Minimising the risks if your contractor might go bust

According to industry figures nearly 10,000 construction and manufacturing businesses went bust since the start of 2010, 5,000 of which were construction-related insolvencies. Although the rate of construction insolvencies slowed in 2011, many think this may have been a false dawn and 2012 is expected to be another tough year.

This may prove to be a problem for developers that have engaged contractors on projects where developers have also entered into an agreement for lease with, for example, a prospective retail tenant. An agreement for lease will typically include a longstop date. Failure of the developer to reach practical completion by the longstop date gives the prospective tenant an excuse not to enter into the lease and call the whole thing off which, in the current economic climate, may well be an attractive option for a retail tenant who is having second thoughts about taking out the space. This is a concern where contractors have either gone bust or are experiencing severe financial difficulties evidenced by a reduction or slowing of activity on site.

If the developer terminates incorrectly, the contractor could sue for damages

Take this scenario: a developer enters into an agreement for lease with a retail tenant and agrees a longstop date. The developer engages a contractor and the works start off in earnest but, a month or so in, the rate of works start to slow down. Concerns are raised by the developer in progress meetings but assurances are given by the contractor that things are still OK and that time can be made up over the coming months. Progress worsens over the next month and the contractor eventually “fesses” up to the developer that it is experiencing fiscal difficulties. Crucially though it has not gone bust - yet. What can a developer do? If it does nothing, it runs the risk of jeopardising the agreement for lease longstop date since this can be only normally extended in the event of an extension of time being granted under the building contract - not as a result of contractor insolvency. The developer will need to ask himself whether there are grounds for him to terminate the contractor’s employment and get another contractor on board. But even this is likely to cause delay to the project. The main JCT contracts allow the employer to serve a default notice on the contractor under a number of circumstances one of which is for failing to proceed regularly and diligently with the works. The contractor has 14 days to rectify the default, failing which the employer can terminate.

As Mr Justice Coulson said in the recent case of Leander Construction Ltd vs Mulalley and Co Ltd, cases dealing with the meaning of “regularly and diligently” are a bit sparse; the best judges could come up with was that it meant that the contractor had to “get on with it”. A potential problem arises when the contractor has not yet gone bust but it is not clear whether it can be said with certainty that he has failed to progress the works regularly and diligently, such that the termination provisions can be triggered. The risk is that if the developer terminates incorrectly, the contractor could turn the tables and sue for damages for wrongful termination. So what happens if the developer simply gets a replacement contractor either to help out the struggling contractor or to take over the job in its entirety? Again, the ousted contractor could claim that the developer’s actions in bringing a replacement contractor on board was a repudiatory breach and issue proceedings for damages resulting from the developer’s actions.

To try and minimise the risk of this scenario occurring developers should carry out as much due diligence on the contractor before and during the tender process and again just before he signs on the dotted line. In addition, parties should make sure that any performance bond they obtain pays out in the event of the contractor’s insolvency. Most standard performance bonds only pay out in the event the contractor’s employment under the building contract is determined as a result of the contractor’s insolvency. This is because most performance bonds only pay out in the event that there is a breach of one or more of the terms of the building contract. Insolvency is not, in and of itself, a breach of contract. Developers should keep a close eye on progress throughout the construction phase and look for tell tale signs of financial hardship on the part of the contractor (a reduction of site activity being the most common). If the contractor is not “getting on with it” consider triggering the default provisions in the contract.

Joe Griffiths is a partner at Edwin Coe