Contractual Protection for the Employer Against Contractor Insolvency

In light of recent high-profile events of contractor insolvency, it is worth setting out the provisions and requirements that an employer should consider including in its construction contracts to ensure that it is properly protected in the event that its main contractor becomes insolvent prior to practical completion. If prudent attention is paid to the prospect that the appointment does not pan out as expected, an employer can at least ensure that it can rely on its contractual rights to salvage the project and limit its financial losses.

Although a parent company guarantee will be of little assistance in the event of a group insolvency affecting both contractor and its parents, if applicable an employer should procure at contract signature a guarantee, from a direct parent or appropriate group company of sufficient covenant strength, which can be called on either to require the guarantor to complete or to procure completion of the project. An employer should also or alternatively require a performance bond, with very careful attention paid to the terms of the bond so that it can be called on, but also so that as and when the need to call on it arises the procedures and deadlines for a call under it are clear and can be complied with. In the event of termination for insolvency, the contract and the bond should enable the employer to make a call that will provide funding to complete the project based on estimated costs (subject to the bond amount), with an adjustment further down the line if necessary when actual costs are established.

Ordinarily an employer will expect to have collateral warranties from all the consultants appointed directly by or novated to the contractor, and from the sub-contractors with responsibility for design. These should be clearly required under the contract as far as applicable, with strict deadlines for providing them (off-set against the right to withhold payment under the contract until they are provided), to avoid a situation where the contractor is insolvent prior to the delivery of any such collateral warranties. These will go some way to providing protection to an employer for any defects that do materialise over the project lifetime. However, these collateral warranties will not fill the void left by an insolvent main contractor. For that reason, it is worth considering including in the contract from the outset the ability to procure latent defects insurance in such a situation. This both constitutes a demonstrable cost incurred, and which can therefore be recovered from the contractor or its administrator or claimed under a bond, and provides protection against defects which cannot be identified at the time of insolvency but may manifest themselves in the future.

Whilst the insolvency of the contractor is inevitably the source of practical and financial complication, with proper planning and consideration for such a situation at the outset, an employer can put in place contractual arrangements and protection so that its interests and the project are protected to the best possible extent should that situation arise.