July 18, 2019

How can a contractor protect itself against employer insolvency?

As the fallout following Carillion’s liquidation continues, many contractors are looking at ways in which to protect themselves against employer insolvency. Phil Morrison, Head of Construction at UK top 200 corporate law firm, Shulmans LLP, considers the measures contractors can take to mitigate the risks to their businesses, when negotiating the terms of a building contract and during the construction phase of a development.

Phil Morrison, Head of Construction at Shulmans LLP

When negotiating the terms of a building contract, the following should be considered:

  • Payment protection as a first priority

A common occurrence with contractors is that recent developments show employers have not priced projects correctly. This has led to employers receiving tenders at higher sums than funders expected. As a result, they often find themselves running short of cash before a project is completed. To avoid such a situation, it is vital that contractors take provisions within the building contract to protect payment, which could include:

  • Building in shortened payment periods
  • Suggesting an escrow account
  • Creating a project bank account
  • Weighted stage payments

 

  • Include a retention bond

If the employer becomes insolvent, any retention monies held by the employer may be difficult to recover. Most contracts will state that the retention is not held in escrow. In some cases, an employer may agree not to deduct a retention from payments to the contractor in exchange for the contractor procuring a retention bond in favour of the employer. Typically in the UK, a retention bond will be an on-demand bond.

  • Consider when and how termination occurs

The building contract should specifically permit the contractor to terminate its employment on employer insolvency. This is important because insolvency is not automatically a breach of contract in common law.

The definition of insolvency in the building contract should include all possible varieties under English law.  However, note that many rights to terminate a contract in the event of insolvency are reciprocal, so by arguing for a wide definition of insolvency for the employer, the contractor will be subjecting itself to the same regime.

  • Consider what happens to materials and documents

Retention of title clause expressly reserves the contractor’s rights over materials used in the project. It is generally ineffective once materials are fixed, but reserves the contractor’s title over unfixed materials.

Rights should be conditional on payment by the employer. A contractor proposes provisions that suspend the employer’s rights to copy and use the design documents if the employer fails to pay the contractor in accordance with the building contract.

  • Provisions in sub-contracts

In the UK, ‘pay when paid’ provisions in construction contracts are unenforceable, except to the extent that they apply only in a case of ‘upstream insolvency’. Accordingly, in the UK, a contractor should include a ‘pay when paid’ clause, limited to employer insolvency, in its sub-contracts. This would mean that the contractor is not required to make payment to its sub-contractors if it has not received payment itself.

 

In order to protect yourself during the construction phase of a development, you should be aware of the following:

  • Be on the lookout for strange behaviour

First and foremost, you should monitor the employer for signs of impending insolvency. Some of the warning signs include:

  • Official announcements to shareholders or the stock market, such as a profit warning.
  • Rumours about the employer’s financial position in the press and from other sources.
  • Delayed payment to the contractor and/or contractors on other projects.
  • Inexplicably personnel and removed from the project.
  • Unexpected or unexplained omissions from the project.
  • The employer suspends the project without explanation.
  • Late filing of accounts or annual returns at Companies House.
  • Unsatisfied court judgments against the employer.

 

  • Conduct Regular and complete invoicing – you should make applications for payment in accordance with the agreed payment schedule and must not allow sums owed to it by the employer to mount up.
  • Adhere to strict compliance with the building contract – make all claims under the building contract within the contractual time limits. Failure to do so may result in losing your right to claim.
  • Consider starting an adjudication before the employer goes insolvent – once they become insolvent, the court (or an insolvency practitioner) may have to give permission before a claim against them is started. Adjudication is therefore a quick and effective method and the difference between securing payment before the employer becomes insolvent and ending up in a queue of unsecured creditors.

What to do if the employer goes insolvent:

  • Secure plant equipment and materials. This is particularly important for plant and equipment that is on hire or may be needed for other projects.
  • Review payment obligations to sub-contractors, professional consultants and suppliers. The contractor may be entitled to withhold payment in some situations.
  • Do not terminate the building contract without considering the situation. Contact the employer or the insolvency practitioner and anyone else interested in the project, such as a funder. These parties may wish to complete the project using the contractor, either by novating the original contract or entering into a new arrangement with the contractor.
  • Monitor insolvency proceedings. If necessary, submit a proof of debt to recover a share of any monies available to unsecured creditors.
  • If the contractor is the largest creditor, it is possible to influence who is appointed as the liquidator. Whilst this will not guarantee any payment, it will give confidence that matters are being properly dealt with.

This article was written by Phil Morrison, Head of Construction at Shulmans LLP. For more information or to discuss how your

business can protect itself against employer insolvency, please visit www.shulmans.co.uk or call 0113 297 8934.