Re-negotiation of contract terms are essential, particularly for Carillion’s low-margin public sector contracts, writes Clyde & Co’s David Hansom

From a contractor perspective, insolvency issues can result in significant problems with contracts involving the public sector. The public procurement regime means that, often, it is not simply a case of a new contract being awarded to a different contractor. In addition, state aid rules often set parameters around what financial assistance the state can offer to contractors in difficulty.

The starting point is to identify all public sector contracts, their status (i.e whether in the construction or operational phase), rights of termination and/or assignment. Many public sector contracts include a unilateral right for the state body to terminate the contract on supplier insolvency, leaving the authority without a contractor to deliver what are often key public services. This would generally terminate all sub-contracts, and trigger, in most cases, an obligation on the authority to re-procure the contract. This creates practical issues, particularly for partially completed projects or those funded by external debt (such as PFI or many PPP arrangements).

The public body could consider novating or assigning the public contract to any entity which takes over the insolvent contractor or relevant subsidiary. The procurement rules allow a transfer to an entity which “universally or partially succeeds” into the position of the insolvent contractor, through “corporate restructuring, takeover, merger, acquisition or insolvency”. This means effectively, that if the contractor is sold to a new contractor, and the contracts are not amended “substantially”, the public body could look to simply novate the contracts over to the new contractor. This can provide a guaranteed income stream for the incoming contractor on day one but the practical issue here is that many public sector contracts are delivered on low margins, making some re-negotiation of contract terms essential for any new contractor.

Often, the public body will have wider value for money and internal financial rules to satisfy, and so may choose to run a new procurement process in any event. Engaging with the procurement and regulatory legal issues quickly means that, in many cases, existing commercial and contractual relationships can be preserved and developed.