As pressures on local authorities to meet service delivery requirements within tightened budgets increase, contracting with private companies can be an attractive option. It does however lead to increased exposure to the risk of insolvency on the part of a contractor, and the various practical problems that can result.
The implications in such a situation can vary widely, but tend to fall into two categories: implications for the authority as creditor, and implications as contract partner.
An authority owed money by an insolvent company will most likely be an unsecured creditor and, along with all the others, will receive a pro-rata share of any funds realised from the sale of the company's assets once secured and preferential creditors and the costs of the insolvency procedure have been paid. In some circumstances a share has to be set aside for unsecured creditors even if there are not going to be sufficient funds to pay the secured creditor in full. However, often, unsecured creditors receive nothing at all.
Equally important to authorities where a contractor has become insolvent will be the issue of continuity of service provision. Some insolvency procedures (such as Company Voluntary Arrangements) are designed to allow the company to trade through its difficulties, in which case service delivery may well continue uninterrupted. At the other end of the spectrum, however, a liquidation is likely to result in the company ceasing to trade, something which can happen with very little warning.
Particularly complicated issues can arise when a contractor goes into administration – a procedure designed to maximise the opportunity for the company to be rescued as a going concern. Administration creates a moratorium, which suspends creditors' rights to take enforcement action against the company or its assets, usually while a sale of the business is pursued. This may limit an authority's ability to take control of the situation quickly by re-entering premises leased to the company, or taking back possession of equipment needed to continue the service.
In addition, as part of any proposed sale the administrator may seek to transfer the company's contract with the authority to his chosen buyer. This may not sit well with an authority's procurement obligations. They will need to consider carefully whether in those circumstances they should allow the contract to be transferred, or if it should be terminated and a new provider sought. The options will depend upon what was in the contract in the first place.
Administrators and liquidators' duties are to the body of creditors as a whole. They will be keenly focussed on getting the best outcome, and will often deal with third parties robustly. This could include challenging the validity of a contractual termination, particularly in an administration where the company is protected by a moratorium. The moratorium does not technically prevent termination of a contract, however authorities will need to be satisfied that termination provisions have properly been triggered and that any notice has been complied with, as any irregularities will leave the termination open to challenge.
Ruth Thurland is an associate in the insolvency and corporate recovery team at Geldards LLP
