After an inflation-ravaged 2022, the industry looks set for further uncertainty in 2023.
In October last, the CIF published its Economic Outlook following a survey of the industry. The survey found that 96% of construction companies have reported a rise in the cost of building materials between June and August 2022, with 85% expecting cost rises to continue to year end. Link.
Earlier in the year, Tom Parlon, director general of the CIF, stated that in light of inflation and increasing costs, the likelihood of construction companies going insolvent was "increasing by the day". The combination of material and fuel costs inflation, labour and supply shortages, viability issues and systemic difficulties with the planning system has created something of a perfect storm, such that the industry is arguably facing its biggest challenges since the 2008 Global Financial Crisis. Link. The situation is not helped by the announcement in the October budget of a 10% levy on concrete products. Although, when the Finance Bill was published a few weeks later, the levy had been reduced to 5% and its scope reduced to ready-mix and concrete blocks (i.e. excluding pre-cast products).
Undoubtedly, there have been some high profile insolvencies this year, including venerable civil engineering firms (Roadbridge), high profile up-and-comers (Sonica), main contractors in the critical social housing sector (Blacklough Construction) and substantial M&E contractors (NSR Electrical).
It is, however, less clear that these well-publicised examples are part of a broader trend of increasing construction-sector insolvency, as predicted by the CIF. The most recent Deloitte survey suggests that the construction sector recorded 23 insolvencies during H1 2022, which was a decrease of 26% when compared to H1 2021, when a total of 31 insolvencies were recorded in construction. It is not yet clear whether the numbers for H2 2022 will present a bleaker picture.
While the decision of the Revenue Commissioners in October last to extend its Debt Warehousing Scheme is a welcome development for construction firms – at best this gives some breathing space while there are other challenges outside of Revenue debt to be met.
The case of Roadbridge is illustrative. Having gone into receivership in March 2022, certain unsecured creditors recently applied to have a liquidator appointed to Roadbridge despite the reported position that there would not be sufficient assets to discharge the liability of the secured creditor who appointed the receiver.
The absence of obvious return for these unsecured creditors implies a determination to fund the liquidator to undertake a close analysis of the conduct of the affairs of the company with a view to exploring other possible avenues of recovery. This type of appointment highlights the risk to directors of companies which are potentially facing insolvency and begs the question what options are open to the directors of a company in that scenario.
The options below list some of the avenues potentially open to the directors of construction firms which have entered the zone of insolvency.
Continuing to Trade:
While it is potentially open to directors to trade through a difficult period, this needs to be approached with caution. The European Union (Preventative Restructuring) Regulations 2022 (the “Regulations”) amended the statement of fiduciary duties of directors set out in Section 228 of the Companies Act 2014 by including a duty that directors must have regard to the interests of the company’s creditors in circumstances “where the directors become aware of the company’s insolvency”. This duty provides a statutory basis for the existing common law duty for directors to have regard to the interests of creditors in the period approaching insolvency. It is important to note that, in common with the other fiduciary duties, this duty is owed by the directors to the company alone.
Further details of the matters to be taken into account are set out in the inserted Section 224A of the Companies Act 2014:
“A director of a company who believes, or who has reasonable cause to believe, that the company is, or is likely to be, unable to pay its debts (within the meaning of section 509(3)), shall have regard to–
(a) the interests of the creditors,
(b) the need to take steps to avoid insolvency, and
(c) the need to avoid deliberate or grossly negligent conduct that threatens the viability of the business of the company.”
As a practical matter, this will require directors to take appropriate steps such as:
- meeting frequently and documenting decisions taken by the board;
- closely monitoring the company’s operations, trading and financial position;
- preserving value and minimising losses to creditors by cutting costs and avoiding unnecessary expenditure; and
- obtaining appropriate financial and legal advice on the alternatives facing the company.
If a company is wound up on an insolvent basis a liquidator is obliged to investigate the circumstances leading to the insolvency, which would include the conduct of the directors. Section 610 of the Companies Act 2014 provides that a director can be held personally liable for the debts of the company in the event they are found to have been knowingly a party to reckless trading. Similar personal liability can arise under section 609 where the company has failed to keep adequate accounting records.
The leading case in the area of reckless trading is Re Hefferon Kearns in which the High Court set out the relevant test for reckless trading as follows:
“Would a reasonable man, knowing all the facts and circumstances which the doer of the act knew or ought to have known, describe the act as ‘reckless’ in the ordinary meaning of that word in ordinary speech? As I have said, my understanding of the ordinary meaning of that word is a high degree of carelessness.”
In that case the Court found that the directors had taken professional advice and followed that advice and so they had not acted recklessly.
In PSK Construction Ltd -v- Companies Act  IEHC 538 the Court found that a decision to underpay the Revenue to address cashflow difficulties created an obvious and serious risk of loss or damage to creditors, and the directors’ decision to ignore this risk by reason of a desire to keep the Company alive amounted to reckless trading. While section 610 provides for potential unlimited liability for a director, the Supreme Court has ruled, in the context of a case concerning a failure by directors to keep proper books and accounts, that directors’ liability “should be proportionate to the wrongdoing that has been made out”. This approach would also likely apply to liability in a case of reckless trading.
Regulation 7 of the Regulations provides that directors may have regard to an early warning system. The Corporate Enforcement Agency has recently issued guidelines in respect of the Regulation in the form of an Information Note (link). The guidance highlights the importance of maintaining adequate accounting records and sets out a number of key definitions and circumstances that could give rise to a likelihood that the company will be unable to pay its debts. This guidance is particularly useful as directors can help to protect their position by having regard to the factors set out in the guidance.
Examinership is the process whereby an insolvent company petitions the court for protection from its creditors and seeks the appointment of an examiner in an attempt to restructure the company and secure an investment. It is an option available to an insolvent company, as an alternative to liquidation or receivership, in circumstances where there is a reasonable prospect of survival for the company or any part of its undertaking as a going concern. The period of protection of the company will usually last 70 days from the date of issuing the court papers but can be extended to 100 days if the examiner is unable to formulate a scheme of arrangement, which will allow the company to survive after examinership, within the initial 70-day period.
Small Companies Administrative Rescue Process (“SCARP”):
SCARP is a process which enables the restructuring of a business operation by way of a compromise arrangement between a company and its creditors where a proportion of debts are often written off and the company agrees to pay back a lower proportion of the remaining debt. It is a cheaper alternative to examinership that is available to smaller companies. The main difference between SCARP and examinership is that in SCARP the protection of the Court is not automatic and Revenue can opt out of any proposed scheme.
Where a company is insolvent and examinership/SCARP is not a viable avenue there are two options available to the directors to wind up the company: (1) creditors’ voluntary liquidation and (2) court ordered winding-up.
The nature of the construction industry throws up a number of unique challenges for the directors of a company who wish to preserve the company’s assets and arrange an orderly wind-up of the company which minimises disruption to the projects the company is currently engaged in.
Typically, under the various standard form contracts, insolvency of the company will allow for the contract to be terminated by the employer. This can jeopardise the work-in-progress of the company (which may amount to one of its main assets) by virtue of an employer’s right to set off any costs incurred as a result of the insolvency against amounts owed for work-in-progress or retention.
The most common way for directors to wind-up a company is via creditors’ voluntary liquidation. However, this process may not be ideal for addressing the industry specific issues identified above.
A more suitable option may be for the company to seek wind-up thorough the Court and the appointment of a provisional liquidator. This allows the provisional liquidator to take immediate steps to preserve the assets of the Company, without falling foul of the provisions in some standard form contracts which only provide for termination on the winding-up of the company.
In that scenario, the provisional liquidator can take steps to continue projects in order to maximise the return to the company for the benefit of its creditors and so preserve as much of the company’s work in progress as possible. This is obviously not a course which will be suitable or available in every scenario, but we have recent experience of acting in connection with the liquidation of a substantial M&E contractor in which this course was pursued to the mutual benefit of all relevant stakeholders.
It appears that it is an unfortunate reality that, due to the global pandemic, inflation and increased construction costs generally, that otherwise viable construction companies are or will be facing insolvency. It is crucial for directors to take advice on the viability of their business when facing an insolvency situation and to follow the CEA guidelines to avoid personal liability. Where a director forms the view that a company is insolvent there are a number of options available which can either allow for the business of the company to be preserved or for the company to exit its projects on a managed basis that will reduce the liability to the company’s creditors and allow the principals of the business to protect their reputations and preserve relationships.
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About the Authors
Joe is Managing Partner and Head of the Commercial Litigation & Dispute Resolution team at Hayes solicitors. He handles a wide variety of commercial disputes involving high value claims, complex issues and voluminous data for financial institutions and corporate clients.
David is a partner in our Corporate team. He advises clients on structuring and executing domestic and cross-border transactions, including mergers & acquisitions, joint ventures, private equity investments and capital markets transactions.
Michael is an associate solicitor in the Commercial Litigation & Dispute Resolution team at Hayes. He has experience advising commercial clients with respect to a wide variety of issues, in particular restructuring and insolvency cases. He regularly acts for receivers, liquidators and examiners in High Court and Commercial Court proceedings.