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How to protect against contractor insolvency

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We all know that contractor insolvency can derail an entire construction project.

Here we look at seven measures an employer may take to protect itself from a contractor becoming insolvent during a construction project.

  1. Due Diligence

Regardless of whether there is an existing relationship or if it is the first time a contractor has been engaged, an employer should always carry out due diligence against the contractor.

To reduce risk it is vital to understand an organisation’s financial status. This can be done in a number of ways, including:

  • Credit checks
  • Performance references
  • Awareness of other contractor partnerships and joint ventures
  1. Payment

Being aware of whether a contractor is paying subcontractors and suppliers on time is a good indicator of financial health. Progress in accordance with the programme is another useful indicator, as is the adequacy of the level of resources employed.

  1. Performance security

Most employers will require performance security from the contractor, such as a parent or other group company guarantee. Naturally, the guarantee is only as good as the company giving it. If the contractor is in financial difficulty, this could be the same for the whole group.

Another option is a performance bond from an insurer or bank. It is necessary to ensure that the definition of the ‘default’ or ‘event’ under the bond triggering the right to call for payment includes contractor insolvency and that the term ‘insolvency’ itself is defined to fit with the term as used in the building contract.

  1. Retention

Retention is a contractual practice intended to provide security against defective work or insolvency and usually involves the employer withholding a percentage of the amount due for payment.

A higher percentage of retention can be an incentive for contractors to complete works timeously and see a project through to the end.

  1. Warranties

The contractor should be required to procure warranties in favour of the employer from key subcontractors and members of the contractor’s professional team.

  1. Defects

If the right to compel the contractor to repair defective work is lost due to insolvency, the employer may have rights against the professional team (for design defects or negligent certification) or sub-contractors involved in carrying out the defective work.

Protection for patent or future or latent defects in the works can be found against those who have given collateral warranties.

If contractor insolvency occurs during the course of the works, the employer may benefit from having ‘step-in’ rights allowing the employer to step in to the shoes of the contractor in the relevant appointment or sub-contract.

  1. Termination

Where works are ongoing, it may be appropriate or necessary to terminate the contractor’s employment under the building contract for contractor default. Termination may then give rise to rights under a performance guarantee or bond.

It is important to consider the particular termination provisions and the process for carrying out termination therefore you must seek professional advice on the legal effects of the contract provisions regarding termination.

Slater Heelis’s construction and engineering team has extensive experience advising employers looking to manage risk on construction projects.

Please get in touch with me on 0161 672 1427 or email matthew.grellier@slaterheelis.co.uk

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