Completion or Bust

In these depressed economic times we’re not surprisingly seeing a lot of insolvency, both amongst employers and contractors. As a corollary of that, what we’re also seeing a lot of is the fear of insolvency, not just one’s own, but the insolvency of the chap you’re in contract with. It can play havoc with a project when one or other of the parties goes under, and there’s an awful lot of care being taken at the moment to nip any potential problems in the bud and ensure that the necessary procedures are in place to deal with them.

So, what are the warning signs that someone is about to go belly up?

General warning signs that can easily be monitored are late filing of accounts, unsatisfied county court judgments, persistent rumours in the press, or announcements to shareholders or the stock market. More specifically, look out for unusual or unexpected behaviour.

Where we’re talking about an employer, the warning signs you might see are:

Delayed payment to the contractor, or on other projects
Redundancies or unexplained removal of personnel
Unexplained suspension of the project, or
Failure to maintain insurance.

For contractors, on the other hand, warning signs might be:

A decrease in workforce or labourers not turning up on site
A slow-down in progress
Plant, equipment and materials disappearing from site
An increase in the number of defects
Attempts to impose or negotiate increased or accelerated payments
Spurious claims or contra-charges, or
Sub-contractors not being paid.

You should always monitor these signs, especially in the current market

How can the contractual framework protect your position?

First of all, what can a contractor do?

He might try to obtain a project bank account, whereby the employer is obliged to maintain a positive balance in an account. In theory, this ensures that funds are always available to pay the contractor.
A contractor may be able to ask for an advance payment where he has to commit funds before the project commences in order to ensure that plant, equipment, materials or sub-contractors are available when work starts.
A contractor may want payments to be “front-loaded” to give him better cash flow and to minimise the risk of employer insolvency.
Both parties may want parent company guarantees from the other’s ultimate parent to secure payment or performance.
Although employers and funds will resist any obligation on the fund to make payment to the contractor, the parties may agree that payments due under the building contract pass directly from the fund to the contractor without passing through the employer’s bank account.
To prevent retention monies being swallowed up in an employer’s insolvency, a contractor may persuade the employer not to deduct retention in return for the contractor procuring a retention bond in favour of the employer in the form of an “on-demand” bond. Alternatively, a retention trust account can be set up to keep the retention monies separate from the employer’s other assets.
A retention of title clause, or ROT clause as it’s often known, expressly reserves the contractor’s rights over materials used in the project pending payment of outstanding sums due.
A building contract usually requires the contractor to give the employer copy design documents relating to the project and to allow the employer to use those documents to complete the project, if necessary. Contractors may wish to consider including a provision suspending the employer’s right to copy and use documents if the employer fails to pay sums due under the contract.
A “pay when paid” clause in his sub-contracts and supply contracts would permit the contractor to withhold payment to his sub-contractors and suppliers until he’s paid by the employer. These clauses were outlawed by s113 of the Construction Act, except in the case of “upstream insolvency”.

What can an employer do to protect his position in the contract?

The employer should consider including in the building contract:

Express provisions that state that he’s not obliged to make any further payment to the contractor on contractor insolvency until the works are complete.
Express provisions that allow him to complete the project using an alternative contractor and recoup the cost of doing so from the original insolvent contractor (or off-set the cost against sums owed under the contract).
Express provisions that allow him to make direct payments to sub-contractors and suppliers, subject to careful drafting to avoid double payment or falling foul of the pari passu rule on insolvency.

The employer may be able to persuade the contractor to procure a performance bond.
The employer should consider securing rights over off-site materials, or at least a bond to secure any payment made in respect of such materials.
The employer should include in the building contract an express requirement for the contractor to procure collateral warranties from sub-contractors and professional consultants.
An employer should resist any proposal by the contractor to include an ROT clause in the building contract.
Likewise, the employer should resist inclusion of any clause restricting or suspending his right to copy and use the design documents.

Establishing the right to terminate

So, how about the ultimate sanction – termination? What happens if the other chap goes bust? Can you cut him adrift and go in search of someone else to finish the project (if you’re an employer) or go find some other, more profitable, work (if you’re a contractor)? That all very much depends what the building contract says. Under the common law, insolvency (even liquidation) is not a fundamental breach of contract for which you can terminate. It’s not even a breach of contract entitling you to damages. Purporting to terminate without having the right to do so is, however, a fundamental breach. So, you need to be very careful.

What can you do?

First, check the contract to be sure that it gives the right to terminate on insolvency. Next, make sure that it’s the company you’re contracting with that’s insolvent, rather than a group company, and that the insolvency is of a type referred to in the contract.

If the contract doesn’t contain a right to terminate on insolvency, you’ll have to consider whether you can terminate for another reason, for example delay, defects or non-payment. This may well be tricky, because minor defects and delays are unlikely to be sufficient grounds for termination. You should check the exact wording of the contract.

Alternatively, you may in fact have a common law right to terminate for fundamental breach, for example if the contractor has walked off site vowing never to return.

Issues to consider

What should an employer take into account before terminating a building contractor’s employment on the grounds of insolvency?

First off, what’s the situation with regard to agreements with third parties? The employer should check that all necessary collateral warranties have been obtained. If they haven’t been, he should set about obtaining them as soon as possible.
Next, how is the site protected? The employer should check that all necessary insurance cover is in place and ensure that site security is in place to stop plant, equipment and materials from wandering off.
Then you need to think about how materials and documents can be secured. The employer should check whether he has rights over design and copyright in relation to the project and obtain copies of any drawings or documents that he doesn’t already have. He should also undertake an audit of plant, equipment and materials and take steps to secure anything that’s off-site.
How much has already been paid to the contractor? The employer should establish the precise amount already paid, so that he can see if the contractor has been overpaid or if retention has been properly deducted. He should check whether there’s a right to set-off over-payments under the building contract against other payments due to the contractor.
Finally, the employer needs to consider how the project will be completed? He should contact the liquidator or other insolvency practitioner to find out his intentions with regard to the building contract. The contractor may still be able to complete the project if the insolvency practitioner agrees and the employer waives his right to terminate the contractor’s employment under the contract. This may end up being cheaper for the employer than getting someone else in to complete the project, but rarely happens unless the project is very near to completion.

Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.

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