TIPS FOR CONSTRUCTION CONTRACTORS REGARDING A PRINCIPAL’S INSOLVENCY

Insolvency is a game-changer in any industry. It presents a particular risk in the construction industry for two reasons:

a) the frequency of insolvencies; and
b) 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, contractors miss out. Usually, a contractor’s only real chance to protect themselves meaningfully, is when negotiating the terms of the contract (although there are often things that can be done to improve a contractor’s position prior to the appointment of a liquidator when insolvency is suspected, and also after appointment, depending on the individual circumstances).

Is an insolvent principal liable to pay me for work done prior to practical completion?

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, take advice on the alternatives including opting to have your contract novated, which involves passing the contract on to a new, solvent principal.

What can I do right now?

Practically every standard-form construction contract gives you, as a contractor, 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!  Additional clauses can be inserted as schedules to the standard forms and you should have some of these prepared by an experienced construction lawyer, for use when negotiating terms and/or tendering.

There 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 arising from your and the principal’s 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.

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 us

*This information serves as a general guide and does not constitute legal advice. It is based on our research and experience at the time of publication. Please consult our knowledgeable Legal Team for any specific inquiries or advice relevant to your circumstances, as the content may not have been updated subsequently.