Consultant at national law firm Roythornes Solicitors, Derryn Rolfe, explains how construction clients can prepare for all eventualities as insolvency remains rife across the industry
Construction company failures in September 2023 were 40% higher than in September 2022; administrations were 54% up this year on the same period last year, and the industry press has been full of further insolvencies since.
Some big names have gone, with their supply chains going as a consequence, and the projects they were working on suffering delays and additional costs. Some builds become economically unviable due to the additional costs and some are so delayed that the market changes.
There is no upside, but there are means of improving the position for all those affected, and there are a number of strategies that can be put in place to minimise the risks.
Protecting cashflow and contracts
For contractors, it’s all about cashflow, and that can be protected in a number of ways. First, by credit-checking clients. Contractors are actually extending a line of credit to their clients for a month or more, on every project, every month. Some basic due diligence on the likelihood of getting paid would be sensible before even looking at the tender.
Secondly, the contract terms should be considered very carefully. If the tender says that the contract terms will follow later, or that the client’s solicitor or the bank’s solicitor may amend standard JCT terms, for example, then that’s red flag. Amending published contracts is not the problem: what is the problem is not having the proposed terms with the tender. It is impossible to price your risks unless you know what your liabilities are, and what the payment periods are, and whether advanced payments will be made, or what sort of retention will be required.
Once you have the contract terms, you need to take advice on their impact on your cashflow. The Housing Grants, Construction & Regeneration Act 1996 – as later amended – gives contractors the statutory right to interim payments for projects over 45 days duration; if interim payments are not explicitly included then they will be implied into the contract by the Act. The Act, via the Scheme for Construction Contracts, will also imply into the contract due and final dates for payments, and procedures for ensuring certification of applications. If the contract is silent then the period between the due date for payment and the final date for payment is 17 days.
Make sure you read the fine print of each contract
Many clients prefer to use their own standard T&Cs, and these never take account of the legislation. If that is what is provided with the tender, then you can either challenge it immediately or just let statute override them.
The thing to remember is that whilst the legislation will protect you from terms that are completely non-compliant, if the procedures are compliant then you won’t be protected from 90- or 120-day payment periods. That’s down to you to negotiate, or to withdraw from tendering if the risk to your cashflow is too high.
For developers, the most important action is to pre-qualify potential contractors, undertaking rigorous credit-checking and taking references. Novel technologies, start-ups and companies moving outside of their core work areas are all unnecessary additional risks – and this doesn’t just apply to main contractors.
Whilst housebuilders rarely use main contractors, losing one trade crucial to the critical path of the programme will have a disastrous knock-on effect for the others, and the same applies to sub-contractors working for main contractors. Knowing who you are dealing with, building up long-standing relationships, and prompt payment will go a long way to mitigating the risk of losing suppliers of any tier in the case of a construction related insolvency.
Precise documentation is vital
As for contractors, the other most important issue for developers is the contract documents. The developers need to ensure, first, that these are supplied in full and in the greatest detail possible to tendering contractors, and that they properly address and allocate the various risks to the party able to manage them. Agreeing a deal and then sending out the legal documents is the quickest way known to mankind of the price going up.
For both sides of the contractual fence, the documents themselves need to be clear, consistent and certain. Contracts don’t have to be fair – the contractor will simply price for the risks – but they should not contain loopholes, and when considering insolvency potential this is particularly in the termination clauses.
Make sure to clearly outline terms around construction insolvency
It is essential that the insolvency is a reason for termination, without notice, and that the definition of insolvency is not limited to the other party entering into formal insolvency proceedings. Both parties need to be able to terminate on reasonable grounds for suspicion of insolvency, to minimise both delays and losses for the developer and for the contractors the problem with being required to continue working while the likelihood of getting paid increases.
Finally, the documents need to include the best forms of security that can be agreed. For developers these should include collateral warranties, which give the beneficiary the right to sue sub-contractors and the contractor’s designers for defects in the event of the main contractor going under, and a range of bonds and/or guarantees.
For contractors, they should consider requiring a parent company guarantee if the client is a single purpose vehicle, for requiring a retention bons instead of cash retention, and for requiring advance payment for goods and materials.
The developer may require an advance payment bond, or vesting certificates for advance payments, but this is often better than being stuck with materials that haven’t been paid for, can’t be used elsewhere or returned to the supplier.
Different warranties serve different levels of protection
For developers, at the one end of the scale are manufacturers’ product guarantees for goods or systems, and at the other are parent company guarantees, performance bonds, and advance payment bonds. Of these, the most likely to be poorly-drafted or lacking the backing of a solid insurance policy are the product guarantees, which also often cannot be assigned or are dependent on particular maintenance protocols.
Parent company guarantees from contractors or sizeable specialist sub-contractors are excellent – if a parent exists of course – and can be in the form of a cash payment or the parent company completing the works. The risk with an insolvency scenario, of course, is that the parent company may also go under. Performance bonds, backed by commercial bondsmen such as banks or insurers, are therefore more reliable but getting the wording right is essential to ensure that they can be called in.
For contractors, collateral warranties being given to funders, investors or purchasers need to contain step-in rights provisions, so that if the developer goes under the beneficiary has the right to step into their shoes and complete the build.
The risk of insolvency in construction can never be fully eradicated- but you can be fully prepared for it
It is essential that the quid pro quo for giving that right is that the person stepping in can only do so if they pay any outstanding money due from the developer.
Ultimately, it is not possible to prevent insolvency from affecting any project the companies involved in completely. All that can be done is to take all steps possible and keep an eye out for behaviours that might mean that the other side is heading for trouble.
