Employer insolvency hurts – but thinking ahead can help spare contractors some of the pain
AS WE KNOW, IF MONEY CASCADES DOWN THE construction supply chain, then so does bad luck when the client goes bust. It's difficult for suppliers to protect themselves fully against the consequences of insolvency, but the more streetwise firms can minimise their suffering.

So, here's a guide to the pre-emptive action a contractor can take, either while negotiating the contract or during its lifetime …

  • Use your commercial nous Before entering into a main contract, you should consider the financial position of your employer and take a view on the project's viability. You can look at, or ask for, credit agency report and audited and/or management accounts; check whether the company is a "one-project" company and where it was incorporated; and consider whether it is operating in a vulnerable sector. If appropriate, you can obtain a bank reference.

    In addition, the you should consider some general business issues. Does the project makes commercial sense? Has it been pre-let or pre-sold? Who are the funder or funders and what are the terms of their finance? Finally, do the people on the other side of the table look like they know what they are doing?

  • Use the law Contractual terms should be negotiated to protect your position – in particular the rights of determination upon insolvency and rights to determine or suspend work for non-payment. And you should consider whether security for payment is appropriate – for example, a letter of credit, a parent company guarantee or a payment/performance bond.

  • Be vigilant Once the project is under way, look out for warning signs. Are there delays in payment? Or is payment less than invoiced without explanation? Are cheques post-dated? Is the work being undercertified? Is the employer trying to overcertify? Are there variations to downgrade the specification or scope? Are there attempts to set off/levy damages?

  • Take evasive action All these factors point to an increased risk of insolvency. If you experience them, you should think about pre-emptive action to limit your losses and exposure.

    Nobody enters a contract believing insolvency will happen– but it does. Be aware of it from the start and be alert when you see the signs

    First, you should establish rights of set-off and exercise them, or give early notice of the intention to do so, and check that retention cash has been placed in a separate trust account. If it has not, insist upon that happening immediately.

    Next, ensure that all invoices have been rendered and payment made, and if not, hassle the employer. If effective and appropriate, you could even serve a statutory demand or winding up petition for your money. If the contract permits, you could consider downing tools or withdrawing from site.

    From a practical point of view, ensure that all high-value materials are brought to site only if necessary and if clearly tagged and identifiable. The contractor could reduce or slow down work where possible, but not so as to place them in repudiatory breach and/or contractual default.

  • If the worst happens When the employer does declare itself insolvent, contact the architect, the QS and engineer, the lender (if possible) and the insolvency practitioner. Inform the insolvency practitioner of any retention of title claims and give evidence. It should identify the type of formal insolvency as this will affect the impact it has on you.

    On a practical level, you should maintain a site presence to avoid being in breach of contract – and also to keep an eye on what is happening. You must also clarify your contractual position – for example, rights of determination and suspension of works. Invoices will need to be up to date and all materials on site, off site and any uncertified work in progress will have to be valued. You should estimate how much it would cost the insolvency practitioner to complete the project or to mobilise an alternative contractor.

    Insolvency will have a knock-on effect on subcontracts, so you should establish whether a right to determine those subcontracts has arisen, what the effect of such determination would be, and the impact of insolvency on your own payment obligations.

    • Postscript

    Alison Cull is a senior associate at Masons specialising in insolvency law.