April 17, 2018

Insolvency in the supply chain - Sub-contractors’ rights

Insolvency in the supply chain can be disastrous to projects with delays and increased costs almost inevitable. Begbies Traynor's Red Flag Alert research for Q4 2017 highlighted that financial distress in the UK Construction industry grew 31% impacting 62,294 firms. According to Creditsafe, construction insolvencies soared 73% in the first quarter of 2018 compared with the final quarter of 2017 in what was a "turbulent quarter for the construction industry".

Construction firms are likely to continue to balance on a thin financial line with it anticipated that main contractor insolvencies are likely to increase this year. While it is positive news that the struggling construction and support services firm Interserve, a major government contractor, has struck a refinancing deal with its banks, it is a stark reminder that large contractors are not immune to the industry's financial issues.

When main contractor insolvency occurs, subcontractors are left in a difficult and uncertain position.  Some of the key considerations are discussed below.

Termination

Most building contracts contain provisions allowing the suspension of work or termination of the subcontract in the event of main contractor insolvency. However, while it may allow immediate termination, there will usually be a formal notification procedure. 

Subcontractors should review their subcontracts to ensure they do not wrongfully terminate or suspend the subcontract and obtain advice if they have any uncertainty regarding the termination or suspension process.

Sub-Subcontractors/Sub-Suppliers

If the subcontract is terminated, consider how this will affect any sub-subcontracts or sub-supply agreements. It may be that these are automatically terminated or alternatively are terminated following the service of an appropriate notice. All works properly completed and materials reasonably ordered prior to the date of termination will likely require payment. Liability as to other costs will depend on the precise wording of the sub-subcontract or sub-supply agreements in questions.

Direct Employment

The employer may wish to directly employ a subcontractor in order to ensure the project continues with minimal disruption. The subcontract and any collateral warranty given by the subcontractor to the employer should be reviewed to confirm if this is provided for and, if so, what mechanism has been included for doing so, particularly in relation to payment. Subcontractors should note that, in such situations, they may be in a strong bargaining position and might be able to negotiate more favourable terms.

Materials/Retention of Title

Subcontracts usually contain transfer of title provisions in relation to materials. As such, title to materials could pass upon their delivery to the site, when payment is made for them, or when they are incorporated into the works.

If the materials have been incorporated into the works, title usually passes away from the subcontractor to the main contractor or further up the contractual chain. However, if they are not yet incorporated into the works, then the terms of the subcontract (and the provisions of the main contractor's contract with its client) will confirm whether title to the materials passes up the contractual chain.

Ultimately, the subcontractor's right to take materials off site post insolvency depends on whether or not it retains title to them. If a subcontractor is in doubt, it should obtain advice.

Recovery of Equipment

The subcontractor will have the right to recover its tools and equipment provided that it retains title to them. If so, a subcontractor that is locked out of a site could seek an injunction against those controlling access to the site to compel them to return the equipment and tools to it. Such judicial mechanism is worth considering especially when the controlling party has previously refused the subcontractor access to the site.

Retention Monies

A subcontract typically provides that a main contractor may retain 3 to 5% of the value of the subcontract works executed by the subcontractor until the subcontract works have achieved practical completion.  This retention then usually halves, and the balance is retained by the main contractor until the subcontractor completes the making good of defects in its subcontract works.

When a main contractor becomes insolvent, a subcontractor normally seeks the return of its retention money. Its entitlement to the retention money may depend upon whether it was held as trust money, in a separately designated bank account. Subcontractors seeking the return of retentions monies may therefore require advice.

Copyright

If a subcontractor has prepared designs for its subcontract works, the employer's right to use those designs to complete its project will depend upon whether the copyright in them has been transferred to the employer, and if not, whether the employer has obtained a copyright licence from the subcontractor which enables it to use the designs to complete the project. Occasionally, such copyright licences are only granted by subcontractors where they receive all payments due to them in respect of their subcontract works.

Accordingly, the copyright terms in subcontracts and collateral warranties require careful consideration, follow a main contractor's insolvency.

If you have any questions on any of the topics raised in this article, please don't hesitate to contact one of the authors or your usual contact in the projects & construction team.