CONSTRUCTION JOURNAL

How to identify potential insolvency of a contractor

If you suspect insolvency is impending, your client will be looking to you to help assess the situation

Author: Daniel Hutchings

05 February 2019

In a post-Carillion world, the spectre of insolvency can haunt a project. Research by the Insolvency Service immediately after the contractor's collapse indicated that the rate of UK construction insolvencies rose by eight per cent in 2016/17, with more than 2,600 such companies becoming insolvent.

But steps can be taken to avoid an unfinished project, a building riddled with defects, no security for the developer's cross-claims, and an unhappy client looking to blame the contract administrator.

Any of the following may indicate that your client's contractor is in difficulty:

  • contractor demanding swift payment or early release of retention or any other changes in payment patterns
  • subcontractors contacting your client directly, seeking payment
  • withdrawal of labour, including changes to key individuals on site
  • less frequent deliveries or removal of various goods and materials from site
  • a general slowdown in progress of works
  • increased number of defects.

At this early warning stage you should exercise caution and establish whether your concerns are correct, as mistaken allegations will erode trust. Gather all relevant information, particularly about payment and value of works – if the contractor is teetering on the edge, denial of cash flow may result in the unwanted distraction of adjudication or push it into insolvency.

If you suspect insolvency is impending, your client will be looking to you to help assess the situation. Do you advise it to terminate the contract, or think about ways it can encourage and help its ailing contractor finish the project?

The following factors ought to be taken into account.

  • How close are you to the project's end? Could there be an issue with the transfer of design liability to any new contractor?
  • Is there a performance bond? Will your client have access to funds to complete the work? This will usually depend on the nature of the event and the bond's wording. Even when an insolvency event occurs, it may not be possible to make a call without obtaining the decision of an adjudicator. If so, proceedings may need to be instigated before the date of the event to avoid being stayed pursuant to insolvency laws.
  • Is there a parent company guarantee? If so, what is the financial position of the parent?
  • Is the rest of the group financially sound? How is the project financed? Is there a fund or lender your client should involve in the decision? Is your client facing an event of default under any funding arrangements?
  • Is the contractor in breach of contract, and does this entitle your client to terminate? This needs careful thought. Getting it wrong may enable the contractor to claim a repudiatory breach of contract and seek damages for wrongful termination.
  • Can your client quickly build out the works? Is a replacement contractor available and can you keep trusted and reliable subcontractors by using step-in rights?

If you have immediate concerns, you will need to:

  • monitor the contractor's performance closely, both on site and financially
  • consider regular site visits
  • keep detailed records
  • ensure any payments are in line with the work completed and any 'pay less' notices are served in time to the correct address
  • consider issuing formal instruction to open up or test materials or goods, or remove defective work
  • check the construction contracts and ask your client about funding arrangements.

Where there are defects, analyse whether your contract allows your client to engage others, should your instructions about the same be ignored. Ensure you meet any deadlines in such a scenario. This can be an effective strategy, especially if the contract provides that the contractor will be liable for all extra costs incurred by the client in connection with any such engagement.

A composed approach, taking into account the steps above, may not wholly avoid a tricky period for the project. But protecting your client's position and offering practical advice during this time is unlikely to go unnoticed. You'll be rewarded, as calm heads are welcome in any team.

Daniel Hutchings is a senior associate, Taylor Wessing dhutchings@taylorwessing.com

Related competencies include: Contract administration, Works progress and quality management

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