Managing the risk of insolvency on a construction project
07/06/2010
By Chris Kirby-Turner, Solicitor in Construction & Engineering.
A recent report by PriceWaterhouseCoopers found that although the effect of the downturn on businesses in the construction industry is easing, it is still the hardest hit with 674 construction companies affected in the first quarter of 2010.
Nearly all standard building contracts contain provisions that enable the construction contract to be terminated in the event that a party becomes insolvent during the course of a project. The procedure for terminating the contract must be followed very precisely, in order to avoid exposure to claims.
Any adjudication, arbitration or court proceedings currently running when a company becomes subject to the formal statutory insolvency procedures (such as liquidation, administration, a creditors' voluntary agreement, etc) will be immediately subject to a moratorium. The moratorium puts a halt to all current proceedings, precludes new proceedings from being started, and also puts a halt to any enforcement proceedings of an existing decision. It is only in exceptional cases that an application to lift the moratorium will succeed.
Clearly an insolvent contractor (or subcontractor) is one of the worst case scenarios for a developer (or main contractor). In the current economic climate, the best approach remains to take an active, ongoing, interest in your project so that any indications that your contractor is running into financial difficulty can be identified early on.
Some practical steps are set out opposite. However, it goes without saying that none of these steps are risk free. For example, directly paying sub-contractors could lead to a claim of preferential payment under the Insolvency Act, potentially resulting in the payments to sub-contractors being set aside and you having to pay sub-contractors twice.
Also, paying direct may not discharge the obligations to pay the sub-contractor under the building contract. There are inevitably pitfalls to consider, but ultimately offering some assistance may be one of the better ways to reduce the commercial risk.
Practical steps
Early warning signs to look out for include:
- staff turnover that is particularly high, or staff numbers being radically reduced
- the contractor falling behind on monthly progress reports
- works slowing down: short labour, late delivery of materials or sub-contractors failing to show because of non-payment
- requests being made for payments to be made on account and
- the contractor's (or subcontractor's) ‘extras’ claims increasing, as they try to claw back money.
Terminating the contract is not necessarily an attractive option. Instead, the project may ultimately be less adversely affected by other measures, such as:
- shortening contractual payment cycles
- making payments on account
- agreeing to the transfer of the contract to another contractor and
making direct payments to sub-contractors.