On 15 January 2018, the UK’s second largest contractor filed for compulsory liquidation.
Shortly after, the Insolvency Service reported that there had been 2,668 insolvencies in the construction sector in the twelve months ended Q1 2018—more than any other sector.
These events may cause employers across the sector to closely examine the financial standing of their counterparties—but we consider below why insolvency practitioners (IPs) should also carefully consider the contractual mechanisms triggered on contractor insolvency, as well as some of the practical issues that arise.
Upon insolvency, an IP will need to quickly understand both the potential liabilities faced across the project portfolio, as well as the value (if any) that can be preserved from each individual project. This will require a rapid contract review exercise, which, subject to the size of the portfolio, could be a sizable undertaking. Any review will need to identify key rights and obligations that arise on contractor insolvency, positive performance obligations that survive insolvency, and any material value that can be extracted from a project.
Under the JCT D&B 2016 standard form a contractor’s appointment is suspended, but not automatically terminated, on insolvency. This can put an insolvent contractor in a state of limbo while it awaits termination. Although the standard form addresses a number of legal issues that arise at this point, it is silent in several respects. For example, although an employer has the right to secure the site, there is no positive obligation on it to do so. In circumstances where IPs can be held personally liable for health and safety matters, careful thought should be given as to how sites should be secured and protected. Further, once terminated, the JCT requires a contractor to provide the employer with copies of the contractor’s design documents. However an IP will need to consider whether doing so is advisable in circumstances where any such action may constitute the “adoption” of a contract (for more on this, see below).
Value can be preserved by the assignment or novation of project documents. Under the JCT a contractor should, if requested by an employer, assign any contract for the supply of materials and/or the execution of any work. A contract may also permit novation by the contractor. However, in certain circumstances IPs must be alive to the risk that any such action may later be construed as constituting the “adoption” of that contract (which can lead to personal liability for IPs). To mitigate adoption risk, where the insolvent contractor is in liquidation the relevant IPs should be mindful of their broad powers to disclaim onerous property, including unprofitable contracts, and thought should be given to disclaiming where contracts impose positive performance obligations, raise serious health and safety risks, or otherwise have little value that may be preserved for the benefit of the insolvent estate. The availability of disclaimer in liquidation (but not administration) may be a key factor in determining the type of insolvency process into which a contractor enters.