When insolvency strikes - Tips on insolvency

It was on 12 February 2002 when the late Donald Rumsfeld (serving as secretary of defence for the United States of America) made his now famous remark in a press conference at the White House:

Reports that say that something hasn't happened are always interesting to me, because, as we know, there are known knowns; there are things we know that we know. There are known unknowns. That is to say, there are things that we now know we don't know. But there are also unknown unknowns. There are things we do not know we don't know.

Unfortunately, all involved in construction know that situations involving a contractor going into liquidation during a live project is a known known. Despite this employers are often caught out. In this article we look at ten simple tips on what to do in this scenario to mitigate losses and complete the project in the best way possible.

10 tips:

1. Appoint a surveyor: to assess the quality of work completed so far (including recording the state of the work, goods and materials on site). Very often quality slips in the lead up to insolvency.

2. Secure the site: be ready to secure the site or materials may be removed by the parties. The licence under which the contractor occupies the site would (depending on what the contract says) come to an end on insolvency or termination of the building contract.

3. Insurance: ensure that the works are still being covered by the insurer. If in doubt, speak to your insurance broker.

Consider putting in place Latent Defects Insurance as the contractor’s PII will most likely be terminated by the liquidator and whilst there may be protection from consultants and subcontractors via collateral warranties that may not be satisfactory for any funder or future purchaser. 

4. Off-site goods and materials: given the prevalence of off-site construction, consider whether there are any goods or materials located off-site which have been paid for. You should consider using any vesting certificate you have to secure these items as soon as possible.

5. Security (performance bond, advance payment bond and parent company guarantee): check the type and nature of security provided and the procedure to make a claim. Do this prior to terminating any contracts to ensure you do not prejudice your position. For example, some security has better terms in an insolvency situation.

If there is a performance bond in place, you should consider calling on the bond. The ease of doing so would normally depend on a number of factors such as whether the bond is an on-demand bond, location of the bondsman and the duration of the bond.

If there is a parent company guarantee in place, consider calling on the guarantor. However, be aware that there is a possibility the contractor’s parent company may also become insolvent at the same time or shortly after the contractor. 

6. Terminate the building contract under appropriate ground(s): this might seem obvious, however, it is not unheard of for the building contract to be terminated under grounds other than insolvency.

It is important that all grounds of termination allowed under the contract are notified or there may be issues in enforcing bonds and PCGs.

Also, ensure the correct termination procedure is followed as stipulated in the contract.

7. Negotiate: (i) with all stakeholders (liquidator, sub-contractors, suppliers, etc.) and (ii) a new contract – as quickly as possible. The terms may not be ideal, but all delay will be costing money.

8. Collateral warranties and subcontractors: consider using the step-in rights in your collateral warranties from the supply chain to step into the shoes of the contractor and protect against sub-contractors and consultants walking away from the project. This should form part of the process of securing the site.

Alternatively, you may decide not to do so, as typically, doing so may make you liable for outstanding fees. Particularly if those fees are substantial, you may choose to engage an alternative or negotiate a new arrangement.

Again, check the procedure and time limits within the warranties for doing this.

9. Upstream and downstream documents: be ready for attempts to avoid these. Ensure you comply with them, so as not to give any reason for funders and future tenants/purchasers to terminate agreements relating to the project.

10. Final account: keep a complete record of the payments made to the contractor up to the date of termination. This will assist you in preparing a final account after completion. Check the final account provisions as regards an insolvency as they are likely to be different to the normal final account provisions.

Very often, employers take the view that the insolvency scenario will never happen to them or that the security (bonds, PCGs, collateral warranties and PII) will protect them. Unfortunately, the security usually serves only to limit the losses or prevent a project from making a loss. The reality is that that the hard work of renegotiating contracts and getting the project up and running will fall to the employer, as will the cost, on the whole.

Finally, the key point is to do your due diligence – the lowest tendered price may be only superficially attractive.