Contractor insolvency: practical considerations
26th March, 2020
Contractor insolvency has long been an issue in the construction industry, but the collapse of some due to the current COVID19 crisis has highlighted the risks involved.
It is almost impossible to completely guard against the risks associated with contractor insolvency, but there are some steps which can assist in mitigating and managing the risks involved. To be in the best possible position, it is worth considering the following at the outset of any project:
- Check the contractor’s financial position – particularly the specific company which will enter into the building contract, as the employer’s rights will be against this company rather than the business as a whole;
- Take legal advice to ensure that the building contract is properly drafted with appropriate provisions to deal with an insolvency event;
- Consider requiring a performance bond and/or parent company guarantee (each serve slightly different purposes);
- Obtain collateral warranties from the consultants and sub-contractors involved, so that there are contractual rights against other parties if the contractor is no longer able to meet claims;
- Consider requiring retention bonds, advance payment bonds or vesting certificates if necessary;
- Project bank accounts and escrow accounts can also provide some further assurances for the parties involved.
Early warning signs
As the project progresses, it is important to continually monitor the contractor’s performance. Any one or more of the items below can be early warning signs that the contractor is in financial difficulty, and that further actions may be necessary:
- Decrease in labour or contractor’s personnel on site, and/or rapid turnover of contractor’s personnel;
- Slowdown in progress on site;
- Plant, equipment or materials suddenly disappearing from site for no apparent reason – unpaid subcontractors may unilaterally decide to remove items from site regardless of their contractual rights to do so;
- An increasing number of defects and reduction in the quality of the contractor’s work;
- The contractor seeking changes in the payment arrangements, and in particular early payments;
- The contractor making spurious claims or contra charges;
- The contractor seeking assignment of its benefit of the building contract;
- Late filing of accounts by the contractor at Companies House;
- Unsatisfied court judgements against the contractor;
- Subcontractors and suppliers not being paid or being paid late;
- Rumours in the press, in the industry, on site or elsewhere regarding the solvency of the contractor;
- Unusual visits to site, for example from the contractor’s senior management or other personnel who had not previously been present or are not expected to be present;
- Increasingly aggressive behaviour by the contractor;
- The contractor’s parent company or another company within the contractor’s group displaying any of the above signs.
What to do if the contractor is in suspected financial difficulty
If the contractor is displaying one or more of the above signs, then it is worth considering the following actions to protect the employer’s position as far as possible:
- Closely monitor the financial and on-site performance of the contractor in order to assess the likelihood and timing of potential insolvency;
- Ensure all bonds, guarantees and collateral warranties have been obtained under the building contract, and if not take steps to obtain them immediately;
- Consider the terms of any guarantees to ensure that the guarantor’s obligations are not inadvertently discharged;
- Bonds may require adjudication to have been commenced (or even completed) prior to insolvency so as not to be stayed pursuant to insolvency laws;
- Carry out an audit of the on-site plant, equipment and materials, and evidence this (for example with photographs and written records);
- Ensure that copies of all relevant documentation have been obtained, for example drawings, specifications and anything required to comply with CDM requirements. If not, take steps to obtain these;
- Review the payment position under the building contract, including whether any over payments have been made to the contractor which should be reclaimed, what retention is held or has been released, whether any payment notices may be necessary, and whether there are rights of set-off which should be exercised;
- Check whether the involvement of any third party is required, for example funders, landlords, tenants or purchasers who may have rights in relation to the building contract and how it is administered;
- Review the terms of the building contract relating to contractor insolvency – hopefully the parties will be fully aware of the building contract terms and have been administering it correctly to date, but if it has been hiding in a draw then now would be a good time to dust it off and ensure familiarity with the relevant provisions!
In general, there is often a stick or twist decision. If the employer chooses to financially support the contractor (for example by agreeing different payment arrangements), this may help to keep the contractor solvent and more likely to complete the project, but it also exposes the employer to greater risk if the approach is not successful. Conversely, withholding payments from the contractor may make insolvency a self-fulfilling prophecy. The precise advantages and disadvantages of the approach will be dependent on the specific circumstances of each case.
What to do if contractor insolvency occurs
In the event that the worst happens and contractor insolvency occurs, there are a number of steps which the employer should take immediately:
- Confirm that insolvency has actually occurred and the type of insolvency (for example liquidation or adjudication) – actions taken based on rumours can have adverse consequences;
- Secure the site and carry out an audit of the plant, equipment and materials present – this may extend to changing the locks on site in order to prevent overzealous contractors and sub-contractors seeking to return and take what they see as their possessions. The building contract may contain a provision that these are the employer’s property, but they can be difficult to recover if they are not within the employer’s possession – possession is 9/10ths of the law!
- Ensure that there are adequate insurance and health and safety arrangements in place for the site – these would usually be dealt with by the contractor and therefore may no longer be in place, so alternative arrangements may be required;
- Ensure that any further payments to the contractor are stopped pending a more detailed review;
- Consider whether any off-site materials have already been paid for and can be secured. This can however be difficult in practice where the materials are not physically within the employer’s possession;
In addition, there are also a number of further actions which the employer should consider in the slightly longer term:
- Investigate the options available and ascertain the cost of completing the works to assist in deciding how best to proceed;
- Consider whether termination of the contractor’s employment under the building contract is required, and if so take the necessary steps in accordance with the building contract;
- Consider whether there are any bonds or guarantees in place upon which the employer can rely, and if so assess their terms as to whether and how to make a claim;
- Make arrangements to complete the works – as a general rule of thumb the cost of completing the works may increase by around 30% if it is necessary to get a replacement contractor;
- Consider whether direct payment to subcontractors is possible or desirable;
- We would strongly recommend taking legal advice, as insolvency and its implications are complex and it is easy to inadvertently fall foul of the various different requirements.
For further information, please get in touch.
Please note that this briefing is designed to be informative, not advisory and represents our understanding of English law and practice as at the date indicated. We would always recommend that you should seek specific guidance on any particular legal issue.
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