Managing realised project challenges

This Insight follows two previous articles considering the challenges (and opportunities) to the UK construction industry at present and how potential risks might be anticipated and avoided. These can be accessed via the links below.

A reflection on economic challenges for the UK construction industry in 2023

Avoiding and managing cashflow risks

Part 2 of this series considered contract risks and how a well drafted contract might assist in managing such risks. This Insight considers a situation where efforts to avoid and mitigate challenges are unsuccessful and insolvency strikes on a project.

Weightmans’ Daniel Barchet, Natalie Keyes, and Oliver Nelson comment on the following key factors to be alive to:

• What are the warning signs that insolvency may be about to occur?
• What options are there, to seek to avoid an imminent insolvency situation?
• What are the potential consequences of an insolvency situation?
• What steps might be taken to ensure project continuance following insolvency?

Warning signs

A number of warning signs may indicate financial distress within project supply chains. They include:

• Lack of, or reduced, staff on site
• Slow, or no, progress of work
• Removal of equipment or materials
• Increased defects
• Requests for changes to payment terms
• Late or non-payment to suppliers and/or payment disputes with their suppliers
• Unjustified claims for variations, loss and expense or contra charges
• Rumours about the financial position either in the press or word of mouth
• Official announcements to shareholders, the stock market, such as profit warnings or redundancies.

There may also be publicly available information which gives an insight into the financial position of any company (albeit, less so for partnerships and sole traders). For example, recent company accounts, court judgments, carrying out a Dun & Bradstreet report, and records of winding-up petitions. Find out more.

If directly asked about potential financial difficulties, many companies are likely to deny that there are any issues, in the hope of navigating through temporary financial storms. Additionally, such a conversation might be too late to avoid the insolvency. However, in our experience, any chance of navigating out of an insolvency scenario requires open and honest conversations.

Seek to avoid insolvency situations

If warning signs (such as those noted above) appear, proactive action is likely to be the best way to manage the interests of all involved.

Contracts might give options to assist in seeking to get the project back on track, understand why certain issues may be occurring, and to limit damage. These may include:

• Some contracts allow clients to issue a notice of default in relation to defects or failing to comply with the contract terms. If so, such notice may be given, requiring any default to be remedied within a specified period, otherwise others may be instructed to remedy the fault and the costs of doing so may be recovered. This might be of lesser impact than a delay.
• Strategic omission of elements of work might provide a degree of relief from the supplier and enable a struggling company to take stock and consolidate?
• It might be possible to agree a temporary change to payment procedures to provide cash flow assistance for a struggling supplier whilst also minimising risk for paying parties. This will require a careful balance to be struck and might be combined with earlier vesting of title of goods and materials to provide the client some comfort/security.

Prepare to manage insolvency situations

Whilst the ultimate destination when an insolvency occurs might be the cessation of a contract, through termination or otherwise, there are numerous other ways to protect against, or manage, the potential negative impact of an insolvency event within a project team.

Protection against insolvency down the supply chain might include:

• Direct payments to sub-contractors etc (though it would be prudent to make clear that no liability is accepted because of any direct payment)
• Use any funds in a project bank account (if applicable)
• Exercising any rights of retention of title, lien, or to take possession of site and use plant and machinery
• Call on any bonds and guarantees in place
• Termination

Protection against insolvency up the supply chain can include:

• Suspension for non-payment
• Notices to parties with step-in rights
• Copyright suspension for non-payment
• Termination

Restrictions on termination for insolvency up the supply chain

Section 233B of the Insolvency Act 1986 was introduced through the Corporate Insolvency and Governance Act 2020 and has significant implications for contracts for the supply of goods and services in the construction industry.

In summary, where there is insolvency of an upward party in the supply chain, suppliers’ rights to terminate triggered by a customer’s insolvency are prohibited.

Section 233B(4) makes clear that this will be interpreted widely and prohibits clauses allowing termination by suppliers for pre-insolvency events even if an insolvency has, in fact, occurred. For example, if a force majeure event occurs and continues for a prolonged period of say, two months, and the contract entitles the contractor to give a notice to terminate at this point, it may not be able to exercise this right during the period of any insolvency, if the client enters into relevant insolvency proceedings before the contractor has given notice. A supplier is not prevented from terminating for a new event unrelated to insolvency when it arises during the insolvency proceedings.

The effect of section 233B is that all termination provisions enabling the contractor to terminate for an employer’s insolvency (for example, as in standard JCT contracts) are ineffective.

There are certain exceptions relevant to the construction industry, i.e. contracts forming part of a public-private partnership project (the project agreement between the public sector authority and private sector entity), contracts of insurance, contracts of guarantee, contracts for financing commercial transactions and "a … forwards contract, including a contract … for the purchase, sale or transfer of … property of any other description, service, right or interest for a specified price at a future date". This seems likely to include some development finance agreements.

Whilst a supplier cannot demand payment of outstanding amounts as a condition of continuing to supply when the client enters an insolvency process, future sums due may be paid as an expense of the insolvency procedure.

If a client fails to pay after insolvency, this may allow a supplier to exercise other remedies for non-payment, (not insolvency), e.g. suspension and termination, and section 233B is likely not to apply to a “termination for convenience clause” which entitles a party to terminate a contract without needing a specific reason for doing so.

Termination in insolvency circumstances

If rescue strategies are unavailable (or unsuccessful) and a party ultimately looks to terminate (subject to the CIGA restrictions noted above), there are some key contractual and practical considerations to consider. Many construction contracts contain express terms dealing with the consequences of insolvency of one of the parties. Commonly, those provisions may provide:

1. A specific definition of “insolvent” or “insolvency”– this may vary between contracts and the precise definition and resultant power to terminate should be reviewed carefully.
2. Sums that have already become due to the insolvent party may be payable, subject to issue of suitable Payment or Pay Less Notices – at the time of insolvency of a supplier, paying parties must review the situation carefully to determine if any pay less notices are required to protect their position.
3. No further payment need be made to the insolvent party – this may be subject to issue of a payment or pay less notice in accordance with other terms of the contract.
4. How, and when, any sums that may become due to (or any sums recoverable from) the insolvent party will ultimately be determined.

A note of caution, however, as termination in anticipation of insolvency may (subject to the terms of any contract) be a breach of contract and have very different consequences for the terminating party.

Also, notice to third parties may be required prior to termination of the contract, for example, if a terminating supplier party gave a collateral warranty with step-in rights to any stakeholder, such as a funder.

How to minimise disruption to the project

In the event of insolvency being imminent, or having occurred, there are a number of steps that can be taken to minimise the disruption to the project.

These might include:

• Taking possession of and/or securing goods and materials paid for. This might involve exercising any title vesting provisions/certificates.
• Taking possession and securing the site.
• Considering whether replacement all risks, or other insurance, needs to be obtained urgently.
• Undertaking a full survey and valuation of the contractor’s/sub-contractor’s works at the time of insolvency to assist with preparation of any post-termination/insolvency account.
• Considering whether any bonds or guarantees in place can be called on.
• Have warranties been obtained from sub-contractors and do those warranties contain a right to step-in, which permits the beneficiary to take the place of the original contracting party and operate the contract in its place.
• Exercising any rights under the contract to require the insolvent company to novate any of its supply contracts (which is available under certain JCT forms).
• If the supplier contractor/sub-contractor company has entered administration, liaising with the administrator to see whether the company might be able to continue with their works or if an alternative company is being set up which might be able to complete the works.
• Liaising with other parties involved in the project so they are aware of the situation and the parties can work together to minimise the impact.
• Consider whether there are any key staff within the insolvent company that might helpfully be taken on to assist with project completion.

Conclusion

In summary, often the best option to (a) find opportunities in challenges, and (b) avoid risks and manage risks, is forward planning; in procurement, when negotiating the contract, throughout the works, and pro-active project management. Hoping for the best in difficult situations is unlikely to achieve the best results for any individual party or any project as a whole.

We are interested in hearing your experiences. Have you seen an increase in supply chain cash flow issues or insolvency? Do you feel prepared to deal with insolvency when/if it arises?

Weightmans has specialists in construction and insolvency matters and can offer numerous services to support businesses dealing with the issues raised in this Insight.

At Weightmans we understand risk, whatever the context or specifics. We can use the law to your commercial advantage. We listen to our clients and can recognise what you need. We base our solutions on what is important to you. You will find that we are genuinely interested in how you are adapting to risk and the steps you are taking to become more resilient in the face of challenging market conditions.