The Spectre of Contractor Insolvency

7th March 2018

The current Carillion liquidation throws into sharp relief one of the key risks on a major capital project for a school or college – contractor insolvency. The construction industry is notoriously competitive and run on tight margins, often with cash flow problems which, combined with the Brexit hesitancy, high materials and labour price inflation lead to precarious positions for SMEs. So what should a well advised organisation do to manage the risk?

The starting point is understanding the risk. A contractor insolvency is multi-faceted:

  • Delay and impact on timetabling: On the run up to an insolvency, a contractor will often start dragging its feet as it struggles to resource materials, pay the wages (and has to reduce the amount of labour on site) and get sub-contractors (subbies) on site or to stay. Then you have the delay of trying to resource a new contractor.
  • Cost. The new contractor will want more money to complete a half finished project and understandably so. Also the subbies and consultant will threaten to quit the site if they don’t get paid – often meaning that you pay twice for the same work.
  • Health and safety risk. Desperate subbies may try to gain access to site out of hours to get their materials, equipment and tools back. The fencing won’t be maintained and site will not be secured.
  • Defects. It is highly unlikely that the new contractor will accept responsibility for the old design, materials and workmanship. It won’t be covered by their insurance and they will not have any knowledge.  This means the organisation will have no-one to turn to, to cover the cost of repairing any defects that materialise in the future

So what can you do to try to prevent this happening?

  • Due diligence, including financial health checks, before and during a project from Companies House and through talking to contacts or those who have used the contractor previously.
  • It is imperative that a good set of contracts are put together before any building begins. This will go a long way to protecting the organisation should things go wrong
  • Ensuring that contractors are paid regularly, on time, and that payments are passed down the line will also safeguard against an unfinished build. In this climate, a decent contract backed up by a good quantity surveyor will be time and money well spent.
  • Should the risk arise that the employer or contractor (in the case of subcontractors) could fall into financial difficulties, then it is necessary to seek advice at an early stage.
  • Have step-in rights in your warranties with the key sub-contractors and consultants so you can keep most of the team on site at no extra cost.
  • Consider project bank accounts so you know the money will flow down to the sub-contractors and suppliers.
  • For big supply contracts or subcontract packages or those with long lead-in times (such as steel frames, large bespoke glazing packages etc), ask for a vesting deed direct with the supplier so you know you will get title in the goods when you pay the contractor.
  • Performance bonds and guarantees are also valuable tools and a useful form of security. Bonds are normally at 10per cent of the contract sum.

The signs will always be fairly transparent: delays in the works, low levels of manpower and dubious payment applications are all evidence of a contractor struggling financially. Early conversations with your contractor may help both of you get to practical completion safely.

Even if your worst fears are confirmed and the contractor enters into an insolvency situation, it will not necessarily mean an end to the matter and contracts will not automatically be terminated as a result. It is therefore still possible to take prompt action to maximise the recovery of monies due to you.

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