Trouble in the supply chain? Sub-contractor insolvency and insurance

Trouble in the supply chain? Sub-contractor insolvency and insurance

The slowdown of the UK’s construction activity in March 2020 was the fastest decline seen since the 2008 financial crisis.

With the UK government having already announced that it will be introducing changes to the insolvency regime in England & Wales, as part of its response to COVID-19, there is a clear indication of what is expected to come. Our general guidance on managing the increased insolvency risk arising from this period of disruption can be found here.

In the construction industry, as cash flow issues bite, the downturn is likely to result in the insolvency of many sub-contractors which, in turn, will see the risk carried by the contractor. Last month a survey from the Federation of Master Builders found that two-thirds of SMEs in the UK construction industry will not last more than two months, unless the government gives them cash grants.

What contractual protection might exist under the construction contact?

Where there has been a sub-contractor insolvency, and the works are ongoing, contractors may have a contractual right to terminate as a result of the sub-contractor’s insolvency. Other options include making calls on any bonds available, or contacting any guarantor to complete the outstanding works.

It is also commonplace for sub-contractors to provide collateral warranties in favour of employers, or other third parties such as a funder (albeit, a collateral warranty is only as robust as the contract to which it relates).

Concern over the potential for costly and long-running disputes involving construction industry participants has prompted the Construction Leadership Council COVID-19 Task Force to publish practical guidance on how to minimise potential disputes. This follows the release of government guidance on responsible contractual behaviour in the performance and enforcement of contracts; “responsible and fair behaviour is strongly encouraged” in relation to matters such as granting relief for impaired performance, granting extensions of time and making payments.

What about the possibility of a recovery under a professional indemnity policy?

Professional indemnity policies will usually exclude cover for losses connected to any claims arising out of, or attributable to, the insolvency of an insured sub-contractor. For example - a claim for unpaid work on a construction project solely as a result of an insured sub-contractor’s insolvency will not be covered under a PI policy.

In Crowden v QBE Insurance, in holding that an insolvency exclusion in a professional indemnity policy applied, the judge found that the insolvency did not need to be the proximate cause, but that it had to “stand out as a contributing factor” to the claim.

The position is, however, different when a negligence claim is brought against an insolvent sub-contractor, such as for defective design. Here, the claim could still be covered, in principle, on the basis that the insolvency had no bearing on the sub-contractor’s negligence. This will, of course, depend on the facts, and will be subject to other policy terms and conditions.

In terms of the practicalities of bringing a claim against an insolvent sub-contractor, if insurance is in place, a third party can bring a claim directly against the sub-contractor’s insurers in accordance with the Third Parties (Rights Against Insurers) Act 2010. This is a major change from the earlier 1930 Act, where the insured’s liability had to first be established (either by a judgment or an arbitration award) before a claim could be brought.

The third-party claimant will still need to establish the insured’s liability, in the usual way, in the action against the insurer, but this will now only be in one set of proceedings. It is also important to remember that third party claimants are still subject to the same policy terms and conditions that would have applied to the insured sub-contractor. This means that any claim could still be blocked from proceeding on policy coverage grounds.

Comment

Some are speculating that given the current uncertainty in the construction market, and the easier route to pursuing insurers under the 2010 Act mentioned above, there could be a surge in construction related insurance claims.

Although that may well be the case, insurers will have the ability to scrutinise claims and contest liability at an earlier stage, which could reduce the number of speculative claims. We will have to wait and see. These are unprecedented times, and we are closely monitoring the position.

 

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About the author:


Jonathan is a Partner at Simmons & Simmons. He specialises in defending professional indemnity claims against construction professionals (including architects, engineers, and surveyors) and major contractors. He also regularly advises on complex, high value coverage disputes for London market insurers.

Jonathan has experience of a wide variety of construction disputes involving iconic buildings, sports grounds, schools, hospitals, large residential schemes, commercial/retail and waste to energy facilities. 
 
His caseload routinely involves mediations and litigation (generally in the Technology and Construction Court), and he also has arbitration and adjudication experience.
 
Jonathan has undertaken a year-long client secondment at a major international Insurer, which provided him with invaluable first-hand experience of the insurance market.