Learn more about the different types of insolvency and what to consider next if your contractor goes under
Construction insolvencies are at cyclically high levels as the UK economy continues to flirt with recession, although happily the RIBA’s latest Future Trends survey shows they are off their peak seen last year.
Many architects will know that, historically, contractor insolvencies tend to rise as economies emerge from recession, rather than enter into it, so now is a good time for practices to arm themselves with an understanding of insolvency processes before they get caught in the fall-out.
David Fendt, senior associate in the restructuring and insolvency team at Russell-Cooke, suggests architects need to understand the different forms of insolvency and how creditors are likely to be treated under these different scenarios.
What are the different types of insolvency?
A common insolvency process where creditors may be involved is the Company Voluntary Arrangement (CVA), Fendt explains. This is a formal agreement proposed by a company and entered into with its unsecured creditors, which allows the company to continue trading. Whilst CVAs are flexible and the terms can take many forms, typically CVAs see part of the company’s earnings paid into a pot that will eventually be distributed among creditors. This gives the company a chance to pay off its outstanding debts over a period of time, usually over a period of three to five years.
The process is led by the company, which makes the CVA proposal and appoints an insolvency practitioner called a nominee, which then becomes the supervisor if the CVA is approved. An important feature of CVAs is that the existing directors remain in control of the company. If a requisite majority of creditors agree to the CVA, the decision is normally binding on all creditors, although there can be technical grounds for challenging the agreement.
Restructuring Plans are a new form of insolvency process, and are similar to CVAs, but the process is led by the Court. Restructuring Plans were introduced in 2020 and are therefore still relatively new, but can be proposed by, amongst others, creditors or the company itself. One of the crucial features of this process is the so called ‘cross-class cram down’, which empowers the Court to sanction a Restructuring Plan even if the requisite majority of creditors has voted against it. This type of process is becoming increasingly popular, although at the moment the costs are prohibitive for smaller companies. That said, some commentators believe Restructuring Plans will eventually be utilised more than CVAs.
Another common form of insolvency is Administration, Fendt continues, where an insolvency practitioner is appointed as an administrator and effectively replaces the directors (who lose their powers) and manages the company for the benefit of its creditors. In some cases, the administrator will be appointed by the company or its existing directors, in others by certain types of secured creditors.
The administrator is required to achieve at least one of three statutory purposes:
- To rescue the company as a going concern.
- To achieve a better result for creditors as a whole than would be likely if the company were wound up.
- To realise property in order to make a distribution to one or more secured creditors (usually lenders) or preferential creditors (usually employees and certain tax debts).
Administration can enable the business and/or its assets to be sold to another company, although there are rules about selling to connected parties in order to prevent the perception of owners of the insolvent company reacquiring its business/assets whilst avoiding its debts.
One of the key features of administration is the moratorium, which prevents virtually all types of legal action being taken against the company for the period of the administration (which is usually 12 months). Indeed, the moratorium is one of the main reasons why administration may be chosen over alternative insolvency processes.
When there is clearly no future for a company facing unmanageable debt, the company will enter Liquidation and the business will be terminated to prevent further losses. A liquidator will be appointed, who will displace the directors, with the purpose of winding down the company’s operations and distributing any money from the sale of its assets to creditors.
An architect employed by a client or contractor would almost always be an unsecured creditor, says Fendt.
Architecture appointments in construction projects
It is important to note that there’s a clear difference in how contractor insolvency effects architects due to the procurement route. Insolvency arrangements become more complicated on design and build projects where, pre novation, the architect is working for the client and, post novation, working for the contractor.
In the event of the contractor becoming insolvent on a project pre novation, the architect should be paid by the client as normal, according to the terms of their professional agreement, says Philippa Jones, Associate at Ward Hadaway LLP. The exception would be where the client's payments to the architect are linked to project build milestones that could be delayed (that is, if a payment milestone was the client entering into the building contract).
In these circumstances, the architect could seek to obtain payment from the client for all work done to date rather than potentially being held to such payment milestones, although there is no guarantee here as the architect could be held to the terms of its appointment.
Post novation
A Deed of Novation refers to the discharge of rights and obligations between contracting parties and a recreation of them in a new contract between a third party and the remaining contracting parties to the original contract.
Novating the appointment from the client to the contractor would usually result in the client’s liability to make payment to the architect ceasing as the architect would be employed by the contractor.
Therefore, if the architect is employed by the contractor or is novated to the contractor, who then becomes insolvent, the architect would not be able to claim against the client for any unpaid fees due from the contractor. Instead, the architect would join the list of the insolvent contractor’s unsecured creditors, Jones explains.
Can an architect negotiate a deal?
If the architect's services are still required on a project (including but not limited to the provision of as-built drawings or other documents) post novation and contractor insolvency there are still options. Jones explains: 'This is an opportunity for an architect to negotiate a deal for payment of any outstanding fees owed by the insolvent contractor, as a pre-condition to continuing work.’
Jones adds: 'The architect could approach the insolvent contractor's administrators to seek to move a project forward and so avoid more loss'.
A practice can negotiate terms for any sums that are outstanding as a pre-condition for continuing its services on a project while also negotiating with the administrators over payments for new work. If a new contractor can be appointed quickly, the architect's original appointment could be novated to the new contractor, with the agreement of the administrators, who may then assume liability for all outstanding architecture fees.
'The architect could also approach the client to see if they would be willing to employ the architect directly to retain the architect's services on the project,’ Jones continues. ‘This could be done via any step in rights the client or funder has from the architect under a collateral warranty or third party rights or by entering into a new agreement with the client.'
A client may be more willing to consider such an arrangement in the event there is a performance bond and the client could claim under the performance bond for the increased costs incurred in completing the project as a result of the contractor's insolvency, subject to the insolvency set off rules. Most incoming (replacement) contractors would want to retain the original architect, who is familiar with the project and likely to be able to complete the services for a lower cost than a new architect.
Collateral warranties
In the scenario where collateral warranties in favour of a client or funder were not entered into prior to the contractor's insolvency, Jones says: 'If such warranties are still required then the architect should consider whether there is a deal to be done with the client/funder/insolvency practitioner/incoming contractor to be paid any outstanding fees before signing a collateral warranty, to ensure the copyright clause is effective if the project is reliant on the architect’s design drawings and intellectual property (IP)'.
If the architect has entered into a post novation collateral warranty with the client (or the client has the benefit of third-party rights under the appointment), the client would usually have the benefit of a copyright licence in respect of IP which would also usually contain a right for the client to request copies of any documents produced by the architect, subject to payment of any reasonable copying fees.
Usually, lawyer-drafted collateral warranties do not make the copyrights licences subject to payment of the architect’s fees.
However, if the architect has provided collateral warranties to third parties under standard form warranties (that is, such as those forms produced by the British Property Federation, JCT and the Construction Industry Council), which do link copyright to payment, then the architect should contact the warranty beneficiary to explain that such licences shall not be effective until any outstanding payments due to them under their appointment have been paid and could threaten to claim against them for breach.
The architect could seek to negotiate payment of outstanding fees before signing a collateral warranty, advises Jones.
She adds: 'Consideration should also be given as to whether there is a project bank account which, dependent on its terms, may enable the architect to be paid for their completed services up to date of the contractor's insolvency. However, the use of project bank accounts is still a rarity on most project especially those in the private sector.'
Always seek legal advice
Jones reiterates the need for legal advice to safeguard in the event of insolvency on a project.
‘I would recommend architects review their appointments to determine if they sufficiently protect themselves, and when presented with an appointment always try to negotiate architect-friendly provisions,’ she concludes.
Thanks to David Fendt, senior associate, Russell-Cook LLP; Philippa Jones, associate, Ward Hadaway LLP.
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