The consequences of contractor insolvency can have far-reaching implications beyond the parties to a construction contract. Insolvency inevitably results in increased costs, project delays and third parties losing the benefit of collateral warranties. It is, therefore, important for an employer to protect its position at the outset of a project and understand the steps that are open to it when contractor insolvency occurs.
Most standard forms of building contracts do not include an express right to terminate a contractor unless included during the negotiation process. Ideally, the employer should seek to include an express right to terminate the building contract by notice, at the employer's option, in the event of contractor insolvency. The inclusion of a notice period provides the parties with an opportunity to engage in meaningful discussions with a view to completing the works, rather than an automatic termination which has far-reaching implications throughout the supply chain.
It is important to define insolvency events as widely as possible in order to capture the full range of proceedings that are open to insolvency practitioners today.
Performance bond and parent company guarantees
No amount of background checks can adequately protect the employer against the risk of contractor insolvency. The employer should always consider the forms of protection available to it at the outset of a project.
A parent company guarantee is desirable because it guarantees all of the contractor's obligations under the contract. However, the employer should also consider other forms of protection given the potential for insolvency to spread to other group companies, including the ultimate parent. A performance bond, given by a third party provider is commonly sought by employers, usually capped at 10% of the contract sum. The employer should ensure the bond contains an entitlement to call on the bond on the occurrence of an insolvency event.
Another issue is the employer's entitlement to have the works completed to their original specification and warranted in accordance with the original contract. In order to ensure direct rights of recourse against the relevant sub-contractors, the employer should seek collateral warranties from material sub-contractors which...