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What are the risks associated with Contractor solvency caused by the financial impact of lockdown and how should we approach and mitigate them?

David Thomson
Managing Partner, Robinson Low Francis
E: David.Thomson@rlf.co.uk
T: +44 (0) 20 7566 8400
M: +44 (0) 7766 997 234

It is widely recognised that the depressed economic situation created by Covid-19 is going to have a big impact in the construction industry. We are no doubt heading into very rough unchartered waters and those of us who have been involved in previous recessions will know that it is likely that some Contractors will become financially distressed and could go into administration or liquidation. When this happens, there is usually a massive ripple effect through the supply chains, which has a subsequent knock-on effect to all the other Contractors and sites that they work on.

Red Flags and early warnings

Normally, when a Contractor starts to hit problems there are clear tell-tale signs on site, such as a slowing of works, reduced number of Sub-Contractors working, materials in short supply etc. This is over and above the normal rumours that circulate around. However, in the current climate it may well be difficult to define whether these signs are a result of applying CLC guidelines to site working, dealing with travel restrictions or general shortages of some materials. It is, therefore, more important than ever to really understand and gauge your site operational warning signs.

Mitigating risk

The big question is what can be done to mitigate the impact from Contractor insolvency:

Firstly, when agreeing terms of contract there can be several security measures that you can put in place to mitigate the risk of Contractor insolvency including:

  • Parent Company Guarantees: Provided that the complete group is not in financial difficulty this can guarantee the Contractor’s performance via a separate entity
  • Performance Bonds: This is likely to be the best form of security on insolvency as it is a guarantee provided by an independent third party, such as an insurer
  • Collateral warranties: These should be put in place for Sub Contractors, suppliers or design teams that have been employed under the umbrella of the Main Contract.

On many projects it is all too easy when you have concluded the building contract to shift focus to the practical side of getting the works underway and the provision of these fundamental security arrangements/agreements are overlooked. This can prove disastrous in an insolvency situation.

Project Rescue and Recovery in the event of Contractor insolvency

Once notification is received on Contractor insolvency, there are some practical steps that you can take to limit the impact and mitigate the losses that could inevitably be suffered.

In both the JCT and NEC contracts, if the Contractor becomes insolvent the Employer may at any time give notice to terminate the Contractor’s employment. As from the date the Contractor becomes insolvent their obligations to carry out and complete the works are suspended. The Employer must take reasonable measures to ensure that the site, the works and ‘site materials’ are adequately protected and retained on site.

Immediate priorities

We recommend that you quickly undertake the following actions:

  • Check insurance and security arrangements for the site and materials.  In particular, the obligation on the Contractor to maintain the Contractor’s All Risk policy will fall away on termination of their employment
  • Understand the terms of any Performance Bond and/or Parent Company Guarantee and provide initial notification to the relevant parties that you intend to take action to enforce the security
  • Review existence of executed Consultant/Sub-Contractor collateral warranties and identify which Consultants and/or Sub-Contractors could be engaged to conclude the project
  • Check what relevant documents/drawings in connection with the project are available and if necessary, seek copies
  • Understand funding or other agreements with stakeholders that are in place and the impact on those arrangements
  • Issue the notice to terminate the building contract, if not already undertaken.

Once the Contractor’s employment is terminated, a new Contractor may be procured to complete the work. They will be entitled to use all materials that were left on site, so this should be recognised in the price negotiation. There may also be the option of using all temporary building, plant and equipment left, but suppliers would have to be approached on terms. You should consider various procurement options and the need for rapid onboarding. This may result in an opportunity to change from the initial type of contract that existed with the insolvent Contractor.

Financial considerations

No further sum should become due to the insolvent Contractor and you do not have to pay any sum that has already become due.

Once the Works are completed you will be expected to prepare an Accounting statement covering

  • All costs associated with completing the works including all expenses associated with the termination.
  • The amount of payments made to the insolvent Contractor.
  • Total amount that would have been paid in accordance with the original Contract.

If, which will be likely, the sum paid to the Contractor and the total amount expended by the Employer to conclude the works exceeds the sum that would have been payable for the works under the contract, the difference is payable by the Contractor (or Administrator) as a debt. If the sum is less, then the Employer pays the Contractor (or Administrator). Generally, the costs and expenses for getting the works completed by a new Contractor are likely to be higher than the amount which would have been payable to the Contractor under the contract.

You must prepare the statement within three months after completion of the works and the making good of defects. Where you have the benefit of a performance bond, you will be looking to recover these additional costs from the Bondsman and you should build up the best evidence possible to support your position.

David Thomson
Managing Partner, Robinson Low Francis
E: David.Thomson@rlf.co.uk
T: +44 (0) 20 7566 8400
M: +44 (0) 7766 997 234

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