Contractor insolvencies are on the rise: guidelines for employers on the warning signs and how best to protect your interests

Posted: 16/12/2022

Introduction

There is a worrying trend in the construction industry: contractor insolvencies are on the rise.

According to a release from The Insolvency Service, the construction industry accounted for 3,213 insolvency cases in the 12 months leading up to April 2022. This equates to almost a fifth (19%) of the overall cases of insolvency and, more worryingly, these numbers are still growing. These insolvencies have occurred throughout the market but have particularly affected smaller and mid-tier contractors.

This article looks at the factors behind these rising contractor insolvencies, the warnings signs for employers, and offers some guidance on how to protect themselves from the risks.

Why are contractors becoming insolvent?

Historically, the narrow margins on which contractors operate have made them particularly prone to insolvency. However, the emergence of various aggravating factors within the market has only served to further squeeze contractors’ profit margins and increase the risk of insolvency.

Many contractors do not have extensive fixed-cost nor long-term supply chains. Accordingly, they are prone to exposure when entering into fixed-price contracts. They also take on the risks of late completion should their supply chain fail to deliver.

In the UK, construction costs continue to significantly rise and contractors are battling increasing inflation rates, most recently driven by the surge in energy prices. The rising costs of raw materials for contractors are a result of unprecedented demand in the market combined with a breakdown in supply chains created by factors including Brexit, Covid-19, the Ukraine War and most recently, a weakened pound following turmoil in the markets resulting from the Truss-Kwarteng min-budget. Finally, this has all been exacerbated by global shipping problems and further logistical issues for suppliers to the sector.

The effect on employers

Employers need to be aware of this situation  as many are being asked for additional monies under their contracts, despite the lack of contractor entitlement to the same. Employers will need to balance these demands against current inflationary pressures and the need to complete projects, especially if their contractors are already under financial strain.

The consequences of these market conditions include lower margins - or even losses - for contractors who were already reeling from the impact of the pandemic. Accordingly, there is already a significant increase of insolvencies in the sector and, as such, particular thought and consideration is needed as to whether support should be given to a contracting party at this time.

The warning signs of impending contractor insolvency

The following trends are five good indicators to which employers should pay particular attention in the current market:

• progress of construction stalling without due explanation and/or the site being abandoned;
• payments to sub-contractors/consultants not being made;
• removal of site materials and/or lack of deliveries;
• inability to procure a performance bond, which may indicate the contractor is more widely overexposed; and
• knowledge within the market and slowdown on other sites.

Guidelines for employers to mitigate themselves against the risk of contractor insolvency

Below are some guidelines that employers should follow when considering the appointment of a contractor to undertake a construction project.

• Always check the financial statements and robustness of any party prior to entering into a contract.
• Consider demanding, under your contracts, an entitlement to review current contractor and developer management accounts to check their current exposure, wider activities and progress across all schemes they are engaged with.
• Take early legal advice on the necessary practical and legal steps you should take to secure a site and best protect its interests if you suspect a contracting party is in difficulty, if a contractor or developer has become insolvent, or an administrator has been appointed.
• Seek advice on any administration or CVA process that a developer or contractor is undergoing to ensure the optimum outcome is reached that best protects your interests.
• If your contractor or developer is already insolvent, ensure that you seek specialist advice on the steps you will need to take to best protect the investment at risk. This will largely be dependent on the status/progress of works and services on site.
• This advice should include the options allowing you to either exit the scheme with minimal or no liability or ways to best complete the scheme and manage risk in the most appropriate and practical way.
• If you are unsure about how to recover from all securities in place under a scheme, you should also seek expert advice that includes a review and enforcement of performance bonds, parent company guarantees and warranties and structural policies (such as from NHBC and Premier). You should also ask for a review of your contract documents and recommendations on your existing protections and the available remedies.

Conclusion

Given today’s market and continuing economic landscape, employers should be taking precautionary steps to mitigate risks and consider what to do in the event that a contactor or delivery partner become insolvent.

Penningtons Manches Cooper is ideally placed to assist you. We have significant expertise and experience in dealing with such matters, both practically and legally. Whether you are concerned about entities you are contracting with or you are suffering issues linked to squeezed margins, slow-downs on site and/or any insolvency concerns, we can assist you. Ultimately, the aim of our advice is always to put the best solution in place for your business, giving regard not only to the legal position but also to the commercial and practicalities of the affected scheme and your desired outcome.

If you would like to know more, please contact Peter Massey.

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