Your client is insolvent – six practical steps

As contractor, subcontractor or consultant, the nightmare scenario of your client/main contractor entering insolvency might be unavoidable and in a post Covid-19 world the risk is likely to be even higher.  This might happen despite thorough pre-contract checks and risk protection measures. It’s important to remember that the type of insolvency will influence the likely outcome: Whilst the purpose of administration is to rescue the business or achieve a better realisation of assets, the purpose of liquidation is to realise assets for creditors.  This article identifies six things to consider.

Can you suspend or terminate your works?

RIGHT TO SUSPEND

There is a statutory right to suspend for non-payment in section 112 of the Construction Act. The right arises if the payer has not paid the sums due by the final date for payment.  To exercise this right you must give notice to the payee of your intention to suspend. There is often an express right to suspend on this basis included in the contract.

As a result of Covid-19 some projects are currently suspended and some construction contracts make express provision for works to  be suspended for various reasons including force majeure, instructions and exercise of statutory powers.  For example, Clause 8.11.1 of the JCT Design & Build 2016 means that if the suspension continues for the period in the Contract Particulars (usually 2 months) then either party can give 7 days’ notice to terminate that contract.

RIGHT TO TERMINATE

You should always consider whether termination is the best option in all the circumstances. Consider what form of insolvency is being entered into.

Ideally, before any decision is made there should some dialogue between you, the insolvency professional and other interested parties (i.e. contractor, employer or funder as the case may be).

At common law insolvency is not by itself a breach of contract entitling a party to terminate.  Therefore the contract will usually include the right to terminate in the event of insolvency. Such a right exists in the standard JCT Design and Build 2016.  This sets out a process to follow which is summarised below:

1. The meaning of “Insolvent” is defined in clause 8.1. It is important that the definition covers the relevant form of insolvency or the clause will not apply.
2. The employer must notify the contractor immediately if he makes any proposal, gives notice of any meeting or becomes subject to any proceedings or appointment relating to any matters in clause 8.1.
3. The contractor may terminate the contract if the employer is insolvent (clause 8.10). The contractor must give notice of termination.
4. From the date the employer becomes insolvent, the contractor’s obligations to carry out and complete the Works are suspended.
5. If the contract is terminated, the contractor shall remove from site all temporary buildings, plant, tools and equipment belonging to the contractor and the contractor’s persons and all goods and materials (including site materials).
6. The contractor shall provide the employer with the design documents required in clause 2.37.
7. Following termination, the contractor shall prepare and submit an account setting out sums claimed including:

• value of works properly executed;
• any loss and expenses;
• reasonable costs of removal;
• costs of materials or goods properly ordered for which the contractor then has to pay;
• any direct loss/damage caused by the termination.

What about step in rights?

If you have provided collateral warranties in relation to the works there may be a number of additional considerations.

These may include step in rights by an employer (if the contractor has gone bust) and funder or purchaser (if the employer has gone bust).  The rights may be inconsistent with your rights under the contract (i.e. to terminate). They might also include additional requirements to be complied with. It is important to avoid being in breach of the requirements in the warranty and thus liable to the beneficiary for its losses.   For instance, the step in provisions may require the contractor to continue working during the period of notice to be given to the party with step in rights.

If step in rights are included check what provision (if any) has been made in relation to any outstanding payments. Such payments may need to be paid by the party exercising the right to step in.

Do you have any additional protection in place?

Check whether any form of payment protection was agreed in the contract with the insolvent party. Also check the exact terms of that protection.  Examples of this include payment guarantees and retention bonds.

If you supplied goods/materials check whether your contract included a retention of title clause. Have those goods/materials have been paid for and/or incorporated into the works.

What about the supply chain?

Check the terms of the contracts with your supply chain including for:

5. Any “pay when paid” clauses entitling you to withhold payments when the upstream payer has become insolvent. These are permitted by section 113 of the Construction Act but narrowly construed.
6. Check for termination provisions which may operate automatically. For example, clause 7.9 of JCT Design and Build Sub-Contract Conditions 2016 provides for a scenario where the contractor’s employment under the main contract is terminated. In such a scenario, the subcontractor’s employment under the subcontract shall also terminate and the contractor shall immediately notify the subcontractor.

What if works completed?

Termination may not be the best option and there may be an appetite to complete the project, either through exercise of step in rights or by the insolvency practitioners.  You should also be aware that administrators are only an agent of the insolvent company and are not personally liable for the insolvent companies’ obligations. The exception to this is if they confirm that any further work will be payable as an expense of the administration.

If you are entering into a new deal, you may want to consider what terms you would like to include. You may require additional financial protection such as payment guarantees, advance payment and payment on delivery of goods.  This will hinge on what bargaining power (if any) you have.

Can you bring adjudication proceedings against the insolvent company?

This depends whether the other party is in liquidation or administration.  If administration, then consent of administrator or permission of the court is required.  If liquidation, then adjudication is not normally available.

Any decisions that may need to be taken in this scenario are not straightforward and depend on the particular circumstances and terms of the contract and any collateral contracts.   Moreover you may need to ascertain your position very quickly.  If you need any further and specific advice please contact our construction lawyers.