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Top tips for dealing with supply chain insolvencies

The outlook for the economy and the industry is as positive as it has been for quite some time. Unfortunately the recovery will come too late for many.

We have noticed a surge of insolvencies, particularly among subcontractors. Supply chain insolvencies add to the pressure on successful project delivery.

They are, unfortunately, inevitable, and it is important to seek to minimise their impact. Here are some practical things to bear in mind.

Heed the warning signs

Project consultants will often learn of impending insolvencies before they happen. It is sensible to keep an ear to the ground for this sort of intelligence.

“Third-party payments may fall foul of insolvency preference payment provisions and may even lead to you having to make such payments twice”

Alternatively, a contractor in the supply chain might ask you to pay a supplier directly to relieve ‘temporary’ cashflow problems. In these sorts of situations, it is prudent to undertake some credit due diligence and review the insolvency provisions in your contracts.

Third-party payments may fall foul of insolvency preference payment provisions, and may ultimately even lead to you having to make such payments twice (eg if you have already paid a supplier but are then ordered to pay your contractor directly).

Contractual obligations

Where a contractor becomes insolvent, it is sensible to terminate any contractual arrangement.

Some but not all contracts automatically terminate upon insolvency. The NEC3 and JCT standard forms, however, require notice to be given.

“Not all contracts will give rise to a right to terminate in the event of insolvency”

The contract should be carefully checked for the grounds upon which you may terminate and the mechanics and timing of notification. Invalid notices may expose you to a claim for damages.

Not all contracts will give rise to a right to terminate in the event of insolvency. The contractual definition of ‘insolvency’ also varies and warrants scrutiny.

Don’t replace in too much haste

Third, an alternative contractor to finish off the works must be found – and quickly. The critical balance to be struck is between avoiding delay to the project and finding the right company that is ready to mobilise at the right price on the right terms (replacement contractors often come at a premium).

These decisions should not be made in haste.

Issues of ownership

There are the practicalities of introducing a replacement contractor to the project team and the supply chain.

Check the contract for provisions dealing with issues that we often see causing problems, for example: securing the site to prevent the contractor or its suppliers removing materials; who retains title in the contractor’s materials; who owns the copyright in designs and how can they be obtained?

The money issue

Possibly most important are the monetary consequences of insolvency. Again, the contract would normally legislate for this process.

“Evidence should be retained of the status and quality of the contractor’s works as at termination”

Broadly, an insolvent contractor will be entitled to payment for works properly carried out. The employer, on the other hand, will in most cases be able to set-off the additional costs to complete the works from any outstanding entitlements to the contractor.

These discussions can become protracted because consensus cannot be reached on assessment. Evidence should be retained of the status and quality of the contractor’s works as at termination (eg by photographs).

Pay-less notices may also need to be issued in respect of payments which have already become due.

Insolvency is, regrettably, a fact of life in the industry.

It pays to keep alive to the supply chain liquidity and be well versed in how your contracts address insolvency so that you can be prepared to terminate, procure the remaining works and resolve the subcontract account with as little disruption as possible.

Digby Hebbard is a partner and Helen Stuart is an associate in the contentious construction team at Trowers & Hamlins

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