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Construction insolvency

View profile for Derryn Rolfe
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Construction News has reported that a total of 112 construction companies have gone into administration so far this year. This affects not only those companies, their employees, and their supply chains, but also their clients, whose projects will be delayed and whose costs to complete will inevitably increase.

What can clients do to protect themselves when the industry’s insolvency rate is high? Some of the most effective forms of protection are the obvious ones, and the first must be the pre-qualification of contractors, including credit check and insolvency rating. This is essential even if the client has worked with them before: most insolvencies are caused by cash-flow problems rather than lack of assets or empty order books.

The second action must be for the client to keep its ear to the ground, both on site and off. If the contract administrator hears complaints from sub-contractors of non-payment, then this should be taken seriously; equally, news heard on the grapevine about other projects should be borne in mind.

The majority of protections, however, should be put in place well in advance of the project starting. The various standard and model forms all include provisions for termination in the event of the contractor becoming insolvent, but the exact provisions vary. The contract should be drafted or amended so that the client doesn’t have to wait for the formal insolvency proceedings to be underway as this can be several months after the issues start; the ability to terminate must also not be contingent on the contractor giving written notice of insolvency, for obvious reasons. Entering any discussions with creditors, rather than appointing an insolvency practitioner, should be the trigger-point, and having genuine reason to believe that the contractor is insolvent should replace the need for the contractor to give notice.

The contract should ensure that the contractor provides vesting certificates on goods, products and materials already paid for but not yet on site, and if advance payment is being made then a bond should be procured by way of security.

Performance bonds or parent company guarantees should be a requirement of the contract and must explicitly provide cover for insolvency.

With live projects, there are usually signs that all is not well with the contractor. Complaints from subbies is one, but equally a lack of resource (both people and materials) and lack of progress on site is another. If the contract has not been amended in respect of the trigger-point, then it is usually the case that the client can use the provisions for termination for failure to proceed regularly and diligently (as the JCTS have it) with the works. Although this requires written notice and then – with most contracts – a period of a week or two to allow the contractor to remedy the default, it is usually quicker than waiting for a practitioner to be formally appointed.

Once the contract has been terminated, the client needs to ensure that the contract administrator draws up a final account accurately, and then, if there are monies owed by the contractor by way of losses or over-payment, a proof of debt is submitted to the practitioner. Taking legal advice is essential, of course. It is also important that the client mitigates its losses, as excessive claims against the contractor will not be permitted by the courts. If there is a performance bond or parent company guarantee, then the bondsman should be put on notice of a claim. It is important to ensure that the notice is given in the specified form if there is one.

If there is a design element to the contractor’s works, and the contractor is carrying PI insurance, then clients also need to remember that PI insurance works on a “year of claim” basis rather than a “year of default”, so insurers need to be put on notice immediately if there are design problems. One of the first things an insolvent company usually does is stop paying its PI insurance, and once the policy is not on risk there is no means of making a claim. PI-backed collateral warranties given to third parties will be value-less, and this will affect the security requirements of lenders and investors.

If you have any questions about construction insolvency, our Construction and Engineering team will be happy to help. Please get in touch for further information.