How to cope with contractor insolvency

Headlines on the ill health of the UK construction sector have been appearing regularly this year, with The Guardian in August citing particularly worrying figures from the UK government's Insolvency Service and the acute impact on the housing sector.

This is sobering reading for those working on projects and having to deal with the practicalities of heightened risk. There is also the obvious impact on the health and well-being of the employees and supply chains of such organisations.

The impacts are felt not only by large, high-profile organisations, but also an increasing number of the UK's 342,000 small and medium-sized construction firms that form the foundation of the industry.

When these smaller organisations go insolvent, they affect the supply chain of larger ones. It has been reported that it is the smaller, specialised subcontractors that are suffering the most, accounting for around 60% of the total insolvencies.

Rebecca Larkin, the head of construction research at the Construction Products Association, has noted that in recent months, the 'increase in insolvencies has been strongest among larger firms', which, she said, reflected 'the inevitable knock-on effects of firms going bust further down the supply chain'.

The Insolvency Service reports that construction has seen more companies collapse than any other sector in the past year, representing 18% of all insolvency cases in the 12 months up to the third quarter of 2023 or 4,272 construction firms.

As a consequence, surveyors working in this challenging and changing environment should be keeping an eye out for particular indicators of insolvency.

Most forms of contract will define the actions that can be taken if the financial standing of a company deteriorates. Therefore, if the status of a company changes as a result of financial stress, contract provisions relating to insolvency may enable termination of the contractor's employment.

Under the 2016 JCT contracts, when the corporate contractor becomes insolvent, both parties have a right to terminate the contract.

Under clause 91.1 of the NEC4 contracts, reasons R1 to R10 set out the types of insolvency procedures which, should they occur, entitle the other party to terminate the contract.

An appreciation of the terminology describing the status of financially stressed organisations is critical in applying contract terms and provisions.

For example, the process by which a company's affairs are wound up, eventually resulting in its dissolution, is known as liquidation. A firm cannot trade while it is in liquidation.

In contrast, administration and company voluntary arrangements focus on rescuing the business. Therefore, it is possible for such a business to continue to trade, which is a significant difference from one that is in liquidation.

These two examples highlight the importance in distinguishing correctly the different terms used, and the implications in terms of the actions available under the different types of contract.

Consideration will be needed as to whether it is in the best interests of the employer, and the project, to terminate the contractor's employment.

It is unlikely that all of the above will suddenly occur simultaneously. However, a combination of issues over time, along with discussions on site and project relationships, may lead to concern.

Those managing projects should then interrogate in greater detail the integrity of the information being provided.

This means, for instance, you should ensure that all responses to correspondence are sent or notifications issued in a timely fashion within the contractual periods.

When work is not progressing on site, continue to visit and record status, taking date-stamped photographs.

If lack of activity results in works being exposed to adverse weather for longer than anticipated, or materials are poorly stored and their integrity is compromised, collate records from inspection software to pinpoint issues precisely on working drawings, accompanied by photographs, and raise these concerns with the contractor or subcontractor.

This evidence will allow you to flag up issues that require remedial action and response. It also means that when interim payment applications are made you can ascertain whether the work in progress accords with contractual provisions and materials have been properly incorporated into construction.

You should ensure, too, that payment applications are accurate and accord with the building contract provisions to avoid potential smash-and-grab adjudications or overpayments, and regularly review the information held about materials off site.

You should also ensure you have an executed copy of the building contract, together with an original copy of other completed documents such as performance bonds, collateral warranties and the latest insurances.

Alongside this, monitor the management of the works and set-up on site. This will allow you to raise any concerns about the way materials are stored and whether they continue to be protected, while ensuring the health, safety and welfare of those on site and preventing any unauthorised access.

As part of this approach, ensure that records continue to be provided about those attending site whose function is to review quality, sign off key stages, authorise or inspect, such as building control surveyors, building warranty inspectors or clerks of works.

This will be of particular importance regarding the continuity of as-built information, evidencing compliance with required standards and the collation of details forming the golden thread of safety information.

You should also check that the required certificates and notices continue to be issued and served effectively in accordance with the building contract provisions.

Finally, undertake an updated financial check on the organisation whose status is being queried.

From my own experience, this is rarely conclusive or the sole source of information determining your course of action, because it will frequently involve historic and outdated records; however, it still helps give a fuller picture about an organisation.

Your potential response will be project-specific, and help inform a risk strategy. While the detailed plans, legal safeguards and financial arrangements of any response are beyond the scope of this article.

If the original contractor is no longer employed to complete the works, there are a number of ways to proceed.

• Inspect the site and ensure it is secure, protecting it from any unauthorised access and arranging security if necessary. Keep all records of expenditure incurred as a consequence of this.
• Undertake an inventory of the site, recording materials and stage of construction and supplementing this with a photographic record.
• Review the stage of construction and work in progress. Ascertain whether there are any unsafe structures and identify work that must be undertaken immediately to protect what has been completed, and the health, safety and welfare of those in or around the works.
• Issue all the notices and certificates required under the building contract and review any specific contract amendments.
• Review insurances, bonds and warranties and confirm that the site is insured, issuing the notifications required by those acting as surety.
• Review with legal advisers the appropriateness and implications of any step-in rights – which enable another party to replace an insolvent party to complete a project – and their impact on current orders. 
• Review the project records to ensure the latest information is available. Download information from the project portal in case access is prevented or not possible at a later stage.
• Ascertain the value of the works at the date the contractor was no longer employed.
• Contact those acting on behalf of the contractor to establish a link and maintain dialogue on progress.
• Start to formulate and develop a procurement strategy to complete the remaining works.

Levels of insolvency in the industry are likely to increase over the coming months, with corresponding disruption and impact on the professional and personal lives of many. Being well prepared will lead to better outcomes.

To support surveyors, RICS' first edition of Termination of Contract, Corporate Recovery and Insolvency offers guidance on the practicalities and implications of terminating a building contract.