Going bust during the build

What happens when a contractor goes bust during the build? William Webb, a barrister at Keating Chambers, examines the legal and practical implications of contractor insolvency.

What are the legal implications if your contractor goes bust during a project?

The legal implications of a main contractor going bust are relatively simple:

  • first, it will stop carrying out any work--this will be a breach of contract between the employer and main contractor
  • second, it will stop paying its sub-contractors--this will be a breach of contract between the main contractor and sub-contractor

Unfortunately, those breach of contract claims may not be worth very much.

How should a contract be structured to protect a developer against contractor insolvency?

There are two or three key structures that can be put in place to protect against contractor insolvency and they are generally standard on most large projects.

One common option is a performance bond so that money can be claimed from a guarantor bank at short notice, often simply on-demand.

A second option is to obtain a parent company guarantee--this is useful where a large contractor is using a regional subsidiary or special purpose vehicle to carry out a project.

A third and very common option is to obtain collateral warranties from as any many different people engaged on a project as possible. This will enable a direct claim to be made against these people in the event of a problem arising. However, these normally don't take effect until conclusion of a project. Thus, they are useful in the event of latent defects, but are of limited use if a main contractor becomes insolvent in the middle of a project.

Unfortunately, none of these options is a magic panacea. There is no way for a developer to completely insulate itself from loss flowing from contractor insolvency which is why the selection of the contractor in the first place is probably the most important step of all.

Does the loss of a contractor have knock-on effects on the other features of the project?

There is no inherent reason why the loss of a contractor should affect the end product being delivered. If the design was good to start with, the replacement contractor should be able to complete to the same specification. The only problem which can arise is that it may be difficult to work out who is to blame later on if a latent defect is discovered.

By contrast, the loss of a contractor will almost inevitably affect the timely delivery of the project. For a start, it is common for the insolvency to be preceded by a period during which fewer and fewer people turn up on site to carry out the works because the contractor is trying to cope with fewer staff or unpaid sub-contractors have started to walk away. Then, when the insolvency occurs there will be a period of no progress whatsoever. A replacement contractor will then need to be found and a basis for payment of that contractor will need to be agreed (probably on a cost-plus basis) before any work is carried out. Any new employees or sub-contractors will then need to get up to speed with the state of the development to date.

The only way in which you sometimes see a substantial delay avoided is if the developer steps in to take over all the sub-contracts to ensure sub-contractors continue to attend site to carry out the works. This can be a useful temporary solution to keep the project on track but a lot depends upon the amount of sub-contract labour being used and it generally comes at a price. It is only a short-term solution, unless the project is very near completion.

Does the position differ depending on the type of project?

The general legal position is unaffected by the type of project, but the risks of contractor insolvency do vary. While at the height of the economic downturn there were some big names going under, as a general rule the larger more well-known construction companies are less likely to become insolvent. They tend to have in place experienced quantity surveyors who will make sure they do not under-price a contract and a single project that goes wrong will not ordinarily be sufficient to cause irreparable damage to their balance sheet. By contrast, a lot of smaller firms carrying out residential projects don't have enough working capital to weather the storm of a single project going badly wrong.

Where do developers stand in the list of creditors if a contractor becomes insolvent?

Developers ordinarily won't rank very highly in the list of creditors. Invariably they will be simple, unsecured creditors, meaning they are about as low down the pecking order as you can be. Secured creditors (those with a charge over an asset, such as a mortgage over a property) and preferential creditors (employees who have not been fully paid) will rank ahead of an unsecured creditor. The firm administering the insolvency will also take their fees out. By the time all this is done, there isn't normally much left for the unsecured creditor and it will be some time before they can get their hands on any small amount which may be available.

William Webb has a busy specialist practice in all aspects of construction, engineering, energy and private finance initiative disputes including claims relating to payment, defects, delay and disruption and professional negligence. He regularly appears in the Technology and Construction Court, where he has a wide experience of both trials and interim applications. William also has a broad international practice having been involved in arbitration claims relating to projects in the Middle East, Africa, Singapore and Russia.

Interviewed by Kate Beaumont.

This article first appeared on Lexis PSL Construction

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

 

 

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