What to do if your contractor is in financial difficulty

You are partway through your shiny new hotel/restaurant/leisure project, and your main contractor looks like it might be in financial difficulties: work is not progressing to programme, despite weekly project meeting promises; supplies are not being delivered to site (or, worse still, are disappearing from site), and there seems to be a general lack of subcontractor activity. Rumours abound that your main contractor is in trouble. Trouble is contagious.

If your contractor is in financial difficulty, consider your position:

• Self-funding? You risk losing revenue from the delay to opening.
• Relying on contractual liquidated damages? On insolvency, you will rank far below secured creditors; you may not see more than a few pennies in the pound.
• Funded? That’s more worrying; you have upstream obligations and may be in breach.
• Got a tenant lined up? When’s the longstop date to complete? There will be significant financial consequences for breaching that date.

Taking early steps to assess the risks and take action now can limit the damage later.

Mitigating the risks

Has the contractor filed for administration or insolvency, or has a supplier issued a winding-up petition? Check via the Insolvency Service or Companies House, put a “watch” on, and run credit checks frequently.

Could you contract on direct arrangements with the supply chain or get a replacement contractor in? Consider if your funders will extend the funding and, if so, on what terms and conditions. The earlier you engage with the relevant parties, the better, but don’t trigger any conditions under the present arrangements while discussing the options.

Getting financial disclosure of the contractor’s payments and supporting evidence now will be extremely valuable if you are left dealing directly with the supply chain

It is good practice to constantly review your own financial viability should you be left with an incomplete project and loan obligations to meet without the revenue to do so. If in doubt, talk confidentially to an insolvency practitioner.

Do you know how much the supply chain is owed? Getting financial disclosure of the contractor’s payments and supporting evidence now will be extremely valuable if you are left dealing directly with the supply chain, especially if they declare they’ve not been paid by the now-insolvent contractor.

Could you find a replacement contractor and, if so, at what cost? If you enlist a replacement contractor, expect a significant overcharge as well as a delay to restart and extended consultant and legal costs. You need to know the likely costs to evaluate your options. Frustrating though it may be, keeping your current contractor financially viable for the duration of the project might be less expensive than the costs of a replacement.

Make some discreet enquiries – if your current contractor hears the project is on the market, that could be grounds for a claim against you. If, on balance, it’s better to remain with them, then consider varying the current terms to minimise the risks. You might be able to negotiate increased security, although be aware that, when dealing with a company at risk of insolvency, any benefit you may receive at this time could later be set aside as a preference or transaction at an under-value.

Is your contract administrator up to speed with notices and have they issued the relevant notices for delay to the works, or have you been working with the contractor, written a few emails and discussed the concerns only in meetings? If you want the option to terminate, you are going to either have to satisfy the contractual termination provisions or be able to assert acceptance of a repudiatory breach – both of which benefit from issued notices. You can be supportive – on a without prejudice basis – but ensure those default notices are issued.

Not got the warranties in yet from the contractor? What’s it going to cost you to get those off the suppliers after the contractor’s insolvency?

And don’t be shy about holding back on payments; your only real leverage is while you have the money needed to complete the work in your account – but do it in line with the payment rules.

Not got the warranties in yet from the contractor? What’s it going to cost you to get those off the suppliers after the contractor’s insolvency? If you have the right to make deductions for a failure to provide warranties or for defects, then start to make those deductions now.

How confident are you that the certified works have not been overvalued? Your quantity surveyor (QS) may be planning to work it all out in the final account, but that’s no benefit if the contractor enters insolvency before then, having been paid too much to date. Your QS should review and provide an accurate certification ASAP; it will assist in establishing the true value of the works in any later discussions, but it may also result in a right to seek repayment from the contractor while they still have some funds.

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Have you been asked or offered to make payments directly to the supply chain? If the contractor is not yet insolvent that may be an option, but it needs to be approached carefully. If no formal rights of step-in exist, then you need to vary the main contract and get agreements in place between you and the suppliers or establish a joint account to ensure that all payments are made directly to the suppliers rather than risk your payment for that new escalator disappearing into the insolvency pot.

Got a bond or guarantee in place? Have you complied with any necessary notice requirements to date? Make good any oversights. How much is it for and what are the current financial circumstances of the guarantor? Is it worth the paper it’s written on? Assuming they remain good for the money, has it been properly executed? What’s the expiry date – before the new date for completion? On issue of making good defects? If so, how is that affected by insolvency? Have your rights accrued before the expiry date? If not, consider whether you have grounds for repudiatory breach now. That’s a step not taken lightly – get it wrong and you are facing a claim for damages for breach of the contract.

Your project costs are likely to be impacted if your contractor becomes insolvent, but the fallout can be contained and mitigated with proactive and timely risk management; by knowing and utilising your contractual and common law rights as early as you can.

Louise Garcia is a construction partner at Keystone Law