Consequences of Main Contractor Insolvency

April 9, 2013

LISA BOYD, DIRECTOR, CLEAVER FULTON RANKIN SOLICITORS, HIGHLIGHTS THE RIPPLE EFFECT OF MAIN CONTRACTOR INSOLVENCY AND STEPS SUBCONTRACTORS CAN TAKE TO AVOID THEM….

Like the ripples in a pond, the consequences of main contractor insolvency reach far and wide. Therefore, it is not only the staff, directors and shareholders of the contractor who lose their main  source of income, but also suppliers, sub-contractors and construction professionals.

Obviously, the employer in any construction project is materially affected by the upheaval of contractor insolvency. However, other third parties might also be impacted such as funders, insurers, landlords, tenants, purchasers and vendors. Naturally, the group most adversely affected by contractor insolvency is creditors. Given the nature of construction, sub-contractors are likely to be amongst the casualties. Whilst some sub-contractors work for a range of contractors, many have built their business in reliance of one or two large contractors. In the good times this proved to be lucrative, but in the current climate can be a risky strategy. Indeed, many construction professionals could name at least a dozen such sub-contractors who themselves have faced insolvency following the demise of a contractor.

In the current climate, sub-contractors may wish, where possible, to spread their source of work so as to minimise the impact of the insolvency of one contractor. However, this may not always be possible given the downtown in work available. Sub-contractors should also carefully review payment provisions before executing contracts to ensure protections against insolvency are maximised. Most importantly they should undertake regular contract audits and act upon any early warning signs. As insolvency is a ground for termination under most contracts, employers are also likely to suffer hardship upon contractor insolvency, the main consequences being delay, increased costs and the need to retender for a replacement contractor.

From the outset, employers should therefore ensure that construction contracts are carefully drafted to include safeguards to contractor insolvency. Employers should not always assume that standard contracts adequately reflect their needs and may need to consider bespoke amendments. For example, employers may wish to include provisions to permit the use of retention monies to cover the costs of retendering.

Furthermore, employers will need to review construction bonds and guarantees to make sure that the event of insolvency is not excluded. A further risk to employers is where elements of the works have been sub-contracted to third parties. The real risk of contractor insolvency therefore makes sub-contractor warranties all the more valuable in today’s market as carefully drafted collateral warranties not only provide a direct contractual link, and therefore contractual remedies, with the sub-contractor but also step-in rights which allows the employer to step into the shoes of the sub-contractor which can help to minimise delay and cost which can ultimately make the difference between success and failure of the project.

Given all of the above, employers and subcontractors need to take steps to minimise the risk and impact of contractor insolvency. For employers this means procuring collateral warranties, bonds and guarantees with sufficient protections and due diligence of contractors before awarding contracts. Equally so, sub-contractors should also undertake due diligence of the contractor before contract execution. Throughout the contract they should also watch out for early warning sign and take action to minimise the fall out.*

For more information, contact Lisa Boyd at Cleaver Fulton Rankin, telephone 028 9024 3141, e-mail info@cfrlaw.co.uk or visit the website at www.cfrlaw.co.uk
*Please note the content of this article is for information purposes only and further advice should be sought from a professional advisor.