Buying an insolvent firm: Risky assignment

Connaught’s demise brings into sharp focus the realities of assignment clauses in construction contracts. When a business such as this needs rescue, much of its value lies in its staff or its contracts. The staff are obviously retained so that the business can perform its contracts, so without intending any disrespect to them, the real value is in the contracts.

However, when corporate and insolvency specialists start looking at a business such as Connaught, they quickly ascertain that the contracts contain a prohibition on assignment. This needs to be overcome if the contracts are to be sold and transferred to other providers.

Those prohibitions are there for a good reason. Parties do not want to spend long periods of time negotiating with a particular party, enter a contract and then find the next day that the contract has been assigned to another party.

Once a party has bought various contracts, the risk is that the paying parties look around to see whether they can get a better deal elsewhere, or with a supplier they prefer

Good old common law seeks to differentiate between the burden and the benefit of a contract. In simple terms you can assign the benefit (that is, the entitlement to be paid), but you cannot assign the burden - the obligation to perform the works in question or to make payment.

However, the common law position is often overruled by specific contractual provisions. Those provisions invariably state that the performing party, the one doing the work, cannot assign the contract at all, or cannot assign it without the consent of the party for whom the service is being provided.

This presents practical difficulties when looking to realise the assets of a business such as Connaught. One way to overcome them is by negotiation and a waiver of the right to rely on the assignment prohibition. This is the commercial reality: without it, there would be nobody else to perform the service. Therefore, in the urgency of an insolvency-type situation, the paying party has good reasons for overlooking the prohibitions on assignment.

However, anybody looking to buy the contract assets of a business needs to be careful that the receiving party’s desire to overlook a prohibition on the assignment of contractual services is not just a temporary stage in their thinking.

Although a party may be willing to waive the prohibition on assignment in the short term, anybody purchasing the assets of a business needs to ask themselves whether that will remain the position. This is because contracts can contain provisions that allow termination at will in the future.

For instance, the NEC contract, which is often used for public and quasi-public procurement, specifically provides for a right of termination at any time. The risk is that once a party has purchased various contracts, what then happens is that the paying parties look around the marketplace to see whether they can secure a better deal elsewhere, or with a supplier that for some reason they prefer. At that point notice can simply be given and the contracts will come to an end.

The obvious commercial solution in such circumstances is for a party acquiring a contract from a defunct contractor to make sure they secure that contract in the medium-to-long term. This will obviously depend on issues in relation to performance and therefore relates back to the points regarding the workforce. If the workforce is good and can be kept on board during
such a transaction, and they perform the contracts well for the paying party, that gives the best prospects of protecting the interest in the contracts.

There may always be instances where a paying party is not willing to waive the assignment clause. Perhaps they are not happy with the party hoping to buy the contracts. In this case little can be done. The existing contract will come to an end and the paying party will have to find the services elsewhere, perhaps at short notice.

Also, there will be provisions that will relate to the contractual payment regime in the event of insolvency. Although this can, in theory, give rise to a right to recover overcosts from the original contracting party based on their default (namely entering insolvency), the practical reality can be quite different if there is no or very little dividend for unsecured creditors.

Buying out interests such as contracts on a business failure is therefore a specialist area requiring care if one is to avoid signing up for more than the contracts are really worth.

James Bessey is a partner in the constructionteam at Cobbetts