Contractor insolvency: advice for employers

With firms in the construction sector continuing to face tough conditions, the industry saw the highest number of insolvencies out of all sectors in 2023, and the trend is set to continue. 

When a contractor goes into insolvency it’s a stressful time for all involved and employers often need to take quick action to keep a project going. 

What should you be considering in the immediate wake of an insolvency? This guide provides the steps for employers to take when a contractor goes into insolvency.

On report of insolvency

It’s often the case that there will be rumours about a contractor’s insolvency in the run up to formal insolvency events occurring. However sometimes these rumours are just that and no administrator or liquidator is appointed. 

When rumours start, and even if you are verbally told by the contractor themselves, before taking any action, verify what insolvency event has happened. This can be done through filings at Companies House or ringing the Petitions telephone line or asking for written confirmation from the contractor in question. 

Once insolvency confirmed

Once insolvency is confirmed, check your contract! The position relating to an insolvency event differs between contracts. Having a clear understanding of your contractual rights, and observing any notice requirements, is crucial when responding to an insolvency.

When reviewing your contract, you should immediately consider the payment obligations following insolvency. Most construction contracts will provide that an application for payment doesn’t need to be paid if the contractor goes insolvent after the last date for a pay less notice but before the final date for payment. However the timings rarely work out so conveniently. 

As such, once insolvency is confirmed, ensure that a pay less notice is issued to withhold from any sums due to the contractor, the potential additional costs to be incurred to complete the works and/or rectify defects.  

Once any pending application for payment is dealt with, you should then consider immediate steps to protect the site. If the insolvency threshold under the terms of the contract are met, most contracts will set out that even before a termination notice is issued, the contractor is no longer responsible for the site and the employer can take possession. At this point, an employer will need to consider:

1. Taking over insuring the site, communicating with the contractor is key to understanding when their insurance will lapse and when the employer’s cover needs to be in place.
2. Appointing a security firm to ensure a procedure is in place to prevent unauthorised removal of plant or materials from site.
3. Any health and safety steps to be taken. Is the site safe? 

With a safe and secure site, the next step is to take stock of where the project is:

1. Consider whether there are any provisions in the contract which deal with the retention of title for on and off-site materials. This will establish who takes ownership of these in an insolvency situation. If possible, carry out an audit of the on-site plant, equipment and materials (with photographs and written records) and follow up with administrators for delivery of any off site materials that have been paid for.
2. Keep a record of materials and plant on site and progress of the works including photos.
3. Carry out a detailed valuation of the works by a quantity surveyor so that there is a clear understanding of the value of the works carried out by the contractor up to the point of leaving site.

In the immediate to short term

Once the site is secure and the current status of works confirmed, you can now move your attention to how to take the project forward. It’s always best to engage with administrators or liquidators early to explain your project and intentions going forward as they may be able to assist in securing materials off-site and liaising with subcontractors if any are to be retained. 

The immediate to short term steps to consider include:

1. Exercise rights under any parent company guarantees or bonds.
2. Consider termination of the building contract and progress steps to appoint an alternative contractor to complete the works. Any claim for additional completion costs will be subject to a general duty to mitigate your loss and therefore any replacement contractor’s price should be carefully considered as to whether it’s reasonable.
3. Check whether you have any collateral warranties/third party rights in place and start dialogue with key sub-contractors. You may also consider stepping into certain subcontracts to facilitate completion of key areas of work. However, be wary of subcontractors asking for payments to be made directly to them before you step-in to the contracts. If a payment is made directly to a subcontractor outside of the insolvency process, the administrators or liquidators can still require that payment to be made to the insolvent contractor in effect resulting in an employer paying for the same works twice.
4. Keep a detailed record of all costs being incurred by reason of termination, defects, etc and of any market testing of costs to be incurred with a view to the intended claims in the administration.

Longer term

Once you’ve terminated the insolvent contractor and appointed a replacement, focus can return to completing the project. Once completed, a final account process will need to be undertaken to assess whether any sums are due to the insolvent contractor, such as retention, or whether in fact the employer has further costs to be reimbursed. 

The employer will then need to submit its claims to the administrators or liquidators with supporting documents evidencing the costs incurred, and how much this is over and above what would have been payable to the original contractor had they completed the project. 

Whilst it’s often unavoidable that an employer will be left out of pocket in an insolvency situation, taking the above steps, ensuring timely pay less notices (indeed, even prior to insolvency ensuring no overpayments are made) and utilising all contractual mechanisms available, can help minimise the time and cost impact of an insolvency. 

Information 

Dealing with potential and actual contractor insolvency can be complex. If you would like to discuss any of the issues referred to in this article please contact Lianne Edwards or Sian Barrett.

If you would like information about amending standard contract wording to provide enhanced protection in the event of an insolvency situation, please don’t hesitate to contact Laura Reeve.