How to deal with the growing problem of contractors going insolvent during a project

So, what can an RP do to protect itself against this happening on projects? The obvious thing is to carry out financial checks on contractors prior to entering into contracts, but these can only provide limited information. Remember that financial figures available on Companies House are outdated, as companies are generally obliged to file accounts one year after the end of its financial year.  

Another option to consider is what security an RP can obtain from the outset: this can be by way of parent company guarantee if a contractor is part of a larger group of companies, or through a performance bond, which is an insurance-backed guarantee that compensates the RP in case of contractor insolvency. 

In addition, an RP ought to ensure it has warranties in place with key designers and sub-contractors, and consider including step-in rights in those warranties. Step-in rights allow a developer or an RP to step in and take over the sub-contract if a contractor goes insolvent. 

There are several warning signs you should look out for that could suggest your contractor is in trouble. If a contractor starts asking for more money in relation to materials, or seeking extensions of time in circumstances where not allowed under the contract, then this should be a red flag.

If the contractor uses terminology such as “viability of the project”, then you may need to be concerned. 

Another key warning sign is if sub-contractors approach you directly asking for payment, saying they haven’t been paid by the contractor, despite the RP having paid the contractor for those works.

If a contractor is in financial difficulty, it may shore up its own position rather than pay its sub-contractors. 

If you are in a scenario where a contractor has become insolvent mid-project, then the first thing you need to do is look at the contract to see the remedies you have available.

Most standard form contracts, such as Joint Contracts Tribunal (JCT) contracts, will allow you to terminate your contract with the contractor, but you need to pay close attention to the definition of insolvency under the contract. 

The second thing you need to do is make provision to take over site security and insurance of the site. This is to avoid materials, plant and/or equipment being removed or damaged and protect the site in general. You will need to accurately record the work carried out by the contractor to date, usually by procuring a site condition survey. 

This is essential to avoid any potential arguments about the value of work carried out by the contractor and will be needed for any onwards claim (for example, against a performance bond).

“In a climate where the risk of contractor insolvency is high, it is fundamental that RPs protect themselves at the start of the procurement process”

In this situation you may find sub-contractors coming to you directly for outstanding payments. 

This risks the RP paying twice: paying the contractor under the main contract, but the contractor not passing payment on. 

Resolving this largely comes down to commercial factors and should be judged on a case-by-case basis.

A key factor here is how important the sub-contract works are to the completion of the project. If it would be difficult for another sub-contractor to take over the existing work, or would affect a warranty for the work, you may wish to consider biting the bullet and paying twice. 

This is usually the case for highly specialised areas of work, such as mechanical and electrical packages. Where the works are less specialised, the RP may take the opposite view and may decide not to pay and insist the sub-contractor pursue the contractor for outstanding sums. 

In a climate where the risk of contractor insolvency is high, it is fundamental that RPs protect themselves at the start of the procurement process and recognise the warning signs of contractor distress. Only then will you be able to mitigate a worst-case scenario of a contractor going insolvent during your development. 

Karen Morean, partner, Devonshires