This is the second in a series of articles on how the changes introduced by the 2024 JCT (Joint Contracts Tribunal) contracts will impact the practical administration of the JCT contractual mechanisms.
In this article, we look specifically at the insolvency related provisions in the 2024 Design and Build (D&B) contract and the 2024 Intermediate Building Contract with Contractor’s design (ICD) contract. We address the updates to the definition of insolvency, the impact of those changes for Employers and Contractors and the related knock-on impact to sub-contracts.
1. Updated insolvency definition (clause 8.1)
As in the 2016 JCT contracts, clause 8.1 (entitled ‘meaning of insolvency’) defines when a company, partnership, individual or person becomes ‘Insolvent’. The insolvency definition is important because (unless otherwise amended) it is only when an entity becomes contractually ‘Insolvent’ that the other party can terminate the contract.
In the 2024 D&B and ICD contracts, the meaning of ‘Insolvent’ has been expanded to include the new insolvency procedures introduced by the Corporate Insolvency and Governance Act 2020 (“CIGA 2020”). As a result, a party will now be Insolvent when:
A) a ‘Part A1 moratorium’ comes into force (clause 8.1.4.3); and
B) a ‘Part 26A restructuring plan’ in sanctioned (clause 8.1.4.4).
But what do these terms mean?
A part A1 moratorium is intended to provide financially distressed companies with a short breathing space from enforcement action by certain types of creditors. It grants at least twenty business days from creditor action, allowing the entity to explore rescue and restructuring options.
A Part 26A restructuring plan is a restructuring plan proposed by a financially distressed company, validated by a court order under Part 26A of the Companies Act 2006, which aims to address the company’s financial difficulties. Once sanctioned, the restructuring plan becomes legally binding, allowing the company to reorganise its debts and continue trading, ultimately with the aim of achieving financial recovery. On this basis, a Part 26A restructuring plan is considered conceptually different to and distinct from that of insolvency.
2. What do the changes mean for Insolvent Contractors and Employers?
These two new clauses provide additional grounds for termination, for both the Employer (under clause 8.5 (Contractor Insolvency)) and the Contractor (under clause 8.10 (Employer Insolvency)).
On the face of it, the right to terminate on such grounds seems to contradict the very purpose of the CIGA 2020 processes, as a contract termination is unlikely to help a company in financial difficulty.
However, on the other hand and in particular from an Employer perspective, these amendments will provide welcome additional protection, allowing a greater spectrum of pre-insolvency processes to trigger a termination right. This will no doubt be particularly important in the current economic climate, in which we are seeing lots of contractors and suppliers struggling financially. As always, the question of if and when to terminate must be considered carefully. However, if the writing is on the wall for a company in financial trouble it will usually be in an Employer’s interest to act quickly, terminating the contract to progress the project with others and to mitigate its losses.
Whilst the changes in the JCT purport to give the same protection to a Contractor (in an Employer insolvency scenario), the updated drafting does not address the seemingly conflicting legislative provisions which cut across such protection. Under CIGA 2020, a supplier is not permitted to terminate a contract or ‘take any other steps’ in the event of an employer insolvency procedure (including the new processes referred to above). This legislative provision (which expressly overrides any counter-contractual provision) directly conflicts with the JCT 2024 provisions allowing a Contractor to terminate for Employer insolvency. As a result, it is unhelpfully left unclear as to whether a Contractor has the right to terminate in an Employer insolvency situation. Generally speaking, Employer insolvency is less common, however the uncertainty created may have an impact when considering downstream contracts with sub-contractors.
3. Knock on effects to sub-contracts
Under the 2016 JCT contracts, a sub-contractor’s employment under its sub-contract would terminate immediately upon the Contractor’s employment being terminated. Therefore, based on the old regime, if the main contract was terminated for either party’s insolvency, the sub-contract would also consequently terminate.
As a result of another change introduced in the 2024 JCT contracts (clause 3.4.1 of the D&B and clause 3.6.1 of the ICD), the automatic termination is subject to any step-in rights in favour of a Funder or an Employer. Upon termination of the main contract, the sub-contractor will be entitled to suspend performance while awaiting receipt of a step-in notice. Any suspension pending step-in is treated as having been instructed by the Employer, entitling the sub-contractor to relief under the sub-contract. If no step-in notice is served, then the sub-contract terminates.
As above, the impact of CIGA 2020 has not been fully addressed, leaving room for uncertainty as to whether or not a sub-contractor can terminate for a Contractor insolvency. However, the need to terminate may be side-stepped by the new changes allowing step-in to sub-contracts in a Contractor insolvency scenario. The chance to step-in to sub-contracts provides welcome protection to Employers (and Funders) and reflects the likely reality in an insolvency situation where Employer’s will want to engage sub-contractors directly in order to complete their projects.
Overall, the changes in the new 2024 D&B and ICD contracts are welcome, largely designed to update the template contract for legislative changes introduced by CIGA 2020. However, given that not all of the provisions of CIGA 2020 have been fully addressed, there is still scope for uncertainty if and when termination rights are triggered in an insolvency situation. The complexity of insolvency rules means that care must always be taken before terminating a contract for insolvency and advice should be sought. The risk of incorrectly terminating a contract could result in a repudiatory breach entitling the other party to terminate, which could fundamentally change the dynamics between the parties.
Look out for the next article in the series and please get in touch with the team if you have any questions.
This article was written by Karen Paley and Sarah Forshaw.