Insolvency is a game-changer in any industry. It presents a particular risk in the construction industry for two reasons:
- the frequency of insolvencies; and
- the interdependence of many different contractors, whose capacity to deliver materials, services and payments properly and on time will often vary and will significantly impact the viability of the project as a whole.
What happens when you are contracted to undertake work or deliver construction materials and the principal goes ‘bust’?
Basically, a liquidator or external administrator will be appointed to help the insolvent principal trade its way out of its debts or to wind up the principal, call in its debts, liquidate its assets and distribute the proceeds to its creditors. However, by definition, an insolvent principal will not have enough cash in the bank or equity in its assets to pay out all of its creditors. Inevitably, some contractors miss out.
Either way, under virtually all standard form and bespoke construction contracts, insolvency will be treated as an act of repudiation entitling the other party to terminate the contract and sue for the losses resulting from the early termination.
Is an insolvent principal liable to pay me for work done prior to practical completion?
Under virtually all head contracts and most subcontracts, the principal has no liability to pay any part of the contract price at all unless and until the works under the contract are brought to practical completion which is when the principal has to pay the lump sum contract price (as adjusted). Prior to practical completion, all progress payments are payable “on account” only as a means of ensuring the contractor’s cash flow while works are being done. However, this does not mean progress payments are to be treated as instalments towards the contract price before practical completion.
This becomes crucially important when the principal becomes insolvent. Terminating your contract with the insolvent principal before bringing the works up to practical completion will mean you are unlikely to recover any payment at all for the works you have done. This is because when the principal becomes insolvent, the only claims that can be made against it are for debts which the principal has already become liable to pay before its insolvency. Other claims, such as for damages or restitution, cannot be made against an insolvent company whilst it is in liquidation or under external administration. So terminating the contract may undermine your only chance of being paid for the work you have done and the work you had left to do.
Instead of terminating the contract, then, opt to have your contract novated, which involves passing the contract on to a new, solvent principal.
What can I do right now?
HHG Legal Group is the only law firm in WA to have developed unique clauses that basically allow you to get paid for the work you have done as a contractor, even under an entire contract. We believe every contractor should include these clauses in their contract, if only to avoid having to argue about their entitlement to be paid if their principal goes broke.
If your principal is already insolvent and you have decided to terminate the contract rather than novating it to a solvent principal, make sure that you terminate it lawfully. Remember, terminating a contract is a step that that the terminating party takes: it is not an automatic consequence of the insolvent party’s repudiation. So do not under any circumstances simply abandon the site. If you do, you will face these risks:
- it will be you, rather than the insolvent principal, that will be taken to have repudiated the contract; and
- the liquidator or administrator of the insolvent principal may terminate the contract based on your repudiation and then sue you for opportunity losses (basically, the commercial detriment resulting from the lost opportunity to get the job done on time and on budget under the contract); or
- the liquidator or administrator may decide to affirm the contract (that is, keep it alive and hold you to your end of the bargain) in which case, you will still have to get the works finished on time, or else pay liquidated damages or otherwise compensate the principal for any delays.
If you are a subcontractor, there is a chance that your contract is severable, rather than an entire contract, which means that you do have an accrued right to be paid for the work you did under the contract before it was terminated. This is especially so, if your part of the works were relatively minor, if you were involved in a finishing trade or if you were paid a fixed rate per unit of work (e.g. a flooring contractor paid per square metre of floor covering laid).
Other situations where you are likely to have an accrued right to be paid under the terminated contract are where:
- the works under contract had been practically completed prior to termination and your claim is for final payment rather than a progress payment; or
- your contract was for the supply of materials or prefabricated structures only.
Whether you are a head contractor or a subcontractor, every standard-form construction contract gives you either a warranty or assurance of the principal’s capacity to pay, or better still, the right to demand proof that the principal can pay. You have these rights: exercise them!
Also, are two kinds of security for payment of debts: security against land and security against personal property, being property other than land. Generally, to get the benefit of either kind of security involves a two-step process:
- first, include terms in your contract which will allow you to take security against the principal’s land and personal property.
- second, register your security.
Choosing the right kind of security for your situation is critical and requires careful analysis of many, often competing variables which may apply differently, or not at all, depending on your individual circumstances. When negotiating rights to security for payment and deciding which securities to register, how and when, taking good, timely legal advice is imperative.
Murray Thornhill is the Managing Director at HHG Legal Group with the Litigation/Commercial Law team. If you would like further information in relation to this matter or other legal matters please contact our office on Freecall 1800 609 945 or contact firstname.lastname@example.org.