Resolution of claims involving insolvent construction companies

The nature of construction operations and the susceptibility of the construction sector to a wide range of external influences mean that construction companies have always been, and remain, at a higher risk of insolvency than comparably sized businesses in other areas of commerce.

Coupled with the extreme practical difficulties and associated costs that can arise when it’s necessary to change contractors mid project, the standard form contracts have long sought to put in place mechanisms for dealing with the fall out of a contractor becoming insolvent, in order to provide some structure and certainty around what needs to happen to determine the final financial position under the contract.

As well as looking to adopt a practical approach, these mechanisms also reflect the limitations that come into play so far as adjudicating disputes is concerned, compared with the pre-insolvency position (which is explored here). The friction between the statutory rights arising under the Construction Act and the insolvency regime under the Insolvency Act remains an unsettled area of law and is quite an involved topic in itself. Generally speaking, a party will only be able to take steps to enforce any adjudicator’s decision if the court are satisfied that the decision reflects the overall net sum due between the parties. Therefore, the usual ability to “cherry pick” issues and gain maximum cash flow advantage by obtaining a temporarily binding and enforceable decision are severely constrained. Unless the court can be convinced that the decision reflects the overall net sum due between the parties, enforcement of any decision would (at best) usually be stayed until that overall position became clear.

The rationale behind that is clear – the “pay now, argue later” approach of adjudication cannot be sustained where a party is insolvent and would not be able to satisfy a later award that reverses the cash flow of an earlier award.  In practical terms, this substantially reduces the occasions where adjudication will be preferable to court proceedings. Unlike in adjudication, court proceedings will enable all claims and counterclaims between the parties to be determined in a single set of proceedings, so getting to that net sum due.

Taking the JCT suite of construction contracts containing detailed mechanisms (which have been preserved, with helpful clarifications, in the recent 2024 revisions), which apply following a contractor’s insolvency:

• The employer has a contractual ground to terminate if the contractor becomes subject to most of the common forms of insolvency (including liquidation, administration, CVAs and the like)
• Irrespective of whether the employer elects to serve that termination, the occurrence of the insolvency event triggers a set of provisions which suspend the pre insolvency payment obligations until a net sum is determined. This extends to any pre insolvency payment obligations, regardless of whether a Pay Less Notice was given
• The employer has three months from the completion of the works the making good of defects by others within which to provide a statement setting out the sums that it has properly incurred in carrying out those works, together with any direct loss or damage arising. This must also confirm the amount of payments made to date, the total amount which would otherwise have been due under the contract, and the net sum then due from the employer to contractor or vice versa, as the case may be – in other words, the final net sum due one way or the other
• Any payment obligation, and dispute capable of reference to adjudication, then only arises once the employer has provided that statement and the insolvency practitioner for the contractor decides whether to accept or dispute that calculation of the net sum due.

Complications may arise where the insolvency occurs after practical completion but before defects notified within the rectification period have been made good, particularly if it suits the employer to simply “sit on” a sizeable retention and not take any further steps. There are default mechanisms that apply where an employer decides not to carry out the works, but with significantly extended timeframes. These provisions in particular have been usefully clarified and strengthened in the 2024 revisions to the relevant JCT forms.

Associated with these mechanisms, the JCT suite of construction contracts also contains provisions to mitigate the impact on the project. Whilst the requirements vary between the particular form of JCT contract used, many of them give the employer the right to require that the benefit of certain agreements relating to the contract be assigned over and/or design documents provided.

Whilst inevitably the insolvency of a contractor will always carry a very significant impact for the project, these types of processes provide a helpful framework in establishing when and how the financial implications arising from the insolvency and the pre-insolvency “loose ends” are to be resolved. The suspension of payment obligations in the interim also provides significant practical clarity and side steps the issues that would otherwise arise from the frictions between the statutory regimes of the Insolvency Act and Construction Act.

The best approach to dealing with claims as or against a contractor in insolvency will therefore require a strategy that works with, and not against, these mechanisms and recognises the significant differences in the tools available, compared with those in resolving a construction dispute pre insolvency.

Our expert Construction team has extensive experience of dealing with this issue, please get in touch if we can assist.