Insolvency within the supply chain in the construction industry and what to do about it – Part Three

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Part Three

 

Introduction

This week we take a look at what practical and legal steps an Employer or Contractor can take to guard against insolvency before engaging a Contractor or Subcontractor.

References to “Contractor” are also a reference to “Subcontractor”.

Practical Steps

These could consist of:

  • financial checks including:
    • (a) Credit checks such as Dun & Bradstreet or Experian (although these must be up to date) and payment performance comparisons against the industry average.
    • (b) The latest management accounts (an NDA is usually required for this).
    • (c) The cash in bank and level of borrowing of the relevant contractor.
  • Investigating the sub-contractor’s trading and trading history e.g.:
    • (a) Details of work in progress.
    • (b) Expected order book (evidence of contractors taking on too much work risks an inability to manage cashflow if a payment is delayed or withheld. This would be a possible concern if the company has a projected significant increase in turnover).
    • (c) The contractor’s ability to procure a performance bond, and the cost of provision of that bond
  • Obtaining references from previous clients. Employers or contractors should also carry out a detailed review of the press and social media and get anecdotal information from others in the industry on potential contractors.
  • Careful scrutiny of the Contract Sum Analysis and cash flow schedules to ensure they are not front loaded, therefore risking insufficient monies left to finish the job if they do become insolvent.
  • Obtaining additional security from the sub-contractor depending on the financial status of the contractor.
Checklist of possible contractual protections

Depending on the size, value and complexity of the works, to the extent that the contract does not already contain such provisions (and the JCT and NEC forms of contract do contain many of these), the Employer or Main Contractor should consider including the following in the contract:

  • An increased retention (either a % of monthly payments or a retention bond).
  • Obligation on the Contractor or Sub-Contractor to provide or procure:
    • (a) Full details of any sub-sub-contractors/suppliers it intends to contract with;
    • (b) collateral warranties from any sub-sub-contractors with step-in rights;
    • (c) product warranties and guarantees;
    • (d) Professional indemnity insurance;
    • (e) Vesting certificates in off-site materials;
    • (f) Performance bond;
    • (g) Parent Company Guarantee.
  • A right to terminate immediately on an insolvency event occurring.
  • obligation on the Sub-Contractor to issue an early warning as soon as it becomes aware of any matter adversely affecting its works or its performance.
  • Requirement to assign the benefit of all and any other sub-contracts entered into by the sub-contractor (Inc. balance of retentions and further sums due under any other such contracts).
  • Right of set-off against any amounts due to the Sub-Contractor under any other contracts between the Contractor and the Sub-Contractor.
  • Subcontractor to grant a lien over its plant and machinery and materials at the date of insolvency.
  • Ability to appoint the Main Contractor or the Employer as attorney and authorise it to carry out such acts and execute such documents as are necessary to render such rights effective within 7 days of any written request from the Main Contractor or Employer.
  • Ability to carry out financial standing checks during the contract term.
  • Payments due to the Contractor to cease upon the Contractor’s insolvency, until the works are completed and the ability for the Employer to employ an alternative contractor to complete the works and recover the cost of doing so from the original Contractor. The JCT D&B allows for this and so if your contract does not, then as an Employer, you would be advised to include these two rights.
  • Ability to terminate upon the Contractor failing to proceed regularly and diligently with the works. If formal insolvency has not yet occurred, this could be a way of bringing the contract to an end quickly. The JCT D&B includes this right;
  • The right for the Employer to (and the JCT D&B contains many of these rights):
    • (a) go on site when the Contractor has become insolvent, secure the site and all plant and materials. The licence under which the Contractor occupies the site would almost certainly be revoked on termination of the contract, but until termination of the contract, the Employer must have the right to secure the site;
    • (b) the right to use the Contractor’s plant and materials for the completion of the project;
    • (c) the right to sell any materials and plant belonging to the Contractor and use the proceeds to satisfy the Contractor’s debts under the building contract. However, there is the risk that plant may be hired by the Contractor rather than owned, giving rise to tortious claims against the Employer by the plant leasing company.
Conclusion

Although it may not be possible to guard against a Contractor becoming insolvent, there are certainly many protections and steps an Employer can take to protect its financial position if a Contractor does ultimately become insolvent during the course of a project.

Please note that this article does not constitute advice. For advice on insolvency in the construction supply chain and further information on any of the issues addressed in this article, please contact Elizabeth Vago, Construction, Engineering, Infrastructure and Energy partner, at Spencer West LLP elizabeth.vago@spencer-west.com.