Managing construction supply chain insolvency

Employers, contractors and their supply chain continue to grapple with very thin margins, rising energy and supply costs and global supply shortages, even as we emerge from the pandemic.

Growth in activity levels in the industry has started to slow, and we are seeing an increase in formal insolvency cases again.

If you are faced with a potential insolvency in your supply chain, there are a number of steps you can take to best protect your business, project or works from the impact of that insolvency. We look at some of these below.

Do your due diligence

Acting quickly to understand exactly the status of a company and a potential insolvency is key to informing your rights and next steps. With the rumour mill often in full flow, acting on incorrect information can lead to the wrong decisions being taken and potentially claims against you if you wrongfully terminate.

Using publicly available searches of the Companies Court insolvency records will confirm in real time the extent to which a particular entity is subject to insolvency proceedings - including the new moratorium process under the 2020 Corporate Insolvency and Governance Act. This, along with regular credit checks and Companies House alerts, will provide you with the financial and legal information to give you an early warning on a potential or actual insolvency, and provide critical time to plan how to respond to it.

Understand your contractual rights

Understanding your contractual rights and obligations upon an insolvency of a subcontractor or supplier prior to it actually occurring will mean that you are in a position to react quickly and confidently when the insolvency occurs.

If the decision is taken to terminate the subcontractor or supplier's employment, it is critical to check the insolvency termination rights to make sure that they capture the exact events that have occurred. Wrongful termination could lead to a counterclaim for repudiation.

It is also important to understand what the provisions relating to title to goods and materials and post-termination rights under the contract are. Has title in all goods and materials passed to you, or is there scope for potential ROT [retention of title] claims? If so, can these be defeated?

Are you allowed to withhold payments? Do you still need to serve a 'pay less'/withholding notice? Can you take custody of plant, materials, drawings and equipment? Is there a termination account mechanism to determine the overall claim in the insolvency, assuming the project or contract is completed by a replacement?

The answers to these questions can be particularly important if you have the benefit of performance security by way of a bond or guarantee and are looking to assert a claim against the bondsman or guarantor.

Understand the commercial drivers of the business

Before any decision is taken as to how you should respond to a potential or actual insolvency, you need to assess the commercial drivers of the struggling business. It is important to quickly understand what the payment position is under the contract and to what extent there are outstanding payments due, or about to become due, to the subcontractor or supplier facing insolvency.

It is also important to understand how critical this subcontractor or supplier is to the project or works - for example, if they are providing a bespoke or specialist supply that cannot easily be procured elsewhere or whether they hold materials or equipment offsite that are critical to the project or works.

It may be more cost effective to reach an agreement with the subcontractor or supplier or any appointed insolvency practitioner for the continued supply for a period. If so, is that practicable and does the entity still have the staff and capability to do so?

Insolvency practitioners may well be willing to reach an agreement for the continued supply of goods and materials post-insolvency, if the costs of the supply and an element of their costs for managing the entity's affairs are covered. However, any continued supply is likely to be procured on bespoke contract terms, and without the benefit of representations and warranties.

Act quickly!

Above all, it is critical that you act quickly to implement some or all of the steps set out above when faced with a potential or actual insolvency. Doing so will give you the best chance to protect your business, project or works from the effect of an insolvency in your supply chain.

Delay can often see value erode and damage or disruption to a project or works, ultimately increasing your costs and losses arising out of the insolvency.