In the last of our series on how the credit crunch is affecting construction firms, we look at how to minimise the damage from terminating a contractor’s engagement

A previous article in this series looked at how you go about terminating a contractor’s involvement in your project in the event of insolvency, and some of the challenges you face when doing so. This article looks at the fallout once you’ve terminated and what you might do to protect yourself against some of it.

One of your key concerns will be to get on site as quickly as possible, take possession of it and make sure it is secure. What you do not want is suppliers removing goods and materials that you have already paid for. Whether the supplier has retained title in the goods in question can be a complex issue but if you have secured them your negotiating position will be stronger.

If you have paid for off-site goods, you will need to check that they have been stored separately and labelled as belonging to the project; you should also check what vesting certificates and bonds are available.

Another issue that will arise is how to deal with the split of liability between the old contractor and the new. The old contractor will still be liable for the work it has carried out, but if it is insolvent it will have no assets against which any decision on liability can be enforced.

None of the options for dealing with this are particularly attractive.

You could ask your new contractor to check and verify the work carried out by the old, and to assume responsibility for it. The new contractor is unlikely to accept this, however. Even if it does, it will ask for a hefty premium to accept the risk.

An alternative might be to take out latent/inherent defects insurance. However, if it is taken out late in the construction process it is likely to be expensive. In addition, any such policy will not cover all types of defects and losses.

If you have taken warranties or third-party rights from key subcontractors then these might provide you with a right of recourse in the event of defects. They will not provide an overarching warranty which covers all types of defects and losses, so you will take the risk of any gaps in cover.

You will, of course, suffer losses from the termination of the old contractor’s engagement, including the additional costs of having to get the works completed by a new firm. Most forms of contract will entitle you to claim these sorts of losses from the old contractor, but, as noted above, that is going to be of little help if it is insolvent.

Claiming losses is going to be of little assistance where the old contractor is insolvent

If you have some security for the performance of the contractor’s obligations, such as a parent company guarantee or a performance bond, that might assist.

A parent company guarantee would generally entitle you to recover from the guaranteeing entity any losses triggered by a breach of contract by the old contractor. Insolvency is not usually of itself a breach of contract (see Perar vs General Surety and Guarantee) so you would not be able to claim for losses immediately on occurrence of insolvency. The breach of contract normally arises once you have claimed the balance owing to you following completion of the works and the old contractor fails to pay those losses. You will need to fund payments to the new contractor in the meantime.

A parent company guarantee will, of course, be worthless if the whole group of companies has become insolvent.

A performance bond does have the advantage of being given by an entity outside the contractor’s group of companies so you have more chance of the surety still being solvent (although this is not certain in the current economic climate). However, it may be of less value to you because, typically, it is limited to a percentage of the contract sum under the old contractor’s contract (normally 10%).

In addition, there are likely to be barriers to making a claim. For example, the point that insolvency is not, of itself, a breach of contract is likely to apply to most forms of performance bond, so you are likely to face a delay in being able to make a claim for your losses.

The bond will also contain an expiry date, which could occur prior to your claim crystallising.

The risks consequent on a contractor becoming insolvent can be severe for you and your project. And, unfortunately, successfully minimising those risks is not easy.