Patrick Holmes - Stock market dives have sparked fears of recession. So, if the economy does turn down, who's going to lose out? And what can they do about it?
The construction industry has had a pretty prosperous few years. But things are changing. Stock markets are in turmoil and the economic gloom-merchants are having a field day. Unfortunately, if the economy does turn down, it is likely that construction will see a number of insolvencies. These arise in relatively good times (remember Longley) and I shall be surprised if we avoid them in bad times.

If contractors go bust, performance bonds will come under the microscope again. Bondsmen paying "on demand" is rare. The Association of British Insurers' model form, which is widely used, requires you to prove a default by the contractor and prove the loss suffered as a result. Sometimes it is possible to amend this so that it may be triggered on demand in insolvency situations. If it is not, you may get your money eventually, but you will first have to suffer the cost and delay of proving your entitlement. In the mean time, if you wish to complete your project, you will have to fund it yourself.

One might hope that parent company guarantees are less of an issue. Good corporate governance might dictate that a parent should not allow its subsidiary to collapse leaving third parties out of pocket, but it does happen. How far up the family tree is the parent company whose guarantee you obtained? Often, companies in between the operating companies and the ultimate holding company are of little or temporary substance. Their wealth is also subject to manipulation (deliberate or incidental) if a group restructuring occurs.

Have Latham, Egan and all the other great ideas really changed things, or are they just a wig that will be blown off in the cold wind of recession?

Are there any current projects where the contractor agreed to procure a guarantee or bond but this has not been done? Remember the Chiemgauer Membran vs New Millennium Experience case in 1999 – the provision of a parent guarantee and bond was expressed as a precondition to any of the employer's obligations (including obligations to pay) under the contract. However, because the employer had operated other aspects of the contract, even though the parent guarantee had not been provided, the condition was waived – the employer had to pay the contractor. The moral: get the bond and guarantee now or ensure the sanctions for not providing them are carefully drafted so that no bond really does mean no payment.

Like it or not, we may start hearing about "pay when paid" again. This was largely outlawed by the Construction Act, but section 113 specifically preserves the right to operate pay when paid where somebody in the payment chain is insolvent. However, there is no statutory right to do this. Do your contracts still include the ability to do so in insolvency situations or did you take out the clause altogether following the act? We should not forget that clients go bust as well. Those entitled to payment are theoretically in a stronger position now than they were in the early 1990s. The act creates a more level playing field by its requirements for notices stating how much is to be paid, allows adjudication as a quick way of obtaining payment and includes the right to suspend work if payment is wrongfully withheld. All of this helps, but look closely at termination clauses. Just how long will contractors have to work before notice periods or opportunities to remedy a breach expire and they can walk away from a client who is not paying? It will be interesting to see how adjudication performs in a difficult economic climate. The advantage of a fast-track dispute resolution system to secure payments that are being wrongfully withheld is clear. But will the court enforce the adjudicator's award if there is a real prospect of the party receiving payment becoming insolvent before the dispute can be finally determined? The Court of Appeal's judgment in Bouygues vs Dahl-Jensen last year shows that they may not. That is also the case where the adjudicator got his sums wrong. It would be rough justice if, before this error can be put right in the courts, an award has been enforced, the overpayment made and the recipient has become insolvent – so the payer will never see its money again.