The insolvency of a main contractor can have a devastating impact on its sub-contractors. James Robbins, a specialist insolvency solicitor at Harrison Drury, looks at what sub-contractors can do to protect themselves.
With sub-contractors generally working to tight margins and relying on short term cash flow to fund projects, they can face significant uncertainty if the main contractor goes insolvent.
Will they be paid? Will they continue to be involved in the project? What redress do they have?
These are all questions that are difficult to answer in the immediate aftermath of insolvency in the construction sector. Before we get into the nitty gritty of what sub-contractors can do, it’s worth reminding ourselves what we mean by insolvency in this context.
What is insolvency in a construction project?
Although the Insolvency Act 1986 defines this as a company being unable to pay its debts, ‘insolvency’ tends to be much more narrowly defined in building contracts and in JCT (Joint Contracts Tribunal) contracts where it means a company entering into a formal insolvency process such as administration or liquidation.
Protection in advance of a main contractor insolvency
There are various provisions that can be incorporated into sub-contracts and, while it may not always be possible to negotiate these, the following should always be considered, particularly if there are concerns about the financial position of the main contractor or employer:
1. Direct payments by employers
Many sub-contracts permit payments directly by employers to sub-contractors in the event of a main contractor becoming insolvent. However, it’s worth noting that this can be problematic and risky for employers and sub-contractors alike as such payments can be invalid under insolvency law.
This is because if the main contractor is insolvent, its monies should be distributed to creditors equally, whereas, in this case, the sub-contractor would potentially stand to receive more than other creditors.
2. Project bank accounts
These can be set up so that an employer can pay a sub-contractor directly based on sums in the main contractor’s application for payment. These accounts generally aren’t invalidated under insolvency law providing they are set up correctly.
3. Retention of title
Retention of title clauses are common in sub-contracts, but care should always be taken to ensure they are properly drafted. They can in any event be problematic and, for example, if the materials have been fixed to a building or have become mixed up with other materials and can no longer be identified, the clause will often be ineffective.
Therefore, while retention of title clauses are almost always better than nothing, if large quantities of materials are being purchased, a sub-contractor could consider asking for payment up front or selling them directly to the employer.
4. A right to suspend work or terminate a sub-contract
The majority of building contracts, including JCT ones, allow sub-contractors to suspend work or terminate a sub-contract upon a main contractor becoming insolvent. However, care should always be taken not to wrongfully terminate or suspend a contract and advice should be sought in the case of any doubt.
5. Clause entitling the sub-contractor to terminate for repeated late payment
While a sub-contractor can suspend works for late payment under the Housing Grants, Construction and Regeneration Act 1996, this is a question of degree and it is preferable for a sub-contract to specify in what circumstances this may be done. Again, care should always be taken not to wrongfully terminate a contract and advice should be sought in the case of any doubt.
6. Pay when paid clauses
Sub-contractors should consider incorporating ‘pay when paid’ clauses into their own sub-contracts so that, in the event of a main contractor becoming insolvent, they are only obliged to pay their own sub-contractors when they are paid for those works by the main contractor or employer. Note that such clauses cannot be used to cover scenarios where a main contractor doesn’t pay but isn’t actually insolvent.
How to spot insolvency at an early stage
Sub-contractors should always watch out for signs of main contractor insolvency so that they can take early steps to exercise any relevant contractual rights and otherwise take steps to minimise their losses.
Such signs can include being paid late or in part, unexplained delays to works, materials and plant being removed from site without explanation and even rumours about the main contractor’s financial position.
James Robbins specialises in dispute resolution and insolvency at Harrison Drury and frequently works with the firm’s professional services and corporate lawyers on matters involving insolvent employers, main contractors and sub-contractors.
For more information on contractor insolvency, or any other insolvency matter, please contact James by email or on 01772 258321.