Construction insolvencies are up – what can developers do?

Thérèse Marie Rodgers, Counsel in the Construction team, has written a piece for React News discussing how the strict application of contractual rights is not always the best way forward.

The latest monthly figures from the government’s Insolvency Service, out last week, show that 4,370 construction firms failed in the UK in the year to the end of November 2023 – around 7% up on the previous year.

While we wait to see whether an upward trend in construction sector insolvencies continues to the end of the year, the figures still make grim reading for the construction industry, and have ramifications for the property and development sectors.

The rate of inflation has been impacting the already slim margins of contractors, many of whom were still recovering from the financial pressures resulting from pandemic-related delays. With the majority of the Building Safety Act 2022 now in force, this financial stress will increase on contractors.

Where difficulties start to arise on some projects as a result, employers and developers should consider whether strict application of their contractual rights is the best option for the project as a whole.

For example, levying liquidated damages as soon as a party is entitled to may initially appear attractive – but it could be the difference between a contractor completing a project or becoming insolvent.

The collapse of a sub-contractor causes delays, but a main contractor’s failure can have a far more serious effect, halting projects for months. Buckingham’s collapse in August left its clients with unfinished projects and the unenviable challenge of finding a replacement contractor.

New challenges

While the focus of the Building Safety Act has been on higher-risk buildings (namely those that are 18m or taller, or seven storeys high), parts of the act will have implications for all buildings. This means that all contractors will need to expend time and money ensuring they are adhering to the evolving applicable laws and regulations for each specific project.

The significant increase to the limitation periods for claims under the Defective Premises Act 1972 – 30 years for works completed before 28 June 2022, and 15 years for claims for works completed after 28 June 2022 – is likely to affect all players in the construction cycle, with claims arising in relation to projects long since completed.

In respect of higher risk buildings, the act brings multiple challenges. The new gateway process introduces the requirement for building control approval before building work can commence, and once it is complete, prior to occupation of the building.

These stages are likely to cause delay, and the risk of submitting the relevant applications and incorporating the period for any such applications into the programme will need to be considered at the outset of a project. There is also more onerous competency and golden thread requirements, which are likely to cause increased costs or put a further squeeze on profit margins.

Warning signs

What are the signs that a contractor may be nearing insolvency? On site, you’d expect to see work stalling, contractual milestones being missed and fewer people on site, as well as equipment, plant and materials disappearing.

Problems with cash flow may lead to the contractor requesting early payments, and potentially submitting over-inflated claims. Further down the chain, sub-contractors might complain of lack of payment – and may even request direct payment.

There are some practical actions developers or employers can take in these circumstances, such as ensuring it has a complete set of contractual documents – all guarantees and warranties, including any sub-contractor collateral warranties – and to check the insurance required under the building contract is still in place and all premiums paid.

It is prudent to increase monitoring of the progress of the works to ensure the information on the contractor and status of the project is understood. It would also be beneficial to understand the contractual position in the event of a contractor insolvency. Are protections in place, such as a performance bond, parent company guarantee, step-in rights and termination rights?

A new agreement

Notwithstanding the above, in the vast majority of scenarios, it’s in everyone’s interest to reach a commercial solution that gets the project completed with the contractor continuing in business. That’s likely to need open and frequent communication – initially to understand whether the contractor is willing and able to complete the project, and whether realistically that can be achieved by a commercial agreement.

Such agreements could restructure payment arrangements, speeding up payments, making them more frequent and perhaps providing that the employer pay subcontractors directly. It’s key that safeguards are put in place to ensure any such funds are only being used to complete the project at issue, and not propping up other projects.

A moratorium on liquidated damages may also assist, with the incentive of waiving them altogether if a new agreed programme to complete the project is met.

If completion by the contractor isn’t possible, the discussion should focus on an orderly handover of works. To what stage of the project is the contractor able to complete? When will an alternative contractor need to be engaged to complete the works? Relieving some pressure on the contractor in this way could lead to improved performance.

Whichever option you take, you must protect your interests. Don’t just agree a new programme without maintaining an incentive for performance, and ensure you have a remedy should the project deteriorate.

Worst-case scenario

If the worst happens, it’s not impossible to continue with an insolvent contactor, dependent on the type of insolvency proceedings and whether the contractor considers it’s able to complete the works. It might be the best option if the project is very near completion.

There is also the option of stepping in to engage subcontractors directly to complete the project or, following termination for insolvency, engaging directly with the subcontractors. This is the approach Liverpool FC has taken (at least in part) to complete its stadium following Buckingham’s insolvency.

Engaging a new contractor is not always a silver bullet, and can come with significant downsides. It could delay completion and is likely to be more expensive. The new contractor may not assume responsibility for the insolvent contractor’s works, or will charge a premium for doing so.

Should your project encounter contractor insolvency, careful consideration of all the options available is needed to get work back on track, with the minimum amount of disruption.

Originally published on 22 January 2024, the article can be accessed here behind the paywall.