Lindsay Ellis and Michael Hiscock of solicitors Wright Hassall, suggest that carefully choosing which customers to work with could protect you from the consequences
of having to continue supplying customers trading insolvently.
More than 50 construction companies fell into administration in the past three months and the finishes and interiors sector continues to lose big names, yet recently introduced legislation changes could make things worse for suppliers in what are already challenging economic conditions.
One major change appears in Section 233B of the Insolvency Act 1986 (introduced by the recent Corporate Insolvency and Governance Act) and prevents businesses
from terminating supply to a customer on the grounds the customer has become insolvent.
It applies to all contracts for supply of goods and (non-financial) services, but only applies to suppliers — customers are free to terminate contracts if it is the supplier
that becomes insolvent. (The interim exemption for ‘small suppliers’ ended in September).
Suppliers are also now prevented from demanding that outstanding charges are paid as a condition of continuing to supply, which for many, will be at odds with good
In the construction market place, industry standard form contracts (JCT, NEC) allow termination by the contractor due to employer insolvency so the statutory position cuts across the contract and removes a right that the industry has accepted as normal practice.
That contractual right allows immediate suspension of work and submission of a final account, both of which help to protect cash flow. If this contractual right is removed, the contractor can still use its statutory right to suspend work for non-payment on seven days’ notice and ultimately terminate for breach of payment obligations but the period between doing the work and getting paid may be weeks or months, extending the risk.
When the new legislation does NOT apply
It only affects suppliers, so let’s look at your relationship with your customers.
• Nothing prevents you from terminating a contract in the period leading up to the insolvency proceedings, or terminating after the insolvency proceeding began, for any reason that’s not triggered by that proceeding.
• You can also terminate your supply contract with the consent of the insolvency administrator or with the permission of the Court, which you will have approached if continuing to supply will cause your business hardship.
• If a customer enters a formal insolvency procedure, you can wait for a new reason to end the contract, like non-payment for supplies you have made after the commencement of the insolvency. You may also be able to exercise other contractual rights, like contractual set-off and netting rights.
• If your contract permits you to terminate for convenience, you may be able to do so, as long as you continue to supply as normal during the notice period.
• If the existing contract is a single-purchase order, you may reject new orders from the customer, particularly when the contract has been structured as a framework agreement, with each new order constituting a separate contract.
• You can also refuse to renew an existing contract once it has expired and can negotiate with the insolvency offi ce-holder to agree an end to the contract.
New supply contracts will have to change
The contract you rely on to regulate your relationship with customers, will have to change in future to protect your own business. It will be important to seek legal advice about how you structure your contracts and what they contain, but a few considerations might include:
• Reducing the contract term to ensure you are not locked into supplying your customer for a considerable period in any insolvency procedure – this will have to be balanced against the commercial objective of securing long-term customers.
• Structuring the contract as a framework agreement, ensuring each supply is treated as a separate contract, which allows you to accept or decline orders as you see fi t.
• Tightening the payment structure to offer an early warning for you of when customers are experiencing financial problems, before insolvency is triggered.
• Shorten the payment periods and increase the number of interim payment applications permitted under the contract.
• Requiring regular financial information from your customers to assess continued solvency, including credit ratings and performance reports.
• Use of project bank accounts that facilitate direct payment.
• As an interim step falling short of termination, you might include a provision allowing you to suspend further supplies under the contract, for repeated or lengthy periods of nonpayment by your customer.
• Reapply fiduciary duties to retention sums to create a form of trust fund.
• Allowing termination for convenience and including as short a notice period as makes commercial sense. However these are very rare in construction contracts due to the duration of a building project, the resource commitment and forward ordering of goods and labour down through the supply chain.
It pays to work with customers that can pay
There will be suppliers like you impacted by this legislation change and in future, carefully choosing which customers to work with could protect you from the consequences of having to continue supplying customers trading insolvently.
It will also be advisable to undertake more detailed due diligence on a customer’s financial position before agreeing contracts, then monitor their payment performance closely to ensure you are aware of any difficulties well in advance of the customer becoming insolvent.
It will be prudent for suppliers to train those managing contracts on the impact of the changes and how to spot the warning signs, including ensuring invoices are paid on time and possibly tightening debt collection procedures.
It’s essential that you understand your contractual rights and you are ready to exercise them if need be to stop supply or terminate the contract promptly, should one of your customers show clear signs of financial distress.
While we are on the subject of contracts, it makes sense to review your standard terms and conditions to ensure they offer protection against a customer’s insolvency, as far as possible. If you want real peace of mind, seek legal advice from someone expert in supply contracts, as a few small changes now, could save you a lot of trouble in the future.
A termination for convenience clause in a construction contract allows one or both parties to terminate the agreement without a specific reason for doing so (such as a default or breach of the contract). Without a termination for convenience clause present, the party who terminates the contract can really only terminate the agreement based on default or breach (or some other term in the contract).