Construction and Insolvency 2023: Where are we now?

Introduction

The construction industry has seen a dramatic and sharp rise in company insolvencies which is forecast to continue in 2023. As reported by the Insolvency Service, in 2022, the construction industry experienced the highest number of insolvencies of any sector in England and Wales, with 4,143 company insolvencies reported, accounting for 19% of all company insolvencies.  Whilst it is noted that “the construction industry usually has the highest quarterly number of insolvencies of any industrial grouping”, the amount of company insolvencies in the construction industry had almost doubled compared to 2021 (with 2,579 company insolvencies reported). According to a new report from Red Flag Alert, a “perfect storm” of factors could lead to more than 6,000 company insolvencies in the UK construction sector during 2023 and warned that over 100 firms in the sector could collapse each week.  

Several factors have contributed to this “perfect storm” including the long-term effects of the COVID-19 pandemic, the Russian-Ukraine conflict, inflation, and the increase in energy prices. According to ONS, in October 2022, just over 12% of Business Insights and Conditions Survey (BICS) respondents from the construction industry perceived energy prices as the main concern for their business between late February and early October. In this period, almost 41% of respondents saw inflation of goods and services as the primary concern for their business.  

Given this context, it is expected that many construction projects will suffer delay and/or termination and commercial parties will seek ways to maximise recovery, leading to a rise in contractual disputes.

This article examines three areas in construction and insolvency law which are expected to be in the spotlight in 2023: insolvency and contractual rights in construction contracts; insolvency and adjudication; and post-insolvency risk to directors of construction companies.

(1) Insolvency and contractual rights in construction contracts

Due Diligence

First, it is recommended that commercial parties undertake careful due diligence to assess the risks of insolvency and potential warnings before entering into a new contractual relationship. A helpful indicator of a company’s financial health is a company’s filed accounts publicly available on Companies House. Also, details of companies involved in insolvency proceedings can be found on the Gazette’s website and publicly available searches of the Companies Court insolvency records.

Contractual Rights

Second, it is important for commercial parties to carefully negotiate, review and understand the contractual rights and obligations upon insolvency of another contracting party. In particular, employees of the commercial parties who are managing projects on a day-to-day basis should be aware of the content of those contractual obligations, for example, the form, content, and timing of notices required by the contract. Parties should also be mindful to keep records of relevant correspondence and evidence in case of a potential dispute.

Termination

Third, commercial parties should be familiar with their termination rights under the construction contract. If a party wishes to terminate a contract, it should check the termination rights under the contract to ensure the events are expressly provided for and captured by the relevant termination clause. Otherwise, a party who wrongfully terminates could be presented with a counterclaim for repudiation.

Parties should also be mindful of the introduction of the Corporate and Insolvency Governance Act 2020 which came into force on 26 June 2020. In essence, this prevents suppliers to contracts for the supply of goods and/or services (such as contractors and subcontractors) from terminating the contract or supply on the grounds of a customer (such as employers and contractors) becoming subject to a relevant insolvency procedure or for any breach which occurred during the relevant insolvency procedure.

In light of this, parties may want to consider enhanced termination rights independent of insolvency such as a right to terminate for non-payment; a right to terminate if upstream contracts are terminated and/or a right to terminate for convenience. Alternatively, contractors may request that an employer provides security for its payment obligations, such as a retention bond or parent company guarantee.

(2) Insolvency and Adjudication

Smash and Grab Adjudications

First, it is likely that “smash and grab” adjudications will continue in 2023. As is well known, “smash and grab” refers to an adjudication where the contractor claims for payment of the sum claimed in the relevant payment application where a valid and timely payment notice and/or pay less notice has not been given. If the adjudicator decides that the relevant notice was not valid or issued in the prescribed period, the contractor would be entitled to immediate payment of the sum claimed. Decisions such as Bexheat Limited v Essex Services Group Limited [2022] EWHC 936 (TCC) make clear that where an employer has failed to serve a payment notice and/or pay less notice, only after they have complied with their immediate payment obligation can they bring an adjudication to determine the true value of the works. In the context of the current economic climate, commercial parties must be mindful to issue payment notices in the correct form and on time in order to avoid smash and grab adjudications.

Insolvency and Enforcement

Second, the relationship between insolvency and adjudication has continued to develop and with the increase of company insolvencies, more insolvent claimants may utilise adjudication. The Supreme Court confirmed in Bresco Electrical Services Ltd (in liquidation) v Michael J Lonsdale (Electrical) Ltd [2020] UKSC 25 that insolvent claimants are able to pursue claims through adjudication, although the TCC would continue to have discretion regarding the circumstances in which enforcement would be appropriate and what undertakings would be necessary. Further, in John Doyle Construction Ltd (In Liquidation) v Erith Contractors Ltd [2020] EWHC 2451 (TCC), the claimant’s intention to apply for security by advancing a letter of intent was not considered a sufficient safeguard and summary judgment was refused.

The 2022 report on Construction Adjudication in the UK, published by King’s College London in collaboration with the Adjudication Society, concluded that in the last two years:
•    23% of respondents took part in an adjudication commenced by an insolvent party; 
•    12% of respondents took part in an adjudication commenced against an insolvent party; and
•    6% of questionnaire respondents took part in adjudication enforcement proceedings brought by an insolvent party.

The main obstacles perceived by respondents were the insolvent company’s failure to provide adequate security as per John Doyle and the existence of a cross-claim for set-off might make summary judgment entirely inadequate, as per Bresco. As concluded by the survey, “this does not mean, of course, that an insolvent company cannot successfully make a claim under a construction contract. It means that recovery by way of enforcement of an adjudication decision is now more difficult. If the adjudication route is not available, it remains open to the insolvent company to recover in an ordinary way, as any insolvent company would have to do if it has claims under contracts in respect of which statutory adjudication does not apply.” Given the increase in company insolvencies, it will be interesting to see whether there is a concomitant increase in the use of adjudication by insolvent companies.

(3) Post-Insolvency: risk to directors of construction companies

As more construction companies become insolvent, claims by insolvency practitioners against directors of such companies are also likely to increase. When a company goes into insolvency, the relevant insolvency practitioner will seek to maximise the realisation of assets for the creditors owed money by the company. The Insolvency Act 1986 (“IA 1986”) gives wide powers to insolvency practitioners to bring claims against directors where they have not acted in the best interests of the company. Potential legal causes of action which may be available to insolvency practitioners include inter alia:
•    s212 IA 1986 - Misfeasance
•    s213 IA 1986 - Fraudulent trading
•    s214 IA 1986 - Wrongful trading
•    s238 IA 1986 - Transactions at undervalue
•    s239 IA 1986 - Preferences
•    s1 Company Directors Disqualification Act 1986 - Disqualification

For example, one of The Lawyer’s Top 20 cases for 2023 is The Secretary of State for Business, Energy and Industrial Strategy v Richard John Adam and 7 others which concerns the director disqualification proceedings in relation to the former directors of Carillion Plc (in which Anna Lintner of 39 Essex is instructed). It is expected that 2023 will see an increase in insolvency practitioners using the Insolvency Act toolbox to bring claims against directors.