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 in the construction industry; 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, some contractors miss out.
How can I protect my right to be paid for work already done?
Instead of terminating the contract, which most contracts will permit where the principal become insolvent, opt to have your contract novated, meaning the contract is handed over to a new, solvent principal. Choosing to terminate your contract with the insolvent principal before bringing the works up to practical completion, you are unlikely to recover any payment at all for the works you have done. This is because:
(a) 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; and
(b) a principal will generally not become indebted to a construction contractor at all unless and until the works under contract are practically complete which is when the principal has to pay the lump sum contract price.
Is the 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. 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. This does not mean progress payments are to be treated as instalments towards the contract price before practical completion. Prior to practical completion, payment for work done is unprotected.
This becomes crucially important when the principal becomes insolvent. In this event, you have two choices as a contractor: suspend works until the contract has been novated (passed on) to a new, solvent principal or terminate the contract. If you elect to terminate the contract before the works are practically complete, the only claim you will have against an insolvent principal is for damages to compensate you for the lost opportunity to progress the works to practical completion and earn the contract price. However, claims for damages cannot be made against an insolvent company whilst it is in liquidation or under external administration. Accordingly, untimely termination of the contract may throw away the only chance of being paid for the work you have done and the work you had left to do.
What can I do now? Obtain security.
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 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 therefore imperative.
This is general information only, and does not constitute specific legal advice. 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 email us now.