Building Blocks - Insolvency Special Edition 2010 - Mills & Reeve LLP

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the Insolvency Acts of 1986 and 2000, the Enterprise ... receiver. Liquidation This can be voluntary or compulsory. (by
building blocks: insolvency special The cuts revealed in the Comprehensive Spending Review have not been quite as bad as the construction industry had apparently been expecting (£3.5 billion not as bad). Nevertheless there have still been billions of pounds shaved off various departmental budgets which will affect the construction industry. Where public spending has in the past been a reliable source of income, some companies are inevitably now going to feel the effect of the cuts.

Administrative receivership A receiver or manager is appointed over the whole of the company’s property by the holder(s) of a debenture (document evidencing a debt) secured by a charge. This is becoming less common as the power to appoint receivers no longer exists in debentures created after September 2003. A company can continue to trade in administrative receivership although the appointment of a receiver is usually indicative of financial problems.

We have seen a steady stream of developers, contractors and consultants become insolvent over the last six months and find ourselves advising clients on the fall out. At the time of writing, Rok has also just been placed in administration. The running count grows. While this topic is hardly full of Christmas cheer, we felt that this special edition of Building Blocks was necessary following the publication of the government spending review.

Company Voluntary Arrangement (CVA) A proposal made by the directors of a company to its creditors for the satisfaction of the company’s debts at a discount. If the proposal is agreed by the creditors it becomes binding and the carrying out of the arrangement is supervised by an insolvency practitioner. Trading can continue in a CVA and the directors remain in charge of the business. CVAs can last for up to five years.

Insolvency is a huge area of law and the complexities are far too many in number to go into in detail, however, in this edition we set out some basics of insolvency law and give a construction industry specific flavour with the aim of helping you to protect your organisation from the effects of employers, contractors and consultants who have entered or are about to enter into a form of insolvency arrangement. There is a section detailing useful insolvency related resources and we end with an article on insolvency and public procurement by Helen Prandy who is an Associate in our Restructuring and Insolvency Group.

The law The word insolvency covers a multitude of different situations. Some of the technical terms and circumstances are set out below. The law comes from the Insolvency Acts of 1986 and 2000, the Enterprise Act 2002 and the Company Directors Disqualification Act 1986. Administration A process whereby an administrator is appointed with the aim of either rescuing the company as a going concern or achieving a better realisation for creditors than would be available in liquidation. An administrator can be appointed by certain types of floating charge holders, the court or the company directors (the latter is often referred to as self certification administration). The company may continue to trade in administration under the control of the administrator, rather than the directors. Administration should only last for one year before the company must either go into liquidation or a CVA, if it can continue as a going concern.

Insolvency practitioner A licensed individual entitled to take appointment as a liquidator, administrator, supervisor of an arrangement or administrative receiver. Liquidation This can be voluntary or compulsory (by a court order) and is terminal, leading to the dissolution of the company. A company’s creditors may petition the court for an order that a liquidator is appointed and the company is wound up; alternatively A creditors’ voluntary winding up arises at the instigation of the company directors with approval from its shareholders. In either case, the company must be insolvent either on a balance sheet or a cash flow basis. The purpose of the liquidation is to realise assets for creditors. There is no trading in liquidation. Members’ Voluntary Liquidation A solvent liquidation solely for the purpose of a company re-organisation or orderly dissolution of a solvent company. A declaration of solvency must be given by the directors. Pre-pack This is a controversial process whereby the sale of the assets of a company (including goodwill and contracts) is agreed, often to its directors, immediately prior to it going into administration. The sale is then completed by the administrator. The debts are left in the company in administration and its business is carried on by a new company free of debt. In order for the new company to carry on business, the old company’s contracts are assigned to it. Please note however, that under most standard forms of building contract or professional appointment the consent of the other party is needed before the

contracts can be assigned to the new company. Receivership This is not the same as administrative receivership. When a company borrows from a bank the bank will retain a power to appoint a receiver to realise the value of security should the company default. The receiver is appointed specifically to sell the asset (usually land) to pay off the appointing party. A company can continue to trade in receivership and the directors retain control of the business. A receiver need not necessarily be an insolvency practitioner. Finally, although not strictly insolvency terms, the following are useful terms to get to grips with as well: Assignment Contracts create both rights and obligations on parties (often referred to by lawyers as the benefit and the burden). The benefit under a contract is a right which can almost be thought of as a possession belonging to the party who holds the right. The benefit can be transferred to a third party. Note that it is common in standard forms of construction contract to either exclude this right or make it conditional on the written consent of the other party. An assignment therefore, is an agreement whereby the possessor of a right (the benefit of the a contract) agrees to pass it on to a third party. Novation In simple terms this can be thought of as transferring the benefit and the burden of a contract. “Novating” a contract ends the original contract (between A and B) and replaces it with a new one (between B and C), often as if the first contract had never existed. A practical illustration of the benefit and the burden can be shown using a simple building contract example: The employer’s benefit is the right to have a building built and its burden is the obligation to pay the contractor.

The construction industry There are numerous mechanisms that parties can put in place to protect themselves from an insolvency event in the contractual chain. Some may be more appropriate or effective than others, depending upon the circumstances of the particular project. Here we have listed a few of them. It is a good idea to get advice at the outset if insolvency in the project chain is a concern. Advance payment bond Where goods or services needed for the works are paid for upfront an advance payment bond provides protection for the employer that the amount paid can be recovered if the goods or services are not delivered. Collateral warranties A contract between two parties on either “side” of the project who did not previously have a contractual relationship. That may be a contractor, sub contractor, consultant, or sub consultant on the one hand, and the employer, a

funder, tenant or purchaser on the other. This will enable the beneficiary under the warranty to sue the provider of the warranty in the event that it has not complied with its duties of care, skill and/or workmanship under the building contract. As an example, this would be useful for an employer if its main contractor is insolvent but there is a defect in the sub contract works. Further, a collateral warranty can contain “step-in rights” which allows the employer (or funder) to step into the shoes of the contractor, in certain circumstances, to employ the contractor or sub contractor directly and take over the operation of the works contract (or sub contract works). Early warning (NEC) Under the NEC suite of contracts there is an obligation on the contractor to give warning to the employer of any facts which might lead to a key date or the completion date being missed. Insolvency of a sub contractor may well have a delaying effect and may therefore require early warning to be given. Escrow account The employer agrees to deposit an amount in escrow from which regular certified payments to the contractor can be made. The amount on deposit could range from the very large (the entire contract sum) to the small (one or two months payments in advance of certification). Parent company guarantee A guarantee from the ultimate parent company of the contractor or employer may offer comfort when the contractor or employer is a small outfit. If the party whose performance is guaranteed becomes insolvent, this may provide some limited protection. Check the conditions on the guarantee (whether preconditions or limitations). Bear in mind there is however always a risk that if the subsidiary company is insolvent the parent company may be in difficulty too. “Pay when paid” A pay when paid clause means that the main contractor and sub contractor agree that the sub contractor will only be paid once the main contractor has been paid by the employer. Such a clause is illegal and cannot be relied on except in the event of the employer’s insolvency. This is slightly different to a “pay when certified” clause which is often used today, however when Part 8 of the Local Democracy, Economic Development and Construction Act 2009 comes into force “pay when certified” clauses will also be outlawed. Performance bond Surety raised by the contractor in favour of the employer. The surety agrees to pay out to the employer up to a pre agreed amount in the event that the contractor fails to perform its obligations under the building contract. This, coupled with a right to terminate the building contract in the event of insolvency of the contractor, might help an employer where the main contractor becomes insolvent. The employer could terminate the contract and call in the bond in order to pay a third party contractor to finish the job. When putting a bond in place an employer

needs to be aware of what conditions are being placed on it before it can be called in. Project Bank Account The employer, contractor, main sub contractor(s) and possibly main supplier(s) jointly set up a bank account into which the employer pays certified sums. The contractor, main sub contractor(s) and main supplier(s) are paid directly from the project bank account. This should assist cash flow. In addition, in the event of contractor insolvency it gives comfort to the employer, sub contractor(s) and supplier(s) that the latest sum certified will be paid to the parties who have done the work (or supplied the goods). There are however some legal issues causing uncertainty as to the effectiveness of a project bank account in an insolvency situation. Retention bond An on demand bond, which the contractor takes out for the employer, instead of the employer retaining a percentage of certified sums throughout the project. This should improve cash flow for the contractor and protect against the inevitable struggle which would occur to get retention monies paid if the employer becomes insolvent. Retention of title An express clause in a contract that reserves ownership of goods delivered to site, to the supplier of those goods. In the event of the contractor or employer’s insolvency, such a clause would assist a supplier to recover those goods from the hands of the insolvency practitioner, who will want to sell them to raise cash to pay creditors. However, once materials are irreversibly affixed to other property, such a clause is no longer effective. Termination clause The termination clause in a building contract should allow termination by one party in the event of the other party entering into or being subject to any of the wide range of insolvency or bankruptcy proceedings and arrangements, including those under the amended Insolvency Act 1986 (for example self certification administration). Some standard building contract forms contain a more comprehensive list of insolvency events that trigger the right to terminate than others. Where this list is weak it should be made more robust by contract amendments.

Dispute resolution Caution should always be taken before launching into legal proceedings against a party who is or is likely to become insolvent. Even with a solid claim, a party should consider the costs of commencing proceedings against the risk of not being able to recover an award simply because the defendant has no money. Where a party has entered into compulsory liquidation or is in administration, no proceedings (including adjudication and arbitration) may be commenced against it without consent of the court. If a sum is awarded to a party in adjudication

proceedings and that party is insolvent, the normal principle of enforcement by summary judgement may not apply. The court can either refuse to grant summary judgment altogether, or may award judgement but then order a stay of execution. This depends on all of the circumstances.

Resources Companies House website: www.companieshouse.gov.uk WebCHeck: a free online service which can be used to find out a company’s registered name, number and address, see when its last accounts were filed and when the next ones are due. Usefully it also tells you whether the company is active, recently dissolved or in administration. Companies House Direct: a paid for subscription service which allows you to access details of an insolvency procedure against a registered company and to see any reports of the relevant insolvency practitioner.

Credit checks and reports Many companies offer this service through their website. For example: Experian – offers a report from £2 online – www.experian.co.uk Dunn & Bradstreet – offer credit check services – www.dnb.co.uk The Insolvency Service: www.insolvency.gov.uk Provides information and guidance on the various insolvency procedures. The website also has links to the individual insolvency register search. There is also an Insolvency Enquiries Line – 0845 602 9848. The London Gazette: www.london-gazette.co.uk Here you can search for formal notices by an insolvent incorporated body or bankrupt individual. Companies Court - winding up list: www.hmcourts-service.gov.uk/cms/ list_companies_winding.htm Central Index Line Telephone 0906 754 0043 (premium line number) for the Central Index line. Give the company name you are interested in to check for information on any existing petitions for winding up or recent judgements. (NB, it does not hold Technology & Construction Court judgments) Trade press and the rumour mill can also be very useful sources.

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Katherine Souter 01223 222580 [email protected]

Helen Prandy 01223 222344 [email protected]

Hollie Docherty 01603 693242 [email protected]

Insolvency and public procurement: What we can learn from Connaught On 7 September 2010 “property and environmental services giant” Connaught appointed KPMG as administrators and on 8 November Rok followed suit. In the wave of publicity which followed KPMG quickly announced that it had “sold” the “majority of the ongoing contracts and their related assets” to Lovell a subsidiary of Morgan Sindall. Since then announcements have been few and far between. In fact, many local authority lawyers are now saying that their clients have refused to recognise the “sale” and have taken the work in-house or re-started time consuming and expensive procurement exercises in some of which Lovell are competing with other interested parties despite the purported sale. The predicament of councils across the country following the collapse of Connaught encapsulates both the problems said to have caused that collapse and the difficulties now facing insolvency professionals and local authorities in the aftermath of that collapse: the effect of the Public Procurement Regulations (“the Regulations”). For many cash-strapped local authorities Connaught represented a very good deal. Too good some competitors complained leading to legal challenges that the bids were in fact economically unsustainable. Unfortunately, if something seems too good to be true then it often is and the collapse of Connaught has left those who thought they had secured a good long-term deal without a supplier for essential building and other maintenance work. When companies become insolvent the ripple effect on smaller enterprises is dramatic but the problem is magnified where a large number of public contracts are involved. The problem of unpaid debts is exacerbated by the already hard economic conditions and the most swingeing cuts in a generation to public services recently announced by the Coalition. Moreover, the effect of the Regulations is that an administrator cannot just “sell” or novate from one supplier to another making the continuity of work and provision of services difficult

to guarantee both for the public authority and the many smaller contractors caught out by the insolvency. The problem centres on a ruling by a European court which established that in order to ensure transparency of procedures and equal treatment of tenderers, amendments to the provisions of a public contract during its term will constitute a new award if those amendments render the contract “materially different” from the original contract. Substitution of one party for another or, in other words, novation by private treaty of public services is unlikely to be compatible with European law and in order to make it compatible the whole tendering process should be undertaken again. The problem is very real. Many of those councils whose contracts were apparently sold to Lovell or which have tried to arrange alternative provision have spoken of contractors who were prepared to challenge the arrangement under the Regulations had they gone ahead with a replacement for Connaught. It is unlikely that the law on this issue will change (or certainly not soon) despite the fact that it fundamentally undermines the efficacy of administration for companies with significant public contracts and creates untold uncertainty both for those dependent on public bodies and those procuring services on behalf of public bodies. Given the extent of public spending cuts and the dependence of the economy on public sector contracts, Connaught and Rok may only be the tip of a substantial iceberg.