by Tony Ensom
The little-known provisions of the “determination clauses” in building contracts are taking on a new significance in the light of the increasing number of insolvencies in the construction industry. The media has, of course, concentrated on the major companies, like Rush & Tompkins, but other contractors may also be in trouble.
During the next few months many employers having building works carried out for them will be faced with the spectre of an insolvent contractor. How many of them — and the consultants on these projects — will understand the implications and what action they should take? If and when it happens they will need to act very quickly: speed is essential.
Most standard forms of contract provide for automatic determination of the contractor’s employment if he becomes insolvent. This immediately triggers the determination of the subcontractor’s employment, which these days often produces a very complicated situation. This, on the face of it, obviously conflicts with the employer’s aims, which are to get his project completed on time and within budget. However, all may not be lost, because most contracts allow for reinstatement of the contractor by agreement, and the employer may be surprised to find that his aims are similar to those of whoever is dealing with the contractor’s affairs. Insolvency does not necessarily mean that the contractor company is wound up and liquidated.
There have been several interesting and useful changes in the law on insolvency since the last property recession. The Insolvency Act 1986 has created some new concepts and roles. Clients and their project consultants might find it useful to look at the differences between the roles of an administrator, an administrative receiver and a liquidator, all of whom must now be licensed insolvency practitioners.
An administrative receiver is appointed by a secured creditor (such as a bank) and his aim will be to realise sufficient assets to repay the secured creditor, following which the company will probably go into liquidation. In the interim, however, he will carry on the business, and this will be assisted by the automatic freeze on payments to creditors which comes into effect immediately on his appointment.
An administrator is appointed by the courts on the application of either the company itself or one of its creditors. Again, a stop is put on the payments to creditors, and the administrator effectively runs the company while he considers what further action should be taken. The business could be made solvent again, the administrator could come to an arrangement with the creditors, or he could allow the company to go into liquidation. In any case there will be a period during which the company continues to function.
Liquidation, in which a company’s affairs are wound up and its assets distributed, is put into effect either by the courts (compulsory liquidation) or the shareholders (voluntary liquidation). In either case, there will be a delay in appointing the liquidator and it is unlikely that there will be any chance of the business continuing.
Employer’s options
Any employer faced with an insolvent contractor has a number of options, all of which should be considered before he makes his choice. He should also make contact with the insolvency practitioner dealing with the contractor’s affairs and exchange information and ideas. Co-operation may well lead to an agreed solution to the employer’s problems.
First, where either an administrative receiver or an administrator has been appointed, the employer should consider whether the contractor should be reinstated. This will probably be appropriate only when the work is almost complete. It would certainly suit the employer if the contractor could satisfactorily complete the work near enough on time and within budget, even if he had to agree to amendments in the contract to speed up the contractor’s cash flow. The insolvency practitioner may see some advantage from his point of view in having funds released to him as soon as possible by such an arrangement.
In other circumstances it might also be worth considering allowing an insolvent contractor to continue temporarily with the works under an interim agreement. This would give everyone breathing space to consider a longer-term solution, but at the same time would at least keep the building work going. The contractor’s employment would remain determined, and he would work under a separate agreement, probably with frequent payments for satisfactory progress of works. Any payments could be treated as interim payments under the original contract.
The second option would be for the contract to be “novated” to another contractor. Novation involves a substitute contractor taking over the original contract lock, stock and barrel, with all its obligations and benefits. There would, of course, have to be sufficient profit left in the project to satisfy both the insolvency practitioner and the substitute contractor, who would enter into a three-way agreement with the employer. Where any surplus in the contract is insufficient, the novation could still take place, but perhaps be conditional on some changes being made to the contract terms. Any amendments are likely to be in the areas of price and programme. It will probably be difficult to find a substitute contractor, although if the project is still in its early stages one of the other contractors who originally tendered for the project may be interested.
Determination
The final option will be to allow the determination of the contractor’s employment to stand and find another contractor willing to complete with works under an entirely new agreement. This will almost certainly have to be the case if the contractor goes into liquidation. It may well also apply if a large number of subcontractors are involved in the project and are unwilling to be reinstated under their original subcontracts. The problem for the employer is that this course of action will almost certainly be the most expensive both in direct costs and in delays.
In turning to the determination clauses, it is worth noting that it is not the contract which is determined but merely the contractor’s employment. The contract remains in place and the determination provisions set out what action has to be taken in order to complete the original contract. These need to be looked at very carefully.
The first action of determination, however, should be to obtain as quickly as possible a clear picture of the situation on the date of determination. The architect and quantity surveyor should be instructed to produce a report on such things as the state of work, materials and plant on site, details of defects, payment certified, payments made, the amounts in the retention funds, extensions of times awarded and claimed, financial claims made and expected etc. Armed with this information and any advice obtained at that stage, the employer can then approach the insolvency contractor to establish his intentions. Only then will a clear picture emerge on which action can be taken.
There are, of course, all sorts of practical problems which will have to be addressed. One of the more complicated may well be the question of subcontractors. If they are to be persuaded to continue with their involvement on the project they will certainly need reassurance on future payments and may, quite understandably, try to recover any shortfall in payments by the insolvent contractor by other means. Where subcontractors have been chosen by the employer and therefore “nominated” by a procedure set out in the contract, they could well be in a slightly better position than those selected directly by the contractor. Where a “nominated” subcontractor has been responsible for all or part of the design of his work, the employer will be anxious to retain that company if he is expecting them to offer warranties on their design which can be passed on to purchasers or tenants.
Materials delivered to the site are a frequent source of dispute, with suppliers anxious to recover the goods if they have not been paid. We have all heard horror stories of materials by the lorry load mysteriously disappearing overnight from sites which were thought to be secure. The question of ownership of materials is very complicated and legal advice will probably be necessary.
Retention moneys also need careful consideration. These are amounts deducted by the employer when he pays interim certificates and held by him on trust for the contractor and, where applicable, nominated subcontractors. Although the contractor and subcontractor retain beneficial interest in this money, the employer has the right to make deductions from the amounts held. He will certainly need expert advice, however, to help him through the complicated rules which must be followed before deduction can be made.
One very important condition in the determination clauses is that from the date of determination of the contractor’s employment the employer need not make any further payment to the contractor until the work has been completed (by another contractor). Once the project is complete, the employer’s quantity surveyor will need to draw up a theoretical final account for the original contract as though the insolvent contractor had actually completed the work. From this, he will deduct the cost of completing the work by another contractor and all other expenses incurred by the employer as a result of the determination.
Insolvency and its consequences are complex issues and the employer will need clear advice from his professional team. He may also need the assistance of a solicitor and perhaps his accountant.
It would be nice to think that every employer who said “it will never happen to me” turned out to be right. Unfortunately, too many are now discovering that it can happen to them! Just in case you are the unlucky one, why not spend a little time thinking about what you would need to do if your contractor was the one referred to in the newspaper headline “Another contractor goes bust”. As the Boy Scouts say: Be Prepared.
