Insolvency: When contractors go bust – how to prepare for the worst

In this article, our solicitors at Humphries Kirk explain issues that can arise when building contractors become insolvent. This includes contractual safeguards which developers can add to their advantage.

What is insolvency and why does it affect me as a developer?

There are various definitions but a company or individual is insolvent when it is unable to pay its debts on time. In the case of building contractors insolvency tends to mean that they are unable to buy materials and pay employees and subcontractors. Quality of performance tends to slide and projects typically fall behind schedule until they grind to a halt.

Should the contract end upon insolvency?

You should seek a ‘right of termination’ in the event that your builder becomes insolvent. Where possible, avoid ‘automatic termination clauses’ as it might be preferable to keep the contract alive in order to start a dialogue with the builder’s insolvency practitioner and strike a deal to see the works completed.

Employing alternative contractors

Ensure that you have a right to employ an alternative contractor and to set-off the cost of doing so from funds owed to your insolvent builder. Include provisions in the contract so that no costs are payable to the insolvent builder until after the works have been completed.

Collateral warranties and third party rights

Obtain collateral warranties or rights from key sub-contractors and professionals who are employed by your builder. Collateral warranties in this context are contracts where the professional or sub-contractor warrants to you the developer that it has complied with the terms of its appointment or sub-contract with your builder. They are important because they create a contractual link so that you or your successors in title have the right to claim against them if their work is defective.

Collateral warranties will typically include other important provisions such as the right to use design drawings and plans which may be essential in order to complete the project. They usually come with a requirement that the party giving the warranty carries indemnity insurance to cover your losses in the event of negligent performance.

Employing sub-contractors of the insolvent builder

It is often attractive to employ sub-contractors and professionals who were previously employed by the insolvent builder in order to ensure continuity and to minimise delay and cost. Bear in mind that insolvency rules are complex. Care is required to avoid incurring liability to both the sub-contractors and the insolvent party for work carried out under your instruction.

Materials

Ensure that there are provisions in the main contracts and the sub-contracts which provide that you own title to goods on site, whether or not they are incorporated into the works and, where possible, off site as well.

Financial checks

Check the financial standing of the other party. Insolvency of a contractor or employer usually causes the other party substantial additional cost. Where in doubt seek third party security or alternative options.

If you require further advice from Humphries Kirk please contact your local office by clicking here.