This week, we took a look at insolvency – what are the risks, how can you manage them, and what has happened in the law since the start of 2020?
Watch the video here, or read our full review below:
David Birne of Opus Restructuring opened with a definition of insolvency, and the importance of considering the options available. Being short of money need not necessarily lead to insolvency. Directors do need to take advice as there may be other claims against them during insolvency. Liquidation and winding up of the business are not the only options.
One route is an administration ‘pre-pack’. Under this route, there can be a continuity of supply and trade which can also maintain jobs- this is why it is so desirable.
A moratorium is a new option in which directors stay in control, and this period lasts for 20 days which can be extended.
Company Voluntary Arrangements: Essentially a deal with creditors. You can use debtors to fund the business or restructure through redundancies. Directors may find this undesirable due to the restrictions on credit and the tie in period.
Liquidation: A Last Resort?
Liquidation really is the last resort. However, if you are not insolvent there are lots of options, so seeking the advice of an expert is essential. Reducing stock levels, dropping less profitable work and reconsidering the way assets are managed are options here. Tactical advice is essential and always needed in these cases.
Beth Kalischer explained to us the role of the solicitor and whether they simply come in and mop things up after everything has gone wrong. Beth explained this is not the case. Lawyers can help best if they come in early. The earlier you get advice, the better.
Along with Insolvency Practitioners (IPs), solicitors can help explore options for the company. The sooner advice is taken the more options are likely to be available. Generally speaking, liquidation is not the best course of action – it may result in a better scenario for creditors if a company continues to trade.
In terms of warning signs to look out for, Beth lists a few key points:
They can include any obvious cashflow issues such as being late on invoice payments.
Companies House is a useful place to view red flags if anything has been filed there.
Solicitors can assist in monitoring if anything has been filed against the company.
In terms of mitigating the risk, it is important to carry out financial diligence on the party.
Other options include to take out a parent company guarantee where one exists. Or project bank accounts/ escrow accounts.
You can also put different provisions in the contract to protect your position.
You could potentially introduce payment periods, title clauses into the contract, for example.
A key point to mention is that an option previously would have been to terminate the contract. The Corporate Insolvency and Governance Act of June this year has barred this in the construction industry. You could still allow for early termination before proceedings commence. The key thing is to look for warning signs and seek advice as early as possible.
David adds that taking on jobs on the larger size for the size of the contractor is another big risk and possible warning sign. There is also a risk that it may be the goal of the contractor to push the subcontractor towards insolvency to keep the cash for themselves. Finally, on this point, offshore companies have been used as the client/contractor. In such cases, it becomes difficult to sue that company if there is a breach of contract.
James Bowling of 4 Pump Court talked to us about the role of the courts. The construction industry is particularly vulnerable to insolvency-type issues, particularly as there are lots of small to medium enterprises. Furthermore, COVID-19 has completely upended the legislative framework that is currently in place. There has been a blanket ban from about the 27th of April to administration moratoriums. There are some limited exceptions.
Section 214 of the Insolvency Act 1986 on wrongful trading is a powerful stick that the court holds by its side to deal with directors who might otherwise be tempted to trade whilst they’re insolvent. In normal times directors have to take every step to minimise the loss of assets to the creditors. It would be wise to speak to people like David or Beth. They can help you show that you’ve taken a sensible course that a competent director would have taken in your position.
Though section 214 is currently in abeyance, the other duties that tend to go along with that are still very much alive and well. For example, the prohibition on fraudulent trading under section 212 is still in place. As are the rules against misfeasance which apply director duties. The director has a duty to act in the interests of the shareholders as well as an obligation to act in the interests of the creditors. Director’s disqualification is still in existence.
When Does Enforcement End and Insolvency Start?
James also notes it is important to distinguish between insolvency and enforcement. Insolvencies occur if you can’t enforce. Inability to pay means that the court has to be satisfied you cannot pay your debts as they fall due. If the inability to pay is demonstrated, people tend to skip enforcement and go straight to insolvency. When a judgement is obtained, they must pay within 14 days. If not, a winding-up petition will follow.
The threat of winding up will force them to essentially self-liquidate enough assets to meet their judgement. Assuming that doesn’t happen, they must enforce. There’s a whole suite of powers in the Civil Procedure rules 2 and in the insolvency legislation to assist with that. The last resort is the appointment of a provisional liquidator. This is an officer of the court that takes control of the company for the benefit of all of its creditors including the judgement creditor. This occurs only when the court is satisfied that there is strong evidence of a real risk of dissipation of the directors that are left in charge.
In summary, enforcement should be done first and then insolvency if you can’t enforce.
Recent Cases – Bresco, John Doyle v Erith Contractors
Finally, we looked at the recent case law of Bresco, and John Doyle v Erith. These two cases have led to changes in the approach to enforcement of adjudication in favour of insolvent parties.James notes there has always been a tension between the construction act and the insolvency act. The Insolvency Act has always said you can’t make someone bankrupt or wind them up until all disputes on both sides of the line have been dealt with. There has always been that latent conflict between the two. You have to determine which act trumps the other one. Coronavirus has also turned everything upside down, and the conventional wisdom on the use of adjudication for insolvent companies has been turned upside down by Bresco.Though the two are not related, it has led to a series of quite rapid changes for insolvency lawyers and practitioners.
The more recent case of John Doyle v Erith Contractors relied upon the decision in Bresco in putting forward their case. HHJ Fraser gave a set of principles in which an adjudicators decision will be enforced in favour of an insolvent party:
Enforcement will only be available for a final or termination account dispute.
If there are other disputes outside the construction sphere the adjudicator couldn’t deal with, the court will have to look at those too. However, James wonders how likely this is to arise.
Were any defences to the claim not available in adjudication which James suggests is similar to point 2.
If hurdles 1-3 are overcome, the court may enforce if a liquidator can give sufficient guarantees that it will be able to repay the money. It may be necessary to arrange some form of security or bond including possible security for costs.
James also suggests there are a number of questions that perhaps remain unanswered as a result of the two cases, so it is likely that this area will evolve.