REUTERS | Ints Kalnins

Dangers of construction insolvency

For many years, the construction industry has suffered more than most with insolvencies.

In 2018, it was the hardest hit economic sector, with construction insolvencies representing 17% (3,001 from a total of 17,454). This trend continued into 2019, with provisional figures indicating construction insolvencies accounted for 18.6% (3,198 from a total of 17,197). These statistics are regularly translated through the media as there never seems to be a month that goes by without news of contractor insolvency – from high profile industry names to historic brands to specialist contractors – no one appears to be safe.

Heading into 2020, and even before the COVID-19 pandemic changed the world, many industry analysts were warning that the construction sector should prepare for distress within the supply chain as market analysis indicated a falling demand, rising input costs and lower margins.

In addition to the already precarious market, COVID-19 is having a significant impact on the construction sector at large, with pressure on the labour, supply chains and finances of all companies involved. The environment in which these organisations are having to operate is ever-changing, with regular advice from the government and the Construction Leadership Council (CLC) about how to keep sites open while ensuring that contractors comply with the government’s social distancing requirements. Notwithstanding the emergency support measures introduced by the government, and the continued efforts of the construction industry to be open for business, it is inevitable that the financial health of all companies will be impacted and, despite best efforts, some will be fatally wounded.

Given the current climate, there is a growing need to be alert to the fragile market with contractors displaying early warning signs of distress. The challenge is for employers to identify these early warning signs and to act quickly wherever possible.

Pre-insolvency – the warning signs

The warning signs can be split into two – site issues and commercial issues.

The warning signs concerned with site issues broadly relate to numbers of staff/labour, the quality and progress of workmanship and availability of materials. Examples of common issues include:

  • A high turnover of staff.
  • A general decrease in labour on site.
  • A slowdown in the progress of the works or the works not achieving project timescales or milestones.
  • Poor quality workmanship and/or an increase in defects.
  • Removal of plant, equipment and/or materials from site.

Commercial issues warning signs relate to steps that a distressed contractor may take to improve its cash flow and generate cash collection. This may include:

  • Requests from the contractor for changes to the payment mechanism.
  • Inflated applications for payment and/or unsubstantiated claims.
  • Complaints from sub-contractors regarding payment.
  • A lack of response to correspondence.
  • Late filing of statutory accounts and annual returns.

If any of these warning signs start to manifest themselves and the risk of insolvency for a contractor increases, it is essential that the employer acts quickly to protect itself.

Pre-Insolvency – simple do’s and don’ts

With this in mind, there are some simple “do’s and don’ts” that can be adopted to help safeguard the employer’s position and ensure that it does not fall victim to a number of pitfalls.

Without taking legal advice, the don’ts include:

  • Not terminating, novating or assigning contracts.
  • Not appointing a new contractor to carry out relevant work.
  • Not paying sub-contractors directly.
  • Not making advance payments or paying for off-site materials.

If the prospect of insolvency looms, it is critical that the employer has a clear understanding of its contractual rights and obligations, and that it complies with all the relevant provisions. Issues related to termination, the appointment of new contractors and payments at this time are fraught with danger and need careful manoeuvring. This avoids the employer making common mistakes, such as terminating prior to the formal appointment of the administrator/liquidator or giving a termination notice not in accordance with the contract terms and/or issued to the wrong contractual party, which would potentially expose the employer to considerable financial consequences.

Notwithstanding the above, there are several steps that an employer can take to ready itself for the potential insolvency of a contractor, such as:

  • Ensuring that it has a complete set of contract documents (including warranties and guarantees) as it is often the case that these documents are not conveniently stored and /or incomplete, which causes problems.
  • Establishing a full list of the contractor’s management team.
  • Identifying sub-contractors that are critical to the timely completion of the works, and checking whether collateral warranties are in place.
  • Clarifying its rights and obligations in the event of an insolvency, such as seeing if it has step-in rights.
  • Scheduling and, if possible, safeguarding any plant, equipment and materials that it has paid for.
  • Getting the paperwork in place. Instigating full monitoring of progress and determine the scope and value of the work remaining – mark up drawings, take photos, and so on.
  • Preparing a contingency plan in the event of the contractor’s insolvency.

The basis of these steps is to ensure that the employer has a robust contingency plan in place in the event that the contractor becomes insolvent. In order to develop this plan, it is necessary that the employer has access to all relevant contractual documentation, a working knowledge of key contractual provisions and has a detailed record of the progress of the works and materials/plant that has been paid for.

So, in summary, given that the market is under pressure it is vital that employers remain vigilant, know their contract, and are prepared and ready for a potential insolvency. As we have seen over the years, even the biggest can fail!

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