Joanna Rees is a partner at law firm Blake Morgan
The collapse of ISG in September created waves across the UK’s construction industry. It served as a painful reminder of the knock-on effects that insolvency can have throughout the supply chain, and the challenges it creates in both the private and public sector. A contractor becoming insolvent inevitably disrupts the continuity of a project as costs to completion rise, and ultimately poses a reputational risk for those involved.
“Stressful though it may be, project leads should take a step back, breathe, and consider their options before terminating contracts”
In the event of insolvency there can be an impulse for those leading on projects to reach for the straightforward option and terminate a contract. While there is some merit in this approach, it’s far from the only option – and in many cases it is not the best route to take to ensure protection of the project lead and the project.
It’s important to understand the benefits of instead taking steps to keep the supply chain alive. Exploring alternative responses can safeguard construction projects and be more beneficial in the long term.
Drawbacks of termination
While terminating a contract creates a potential counterclaim to seek recovery for the extra completion costs, the likelihood of this potential benefit is invariably outweighed by other, negative implications.
Chief among these limitations is the impact it can have on the employer’s status as a creditor. Termination will make the employer an unsecured creditor and means that it will rank behind all the secured creditors – and reduces the chance of it recovering anything from its insolvent contractor. ISG’s collapse is a textbook example, with administrators confirming that unsecured creditors are unlikely to recover any funds from its projects.
If a contract is terminated, a new contractor will also need to be sourced and appointed to restart construction, and it will need to procure a new supply chain. Tendering out for a new contractor is an expensive, time-consuming process – and it leaves projects in limbo. The insolvency of Carillion in 2018 was a clear example, with projects left abandoned and uncertainty for months on end. Avoiding this is clearly preferable, and there is a solution. Keeping the original contract alive, if possible, can cut these delays and minimise rising costs in the long term.
Act quickly
Construction contracts often include provisions which, if triggered, can provide safeguards against an insolvent contractor. By allowing a firm to step into the contractor’s role, it can maintain the core contract and keep the supply chain alive. Triggering these provisions, the firm can facilitate a ‘novation’ – a legal mechanism that transfers the contract to a replacement contractor. Stepping in quickly is essential to ensure work continues on the construction project with minimal disruption, and to avoid dismantling the project structure.
Public sector organisations will have the additional challenge of being mindful of obligations under the Public Contracts Regulations 2015.
I recently worked with Cardiff Council on a project where we took this approach. After news of ISG’s collapse broke, the local authority was able to move quickly and novate ISG’s contract to an existing subcontractor on an interim basis.
By doing so, the council was able to arrange for continued payments to the project’s subcontractors, providing valuable continuity for the project and preventing major financial disruption among local small and medium-sized businesses.
Limitations of project bank accounts
Other tools that ordinarily ensure efficient payments to contractors, such as project bank accounts (PBAs), provide some protection to subcontractors. However, their function in insolvency cases can be highly complicated.
Funds within a PBA are held in trust by the contractor for the contractor and any supply chain members who have signed a joining deed.
By signing this, it means the monies held in the PBA do not become part of the company’s insolvent estate. However, this only works if all the required signatures are in place, which, when navigating often complex webs in supply chains, can be difficult to secure.
What to do with an insolvent contractor
To effectively navigate contractor insolvency, preparation is key. Firms should ensure their contracts have the necessary protective measures that will allow them to act strategically and step in if there is an insolvency.
Alongside this, the project lead should review consultant and subcontractor warranties for step-in rights. These provisions enable them to assume control without dismantling contractual relationships. Essential, too, is the need to ensure these warranties are secured early and executed at the start of work.
They should also develop a pre-emptive strategy so that when insolvency rumours circulate, project leads can prepare a response plan rather than rushing to terminate. A calculated approach can safeguard the project’s structure and allow for a smoother transition to a new contractor.
If a PBA is in place, project leads should also confirm that all subcontractors have signed valid joining deeds. Without these, they lack critical protection from the PBA, leaving them vulnerable if the contractor becomes insolvent.
Finally, if a contractor does become insolvent, project leads will need to communicate clearly and engage with the supply chain. They should notify the supply chain promptly and advise them not to terminate their contracts with the main contractor. A terminated contract cannot be novated and would close off critical options.
Keeping the supply chain alive is critical for any construction project – and even more crucial when faced with an insolvent contractor. Stressful though this may be, project leads should be encouraged to take a step back, breathe, and consider their options before terminating contracts. What appears like an easy fix can be a costly – and drawn out – process in the long run and often this approach does not provide the protection needed.
Proper preparation, and stepping in to take over the role of the contractor, can be a powerful way to minimise project disruption and financial insecurity among companies in the supply chain.
