By Linzi Hedalen, partner and Bruce Hale, counsel at Dentons UK and Middle East LLP
It has been widely reported that the construction industry made up 17% of insolvencies in the UK in 2023, making it the largest affected sector. As we hurtle through the start of 2024, we are continuing to see a trend of construction companies, including big names such as Stewart Milne, calling in the administrators.
Administration is devastating news for any company and its faithful employees. It can also spell bad news for those left behind on projects, being the employer, sub-contractors and suppliers.
Focusing on the plight of the employer, we consider what it should be doing in the early days to protect the project, as well as thinking ahead in terms of completing the works and recovering losses.
Early days
Depending on the wording of the contract, once a contractor is in administration, there are a number of issues that an employer should be quick to deal with. Generally, these include:
- Ensuring the site is secured and that any works are made safe. This is followed by ensuring the site and the works are properly insured to cover injury to those accessing the site or damage to the unoccupied works;
- Taking an inventory of materials;
- Valuing the works as at the date tools where downed to assist in calculating what is owed to the insolvent contractor;
- Issuing any pay less notices required under the building contract; and
- Notifying lenders and putting guarantors on notice in terms of possible claims under performance bonds and/or parent company guarantees and making a claim to the administrators as an unsecured creditor.
Completing the project
Thereafter, with a half-built project on its hands, and funders concerned about finances, the employer will be quick to turn to the issue of what to do with the project whilst minimising costs and losses.
Generally speaking, there is no obligation for the employer to finish the works. However, often the employer will want or need to complete the project.
The options for completing the project are typically:
- For the employer to exercise its rights under collateral warranties to step in to the appointment agreements with consultants and sub-contracts; or
- To appoint a replacement contractor.
Which option to proceed with will largely depend on the employer’s skillset and risk appetite; the extent to which the works are incomplete; timing; lender approval; and the extent to which the employer benefits from a full collateral warranty package with step-in rights.
If the employer elects to proceed with the first option, then it is effectively taking on the procurement of the project from the contractor and stepping into the contractor’s shoes under each sub-contract and consultant appointment. This does not come without risk, but may be desirable in certain circumstances. However, we have rarely seen this option used in practice.
Most employers tend to proceed with the second option and appoint a replacement contractor to complete the project. Various issues ought to be considered when appointing a replacement contractor, such as the following:
- Termination of the insolvent contractor in accordance with the terms of the building contract.
- Completion of the project generally should be subject to a tender process so that the employer mitigates its losses and achieves a market rate for procuring the completion of the project. However, this may not be possible if time is of the essence.
- A key issue will be the extent to which the replacement contractor will assume the risk for the existing works. Unless the replacement contractor can appoint the same design team and same sub-contractor team, or a hefty premium is paid, it is unlikely that a replacement contractor will agree to assume this risk.
- The employer may wish to nominate existing consultants and sub-contractors as named sub-contractors in any tender and require that the replacement contractor appoints such consultants and/or sub-contractors. This may be beneficial from the perspective of continuity and liability.
- The employer should assess the extent to which it can transfer a copyright licence in the design for the existing works to a replacement contractor.
- A condition survey of the existing works should be undertaken before the replacement contractor commences works on site. This should avoid disputes about whether damage to the existing works has been caused by the replacement contractor.
Costs and future protection
Regardless of which option is selected, it is very likely that there are going to be costs and losses incurred by the employer in completing the project. Provided that there are performance bonds and personal guarantees in place, and timely notice has been made, there may be options to recover these sums under the securities. There may also be recourse through retention monies and any dividend paid to unsecured creditors of the insolvent company. Records of all decisions, and costs and losses, should be retained for these purposes.
In terms of future concerns, latent defects insurance may be appropriate for the employer. This is often expensive to procure, but it provides comfort to owners, purchasers and funders should a defect become apparent.
Conclusion
The insolvency of a contractor often throws up a myriad of issues for the employer. The above is only a high-level summary of some of the issues to be considered. It is advised that employers retain specialist legal advice as soon as the insolvency is announced to ensure they are exercising their rights correctly and protecting their position as far as possible.
