We are living in very difficult times. Not a day goes by without news of the insolvency of yet another contractor hitting the headlines. Insolvency practitioners up and down the country are reporting increasing numbers of appointments and there is, at present, no end in sight to the current difficult trading conditions we are all experiencing.
An Employer who has to deal with an insolvent contractor will usually look to one of its professional team for guidance when faced with such a problem. The first thing that the advisor should do is to look at the contract. Does the contract provide for automatic termination of the contractor’s employment or is it optional? Has the contractor ceased to trade and is already in administration or is it all just rumour? Has an insolvency practitioner been appointed? What does he say?
But, most importantly of all, and the subject of this article, how should the Employer respond to a proposal made on behalf of an insolvent contractor to novate the contract?
Novation is the process of replacing a party to an agreement with a new party. A contract transferred by a novation transfers all duties and obligations from the original contractor to the replacement contractor.
Vinden does a considerable amount of construction insolvency work. Wherever possible we will try to arrange a novation of ongoing contracts. By doing so we preserve value in the contracts concerned, keep people employed and the Employer’s right to deduct liquidated and ascertained damages for delayed completion is preserved. When a novation is agreed, the impact on the creditors of the insolvent contractor is considerably reduced and, from the Employer’ perspective, the solution is hassle-free and without cost.
You would have thought that such a proposal was a complete “no brainer” but you would be surprised that some Employers still refuse to novate contracts, often due to poor advice from one or more of their consultants, and then wonder why they end up in a dispute with the insolvent contractor over the additional costs of completing the works with the new contractor.
Let’s be clear about this. An Employer does not have to accept an offer of novation of the contract. That is his or her choice. But let me also be clear; an Employer who refuses an opportunity to novate the contract is failing to mitigate his or her loss arising from the demise of the original contractor.
Depending on the express wording of the contract, an insolvency of the contractor may or may not be an automatic breach of contract. However, the subsequent inability to complete the works as a result of the insolvency is a clear breach.
As we all know, under English law, a party that intends to claim damages for breach of contract must be able to show that, wherever possible, the loss was mitigated.
I would suggest that a refusal to novate a contract where an original contractor is insolvent is absolute proof of a failure to mitigate.
The requirement for a claimant to consider the prospect of entering into a replacement contract in order to mitigate losses arising out of a breach of another contract was confirmed in the case of Sotiros Shipping Inc. and AECO Maritime S.A. v Sameiet Soholt (“The Soholt”) heard in the Court of Appeal in 1983 where the following principles in English law were re-stated by Sir John Donaldson M.R.
“The fundamental basis is thus compensation for pecuniary loss naturally flowing from the breach; but the first principle is qualified by a second, which imposes on a plaintiff the duty of taking all reasonable steps to mitigate the loss consequent on the breach, and debars him from claiming any part of the damage which is due to his neglect to take such steps.”
“That duty must include consideration of any opportunity he had to make a fresh bargain”
So, in summary and where a contractor has become insolvent and an offer to novate the contract has been received by an Employer, such an offer should never be dismissed lightly. On the contrary, such an offer is one that you would be very unwise to reject unless you have very good grounds for rejection.
As for those consultants who are no doubt tempted by the prospect of additional fees to be earned in sorting out a replacement contractor, even when there is an offer to novate the contract on the table, it may well be prudent to advise your insurers that you are likely to be on the end of a claim for negligence from the Employer when he learns that the additional costs he has incurred on your advice are not recoverable from the original contractor.
Peter Vinden is a practising arbitrator, adjudicator, mediator, expert and conciliator. He is Managing Director of Vinden and can be contacted by email at firstname.lastname@example.org