UK construction companies are currently going out of business at the fastest rate in a decade. More than 4,000 operators have become insolvent within the past year.
The list of challenges facing the industry includes: higher than average cost inflation; labour shortages; the impact of an increased regulatory burden such as Reverse VAT; "green" measures such as the Plastic Tax; a slowdown in house building; uncertainty caused by the Building Safety Act, and delays to government infrastructure projects.
Those involved in construction projects need to remain vigilant against the risk of insolvency and be alert to the signs of operational distress in the run up to a formal insolvency process.
Early warning signs of insolvency include:
- slow-down in progress of works e.g., decline in numbers on site, reduced plant, equipment, and materials
- high turnover of subcontractors or people on site
- decline in quality of work
- the appearance of factoring companies handling payments
- parties seeking to negotiate further payments or release of retention.
Contractual Protections
Before entering into a contract, due diligence is essential, so make sure you are taking the following steps:
- check the company and obtain a credit report
- do searches at Companies House to check that no filings are outstanding (a red flag if they are), understand the group structure
- check other associated companies or entities to assess cash flow.
Consider also embedding contractual protections to mitigate the negative impact of contractor insolvency.
Common Protections
- Parent Company Guarantees – the parent company guarantees the performance of the contract. However, if a company within a group becomes insolvent, the whole group will often fail, so due diligence is important here.
- Performance Bond – a bond is bought from a third-party bondsman to cover a percentage of the contract sum. Bonds can be expensive and will not usually pay out until after practical completion.
- Vesting and Advance Payment Bond – vesting allows the employer to acquire the legal title to off-site materials and equipment on payment, minimising the risk of having to pay for other materials if the contractor becomes insolvent. An advance payment bond secures any advance payments made.
- Retention – retention provisions allow the employer to retain a percentage of the contract sum pending practical completion and making good defects, which can be used to remedy defects if the contractor is insolvent.
- Latent Defects Insurance Insolvency Cover (e.g. NHBC) – covers the cost of repairs for structural damage for residential projects and is worth considering.
Less common protections
- Project Bank Account – a ring fenced account into which money is paid by the employer and then paid out directly to all parties in the supply chain. This safeguards funds and offers certainty to the supply chain.
- Weighted Stage Payments– these are commercially unattractive, because contractors may increase prices at the outset, but will protect the employer, as increased payments are made as the project nears completion.
- Phasing – consider splitting the project into phases to limit exposure to the financial risk of insolvency.
Conclusion
While it is crucial to remain vigilant throughout the lifecycle of a project for any signs of insolvency, prevention is better than cure. We have outlined some contractual protections to consider and are happy to help you explore your options.
