Time to ‘examine’ your right to terminate for insolvency under a construction contract?

Examinership is a court process intended to facilitate the rescue and recovery of financially troubled, yet potentially viable, companies. To avail of examinership, a company must demonstrate a reasonable prospect of survival. If the court is satisfied the company can be saved, it grants a period of protection and may ultimately approve a restructuring plan (called a Scheme of Arrangement). This generally involves substantial impairment of creditors’ claims meaning that creditors will receive less than what they are owed. 

The primary purpose of examinership is to support companies experiencing financial difficulties that still have the potential to operate successfully. The potential to operate successfully being the key point here and speaks to why Section 520(A) has been introduced into law.

Section 520(A) was transposed into Irish law on 27 July 2022 by S.I. No. 380/2022 - European Union (Preventive Restructuring) Regulations 2022 (see extract below). It introduced restrictions on certain contracts during examinership. The regulation was signed into law to give effect to Directive (EU) 2019/1023. 

Section 520(A) prevents counterparties to ‘executory contracts’ and ‘essential executory contracts’ from taking certain actions based on the company’s examinership and/or its inability to pay its debts. 

• An executory contract is defined as a contract where the parties still have obligations to perform at the commencement of the period of protection by a court.
• An essential executory contract is defined as an executory contract which is necessary for the continuation of the day-to-day operations of the business, including contracts such as critical supply agreements or key subcontracts, the suspension of which would lead to the debtor's activities coming to a standstill. 

As a result, parties to these contracts are prevented from terminating or altering such a contract solely on the grounds that a company has entered examinership, even if the contract itself would otherwise allow for it.

Section 520(A) further introduced restrictions on the use of ‘ipso facto’ (sole fact / by the fact / issue itself) clauses in contracts. As a result, creditors cannot, solely by reason of an examinership application or order, withhold performance of, terminate, accelerate or in any way modify a contract to the detriment of a company, notwithstanding any contractual clause to the contrary.

If a construction contract (building contract, consultant appointments, development agreement etc.) is determined to be an executory contract or an essential executory contract, the counterparty cannot terminate, accelerate or withhold performance solely because of the examinership event itself. 

Additionally, any ipso facto clauses (clauses triggered simply by insolvency) in the standard forms of construction contracts will be unenforceable even where the contract expressly permits such termination on a petition to appoint an examiner or on the appointment of an examiner. In practical terms, even if your construction contract provides you can terminate for examinership, Section 520(A) may preclude the exercising of that right.

In the Irish market we tend to work across a range of standard form contracts, each of which deal with termination for insolvency in differing ways. Looking at each in turn:

• RIAI – allows for termination if a petition to appoint an examiner is presented to the High Court. 
• PWC - allows for termination if a petition to appoint an examiner to the Contractor is presented.
• FIDIC – whilst ‘examinership’ is not expressly referred to in this form of contract, the broad terminology used to describe insolvency would extend to include examinership.
• JCT - whilst ‘examinership’ is not expressly referred to in this form of contract, it is often amended to include a reference when used in the Irish market.
• NEC – Similarly, whilst ‘examinership’ is not expressly referred to in this form of contract, it is often amended to include a reference when used in the Irish market. 
• Market Norm – whilst each of these forms of contract (excluding PWC form) tend to be amended by way of practice, termination for examinership is typically retained as a ground for termination. 

Applying Section 520(A) to each of the above forms of contracts, where examinership is the sole ground being relied upon to terminate the contract, this would be prevented by Section 520(A) if the contract can be shown to be an executory or essential contract. In such a scenario, the contract will continue to bind both parties so long as examinership protections apply and there is ongoing performance of the contractual obligations. The counterparty’s only avenue to terminate would be via other non-insolvency breaches. 

Whilst you do not necessarily need to go checking and amending all your construction contracts to remove references to examinership, parties should be live to the fact that if seeking to terminate a contract solely for examinership, they may be prohibited from doing so where Section 520(A) applies. Leaving in the optionality around termination for examinership is still a valid ground for termination, if relied upon in conjunction with another valid ground for termination.

The biggest risk here is wrongful termination. If a construction contract is wrongfully terminated simply because an examiner has been appointed or a petition has been presented to appoint one, this may lead to practical risks such as delay or loss and expense claims, damages for repudiation and serious project disruption.