) and Architectural Installation Services Ltd vs James Gibbons Windows Ltd (1989) illustrate the difficulty, but it is suggested that one should generally rely on express contractual provisions.

Where terminating under specific contractual provisions it is essential to follow the procedures set out because otherwise serious consequences may follow. SBC2011 provides that if a contractor is insolvent (defined in clause 8.1) the employer may give notice at any time to terminate the contractor’s employment; no warning notice is required but, as it is generally appropriate to have discussions with the contractor upon insolvency, such notice is unlikely to be a surprise.

Where terminating under specific contractual provisions it is essential to follow the procedures set out because otherwise serious consequences may follow

Clause 8.5 spells out the position upon insolvency, which applies whether or not the employer has given notice of termination. This clause brings into effect clause 8.5.3 and consequentially (inter alia) 8.7.3 which means “no further sum shall become due to the Contractor  […] other than any amount that may become due  […] under clause […] and the Employer need not pay any sum that has already become due either”, where a payless notice has been given or the contractor has become insolvent after the last date that a payless notice could have been given.  

Those provisions (under the JCT Intermediate Building Contract with contractor’s design 2011 (ICD2011)) came under scrutiny in Wilson and Sharp Investments Ltd vs Harbour View Developments Ltd (2015).

That case revolved around whether the insolvency provisions applied in all situations of insolvency or just those where insolvency occurs prior to termination of the contract and those where the contract is terminated for insolvency. The issue was relevant because the contractor (Harbour View) had become insolvent after termination had arisen. If such provisions did not apply where the contract had previously been terminated by the contractor, then clause 8.7.3 governing the suspension of payments would be inoperative. The Court of Appeal established that the “insolvency” provisions under clause 8.5 of ICD2011 apply, regardless as to whether the insolvency occurs prior to or after termination (and regardless as to whether termination is because of insolvency). In doing so the CA disagreed with the High Court judge who had taken a more limited view.

Also it established that where the “employer accepts that interim payments have become due, because of a failure to serve a payless notice, (the employer) is not prejudiced by such acceptance when it seeks to raise a serious and genuine cross claim”. Insolvency together with a serious and genuine cross claim means payments on account that arise at any time, regardless of the absence of any payless notice, can be suspended. That was the position established in Melville Dundas Ltd vs George Wimpey UK Ltd (2007). The fact that suspension of payment can apply at any time may seem surprising, particularly in light of the new provision in the Construction Act, as reflected by clause 8.7.3.2 ICD2011, but it appears insolvency law generally prevails. Though the outcome of the Wilson and Sharp case may not meet with everyone’s approval it confirms JCT’s intentions.

Although enforcement by summary judgement of an adjudicator’s decision for payment will often be successful where there is no payless notice, a contractor’s insolvency creates a very different situation and enforcement depends upon the facts: the outcome may well be one that is not expected.

Peter Hibberd is the past chair of the Joint Contracts Tribunal