Construction insolvency

Construction projects are inherently complex and financially demanding. The insolvency of a contractor can have significant repercussions, leading to delays, additional costs, and potential legal disputes. To safeguard projects, employers should proactively mitigate risks through carefully drafted contracts and contingency planning.

How to mitigate construction insolvency risk

When negotiating a construction contract, it is crucial to incorporate provisions that minimise the impact of a contractor’s insolvency. Key considerations include:

• Expressly making insolvency a breach of contract - insolvency is not automatically considered a breach of contract, which may affect the recoverability of losses. Employers should amend termination provisions to explicitly state that insolvency constitutes a breach.

• Obligations to notify financial position - the contract should require the contractor to notify the employer if their financial position deteriorates or if insolvency is anticipated.

• Suspension of payments - the contract should contain express wording confirming that no further payments are due to the contractor until the works are completed where insolvency may be possible. Although some standard contracts include such provisions, bespoke agreements should ensure this protection is in place.

• Performance bonds and parent company guarantees - employers should secure performance bonds and parent company guarantees (where applicable). Additionally, the contract should include provisions allowing the employer to withhold payments until such securities are in place.

• Escrow Accounts and Project Bank Accounts - placing funds in escrow or using a project bank account can help safeguard payments and ensure funds are appropriately allocated in the event of insolvency.

• Retention of funds - withholding a portion of payments (typically 3-5% of the contract sum) can provide additional financial protection. The retention amount should be commercially negotiated.

• Collateral warranties and step-in rights - employers should obtain collateral warranties from contractors and subcontractors early in the project, including step-in rights to allow direct engagement in case of insolvency.

• Ownership of On-Site and Off-Site Materials - contracts should clearly define the treatment and ownership of materials to avoid disputes over access and use if insolvency occurs.

In practical terms, retentions, performance bonds, collateral warranties and escrow are the strongest forms of protection.

What to do if a contractor becomes insolvent

If a contractor becomes insolvent during a project, the consequences depend on contractual terms. The following steps can help mitigate disruption and financial loss:

1. Review the contract - assess termination rights, financial security provisions, and any obligations that arise upon insolvency.

2. Notify funders and key stakeholders - promptly inform any funders, insurers, or third parties who may need to consent to contract termination.

3. Secure and protect the site - take immediate action to safeguard materials, equipment, and unfinished works.

4. Assess insurance coverage - check if the contractor’s insurance policies remain valid post-insolvency. If coverage lapses, consider taking out alternative insurance to protect the project.

5. Evaluate outstanding payments - determine what, if any, payments are still due to the contractor.

6. Call on performance security - if applicable, initiate claims under performance bonds or parent company guarantees to recover losses.

7. Engage subcontractors and consultants - where possible and practicable, exercise step-in rights under collateral warranties to retain existing subcontractors and consultants to continue work.

8. Record financial losses - maintain detailed records of all direct costs and delays incurred due to the insolvency to facilitate recovery.