The latest figures from the Insolvency Service report that insolvencies in the construction industry increased by around 8% last year.  These figures, together with reports on the recent collapse of Carillion, have brought the issue of insolvency in the construction industry back into the media spotlight. 

Carillion’s collapse has attracted much criticism in the media.  Concerns have been raised about the government’s decision to award further public service contracts to the company notwithstanding so called “warning signs” about the company’s perilous financial position.  For instance it has been suggested that the problems with the £335 million Royal Liverpool University Hospital contract, which contributed to Carillion’s first profit warning, ought to have set alarm bells ringing and prompted the government to investigate the company’s financial position before awarding it further contracts. 

However, identifying perceived “warning signs” is always easier after the event with the benefit of hindsight.  In practice, spotting the early warning signs of the risk of contractor insolvency before an insolvency process starts can be difficult.  The warning signs of contractor insolvency (whether that be the insolvency of the main contractor or the insolvency of a sub-contractor) are not always obvious, or easy to spot particularly on larger construction projects.

Given the latest figures and the inevitable risk that Carillion’s collapse will trigger further insolvencies within the construction industry, it is important that banks, other lenders and businesses are aware of the common warning signs of a distressed business within the supply chain and proactively manage projects to ensure that, where issues exist, they are identified before matters escalate. 

What are the warning signs of a distressed business?

Spotting the warning signs of a distressed business will be easier in some cases than others.  Many assume that lack of cash is the key indicator of a distressed business.  However, there will often be earlier warning signs on the site before cash flow difficulties emerge.  Examples include delays with the project, a slowdown in progress or a decline in the quality of work being undertaken on the site.  Delays in making payments to sub-contractors, requests for extended payment terms, the late filing of accounts at Companies House, a reduction in the size of the workforce attending site and the unexpected removal of equipment & materials can also be early signals of the risk of contractor insolvency within the supply chain. 

Potentially affected parties who are involved in construction projects would be well advised to familiarise themselves with these signals and carefully monitor projects to ensure that they are kept abreast of any changes on site, particularly where they have a high level of financial exposure in the project.

What steps should be taken if risks are identified?

Where risks are identified, immediate action should be taken by the affected party to investigate the perceived risks and if possible secure the project before matters escalate.

There are a number of practical and legal steps that potentially affected parties may wish to consider.  The follow up steps will vary depending on the party’s position within the supply chain and the structure of the project; however, initial steps may include:

• Collating and reviewing the terms of any relevant contractual documentation (including any relevant third party agreements).
• Checking whether the contractual documentation provides for termination in the event of insolvency and if so, identifying what conditions (if any) need to be met for those provisions to take effect. Particular attention should be given to the definition of “insolvency event” within the contractual documentation. 
• Checking the contractual documentation for any other provisions which may be relevant if another party within the supply chain enters an insolvency process. For example, check for warranties, ADR clauses, “step in” rights and retention of title clauses.
• Identifying whether any outstanding payments are due, the extent of financial exposure and whether there are any claims against other parties which could be impacted by contractor insolvency. Where claims are identified checks should be made to ensure that any necessary demands, or notices, have been issued and any relevant provisions within the contract have been complied with.  The affected party may also wish to consider whether any rights of set off or abatement exist, as well as considering alternative options for recovery such as performance bonds or trade credit insurance.  If no security is already in place, the affected party may wish to consider taking out insurance or a performance bond.
• Ensuring any relevant insurance policies are up to date.

These are just a few of the steps that a party may wish to consider where they identify the risk of insolvency within a construction project.  Many anticipate that insolvency numbers will increase within the construction industry over the course of the next year so it is extremely important that ongoing construction sites and projects are carefully monitored.

How can Druces LLP assist?

Druces regularly advises banks, other lenders and businesses within the construction industry on issues relating to distressed sites and projects.  If you have identified issues with a construction site, or project, or would wish to discuss any of the issues raised in this article further, please contact Rachel Brown (Senior Associate) in our Litigation and Dispute Resolution Team by telephone on 020 7216 5562 or by email at r.brown@druces.com.

This briefing was posted on 5 March 2018