Does Your Subcontract Allow You To Terminate if the Main Contractor Becomes Insolvent?

Does your subcontract allow you to terminate if the main contractor becomes insolvent?

Following implementation of new legislation, it may no longer matter! The Corporate Insolvency and Governance Act was enacted on 26 June 2020. It is intended to support companies who are experiencing financial difficulties due to COVID-19, however, as far as the construction industry is concerned, this could lead to some very harsh results for subcontractors.

Some of the key provisions are as follows:

• The Act prevents a supplier of goods & services from terminating a contract or postponing supplies/services under that contract due to the other party’s insolvency (provided that party continues to pay for such goods & services)

• If, prior to the insolvency, the supplier/subcontractor already had a right to terminate due to default by the other party but didn’t exercise it, then the supplier/subcontract will not be able to terminate the contract on that basis

• The supplier/subcontractor is also prevented from doing “any other thing” as a result of the other party’s insolvency – this presumably includes actions such as suspension of the works

• The main contractor is still be able to terminate their contract with a supplier/subcontractor if the supplier/subcontractor becomes insolvent

• Following the insolvency of the other party, a supplier/subcontractor may only terminate for the following reasons:

1. a further default by the other party after the insolvency e.g. non-payment for goods or services provided after the insolvency

2. by agreement with the other party

3. permission of the course on the grounds of “hardship” caused to the supplier – what this means remains to be seen

This new legislation means that you may be required to continue working for an insolvent company, even if a significant debt has already built up pre-insolvency. Whilst this legislation relates to the supply of goods and services in other industries, the effect it could have on the construction industry is significant as margins are already stretched and cashflow issues are prevalent. It also seems to somewhat contradict the provisions of the Construction Act which provides remedies for non-payment e.g. suspension of performance.

Until 30 September 2020, the prohibitions do not apply to “small entities” i.e. a supplier/subcontractor who satisfies 2 of the following conditions: a) turnover less than £10.2m, b) balance sheet less than £5.1m and c) less than 50 employees.

Some Practical Steps

What can you do to protect yourself?

For future subcontracts:

• Negotiate shorter payment terms

• Negotiate shorter payment cycles or more regular stage payments

• Ensure you have a right to terminate for non-payment

• Ensure you have a a right to terminate if the main contract is terminated

• Undertake credit checks and due diligence on the other party before entering into contract

• Ensure title for materials does not pass to the other party until payment is received

For existing subcontracts:

• Ensure all applications for payment are submitted in a timely manner, in the correct format

• Monitor payment dates carefully and maintain communications with the contractor

• In the event of non-payment, consider your right to terminate if you believe there is a risk of the contractor becoming insolvent, but seek advice before doing so

If you have any queries regarding any of the above or would like further information, please get in touch!