Carillion: project companies should put contingency plans in place to deal with contractor liquidation, experts say

There are now over 700 operational PFI/PPP projects in England and Wales across all sectors, with a capital value of over £60 billion. More interestingly, over £200bn remains outstanding to be paid to the private sector for the provision of services over the remainder of the contract term, making the potential scale of the issue significant. The scale, and financial position of, these projects is similar in Scotland.

For those involved in operational projects, understanding the extent of their exposure to any one particular contracting entity is vital, given the number of subsidiaries operating under the umbrella of each of the main infrastructure groups. If you are overexposed to any one particular entity, you should be putting in place contingency plans and be mindful that, if you are a director, you have a duty to act in the best interest of your company.

Impact of compulsory liquidation on operational contracts

Compulsory liquidation does not, as a matter of law, terminate a contract. Rather, contracts entered into with a company in compulsory liquidation may contain contractual rights of termination or other remedies triggered by the insolvency proceedings. These termination rights are often immediate, with no discretion provided for.

You should review the terms of your contracts as a priority to establish what your contractual rights are in the event that a contracting entity is placed in compulsory liquidation, and that a risk register is drawn up.

If the contracts provide for immediate termination or termination by notice, it is important to act quickly. Issue a reservation of rights letter to the liquidator setting out the basis on which the operational contracts will continue to exist, and reserving your rights to subsequently terminate.

Provisions which allow for immediate termination are often impractical, particularly under contracts dealing with the provision of services to schools and hospitals. Part of your contingency planning should include establishing what interim measures can be put in place urgently where continuity of service is vital.

Due to the age of many operational projects, it is very common for documentation to be missing or to not have been executed correctly. Make sure you have access to up to date pricing information, number of employees employed on site, what their terms and conditions are and what assets there are. Not having this information to hand is a common cause of delay, and can prevent interim solutions from being put in place quickly to protect continuity of service.

Liability for construction defect risks

The reality of a compulsory liquidation is that there will be a number of projects where the defect liability risk will pass to the project operating company earlier than expected. Again, a thorough review of all project documentation should be carried out now to identify where the risk of defects is now sitting, and so that you can take appropriate action to mitigate any unexpected risks.

For facilities management contractors, transfer of defect liability risk will very much depend on the terms of the facilities management agreement. It is not uncommon for project companies to retain the risk of subcontractor insolvency. New facilities management providers should carry out in-depth surveys of the project estate before taking over management responsibility, to ensure a clear picture of any potential future defects.

It is likely that there will be significant changes to the risk profile of operational projects where there has been a contractor liquidation. This may lead to future negative project valuations.

Liability for funding risks

Compulsory liquidation of a contracting entity will trigger an event of default under the project finance documents.

You should notify your funder when this happens, and provide them with an initial remedy plan. The project company will be placed in lock-up with an inability to make distributions until the default is waived. Your own risk profile, and that of the project, is likely to be materially altered, which will have implications from a funding perspective.

Consent is required from the funders before you enter into any arrangements with the liquidator, make any changes to the payment profile or enter into any interim services agreements. Funder consent will also be required to enter into replacement facilities management agreements or contract with replacement facilities management providers. The financial position and covenant of the new facilities management guarantor will be critical for funder approval.

While funders are likely to be sympathetic, particularly in the event of a catastrophic compulsory liquidation with wide-ranging effects, they ultimately have their own internal processes to comply with. Funders will not want to see a material change in the risk profile of either the project company or the project, and while this is inevitable in these circumstances it should not be assumed that the funders will accept this position without alternate security measures being put in place.

Liability to the public authority

The project agreement will not protect you in the event of a subcontractor liquidation. Deductions and deficiency points will continue to accrue if service is impacted on. While there is no obvious event of default, you should be mindful that abandonment of the services, any health and safety breaches and poor performance, irrespective of the cause, are all events of default.

The authority must consent to any new facilities management agreements, and to the identity of a new facilities management contractor. This will also apply to any interim measures.

Impact on equity providers

Expected costs on the interim process, anticipated timing and costs of implementing long-term solutions will almost certainly lead to significant delays to distributions from the project to equity providers. There is also the very real potential of a negative impact on the valuation of the project due to the change in risk profile.

Victoria Miller is an infrastructure asset management expert at Pinsent Masons, the law firm behind Out-Law.com.