Preparing for Supply Chain Insolvency

Gordon Shewan
The economic effects resulting from the Covid-19 pandemic are yet to be fully realised. Despite the Government’s multi-billion-pound financial support package, it remains likely that some contractors and consultancies are going to run out of money.

With non-essential construction works stopping, many contractors will receive payments for works completed and will largely have to rely on financial reserves to pay their minimum operating costs. Even for those firms making use of the Government ‘furlough’ scheme, this is a precarious position. This is a situation that is echoed throughout the supply chain.

At Faithful+Gould, we are assisting our clients in protecting their interests. Some of these actions may seem basic, and in times of prosperity they are often overlooked. Right now, they are critical;

Pre-Contract

  • Financial Standing – At some stage, non-essential construction works will be able to resume. With contractor’s cash reserves taking a significant hit, it will become increasingly important to undertake in-depth financial checks. They should be carried out by an appropriate body and reflect the size, scale and complexity of the project. Any red flags should be investigated further or preclude that contractor from the tendering.
  • Bonds and Guarantees – Protection can also be sought in the form of a Performance Bond (PB) and/or a Parent Company Guarantee (PCG). Offering the employer reassurance of a third-party taking responsibility to compete the works, or remuneration which can go towards the costs of completing the project, these can become a lifeline for a project where a contractor is in distress. Unfortunately, it is common place that works commence on site without having such protections in place. Employers should seek to have their PB or PCG executed at the outset.
  • Advance Payment – such payments are essential for the contractor’s supply chain. If advance payments are made to cover the upfront costs of long lead items such as steelwork, lifts etc, then depending on the value of that payment, the employer should insist on an advance payment bond. In the case of contractor insolvency this will guarantee that the whole or part costs expended can be recovered.

Post Contract

  • Communication – Open communication with the main contractor and closely monitoring the progress of the works is critical to identify the early signs of contractor insolvency. Is progress slipping? Are there less subcontractors on site? Is the contractor making applications for works not yet complete? These are clues as to potential issues ahead. Should you suspect the main contractor is at risk of becoming insolvent, it would be reasonable to take steps. Perhaps request to see remittance advice proving they have settled sub-contractor invoices from the previous month, prior to agreeing valuations. This ensures the supply chain remains engaged and that payments are not used to cover other debts.
  • Collateral Warranties – It is important to ensure all collateral warranties from sub-contractors are executed and that signed copies are held by the employer. In the event of main contractor insolvency this can maintain the sub-contractor’s duty of care to the employer, in line with their original agreement with the main contractor. Also, should there being issue with quality of sub-contractor design or workmanship, they can be a vital contractual link to an employer pursuing rectification or costs.
  • Flexibility – completion of a successful project is key, and it may be appropriate to expend efforts working with the contractor to keep the project moving. Avoiding the extreme of termination and completing the project is the goal. One such example is considering shorter payment intervals to relieve the main contractor’s cashflow pressures. Ensuring the employer is not exposed to any additional risk is crucial, and our professional team would provide clear advice in that regard.
  • Contractual Compliance – Should the worst happen it is necessary to follow the steps set out in the contract to terminate the agreement. These vary between the forms of contract, however generally notice of termination should be signed and sent via recorded delivery to the contractor at its registered address and to the contractor’s insolvency practitioner. In every case our professional team would provide clear advice and support, and wherever appropriate we suggest our clients consult with their legal advisors. Termination is not a common occurrence and getting the process and procedural steps correct is fundamental to minimising risk.
  • What next? – As soon as is practical after insolvency, the employer should take steps to secure the site and take detailed records of any goods, materials and plant left in place. These records will prove invaluable when determining the costs and expenses incurred due to termination and when deciding how to proceed with the contract. All of this should be undertaken on the guidance of professional or legal advisors. Due to the current restrictions on movement during Covid-19, employers should prepare contingency plans now to ensure they have the capability to secure their sites safely and timeously.

This is a difficult topic and not one we generally consider day to day. However, all businesses are being impacted by the Covid-19 outbreak and many are under financial stress. It is therefore the responsibility of all team members to be fully vigilant and alive to the possibility of failure of any party to the contract.

 

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