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Insolvency – Termination and Beyond

<a href=Rachel Murray-Smith and Clare Mendelle consider the potential warning signs of, and the compliant manner for dealing with, contractor insolvency.

The Employer instructed a Contractor to design and build a small multi-use community centre. The project started well but a quarter of the way through standards started to slip. The Clerk of Works and Employer’s Agent began to notice workmanship issues on site and a delay in certain activities being completed. The project is now halfway through, and it has become clear that the Contractor is in financial difficulties.

Background

An SME contractor (the “Contractor”) was appointed under the JCT Design & Build 2016 (unamended form) (the “Contract”) to construct a small multi-use community centre. The relationship between the employer (the “Employer”) and Contractor at the outset was positive with everyone feeling optimistic about the benefits that the centre would bring to those who lived in the area. However, by week 16 of the 16-month programme, the Employer’s Agent and Clerk of Works had both noticed a slip in terms of the standard of workmanship. The Contractor had changed the bricks to be used to a cheaper and more readily available type.

In addition, the brickwork itself was not up to the expected standards. The Employer’s Agent raised these issues with the Contractor and its site manager gave lots of assurances that the issues would be addressed, and that workmanship would improve. The Employer, having taken the Employer’s Agent’s advice, was keen to cultivate and maintain a good working relationship with the Contractor and, therefore, accepted the change to the brick type and the assurances that the workmanship issues would be rectified. No formal notification regarding these matters was issued to the Contractor.

Despite the earlier reassurances, issues continued to arise on site which were, again, largely dealt with through the issuing of informal warnings and multiple requests for the workmanship to improve. In addition to the workmanship issues, the Employer and Employer’s Agent noticed that, over the coming weeks, the number of personnel on site was significantly less than expected. By week 30, the Employer’s Agent had heard from a contractor on another project that it was managing that the Contractor was in financial difficulties.

This provided a potential explanation for the limited number of personnel on site. In addition, only the week before the site manager had made a poor excuse as to why some materials, which were due on site, had not been delivered. The Employer’s Agent mentioned this to the Employer who was very concerned by this news. Before the Employer could fully consider the options available the news arrived in week 32 that the Contractor had gone into administration; a few days later the Employer received the notice of appointment of an administrator. The Employer immediately proceeded to terminate under clause 8.5.1 of the Contract. The Employer wanted to ensure that the notice of termination arrived with the Contractor immediately, and so the notice was first sent via email and then by first-class post for completeness.

Termination for Insolvency

The majority of Employers will seek to terminate in such circumstances. It is critical that all of the required procedural steps are followed to ensure that the termination is valid.

The Employer must:

  • Check that it has the requisite ground(s) to terminate. Clause 8.1 provides a very broad definition of insolvency and so it is likely it will apply in most instances of formal financial distress. However, this must be checked, and it is important to confirm in the notice of termination the limb of clause 8.1 which applies. In this scenario, clause 8.1.1 applied.
  • Be mindful of the applicable notice period depending on the clause under which they are terminating. Termination for insolvency under clause 8.5.1 takes effect from the date of service of the notice of termination (i.e., immediately).
  • Check the service requirements. Clause 8.2.3 confirms that “Each notice referred to in this section shall be given in accordance with clause 1.7.4.” Clause 1.7.4 requires that the notice must be “delivered by hand or sent by Recorded Signed For or Special Delivery post.” The Employer, therefore, did not validly serve its termination notice in this scenario and is in repudiatory breach of contract. A repudiatory breach of contract entitles the other party to either accept the repudiation (i.e., end the contract) or to affirm it (i.e., continue the contract). In either case, the other party is also entitled to claim damages. The Employer here could, if it discovers its mistake quickly, re-issue the notice of termination taking care to ensure that it complies with all applicable notice provisions. In so doing it will limit the damages, if any, that the Contractor will suffer and be able to claim.
  • Check that the notice of termination is served on the correct address. In accordance with clause 1.7.3 this will be one of the following:
    • The address stated in the Contract Particulars or such other address as the recipient may from time to time notify to the sender. In respect of the latter, caution should be exercised to ensure that such an address change has been formally notified to enable reliance upon it.
    • If no such address is current, the recipient’s last known principal business address or (where a body corporate) its registered or principal office.
    • If there is any doubt regarding the address, consideration should be given to serving to more than one address.

Steps Following Termination

Here is a practical checklist for Employers, to assist in terms of next steps upon termination:

  • Take back possession of the site (as entitled by clause 8.7.1) and secure the site and the materials on it. This will enable the Employer to manage the Contractor’s return to site, pursuant to clause 8.7.2.1, to remove materials and goods that belong to it. It will also prevent any unauthorised access by sub-contractors (who may be owed money) from accessing the site to remove items.
  • Immediately check the forms of financial security provided under the contract: parent company guarantee, performance bond and/or sub-contractor warranties. Is it possible to make a claim under any of these forms? It is important to remember in respect of the forms of financial security that they must specifically cater for insolvency for you to call on them.
  • Familiarise yourself with – and follow – the relevant termination provisions, including the specific termination final account process.

The background to the scenario detailed a number of performance issues on site. The Employer in this scenario elected to deal with these informally. Performance issues can be an indicator of and precursor to financial distress. In addition to the obvious reasons to deal with such issues formally and in accordance with the Contract, it may also provide the Employer with grounds to terminate under clause 8.4 (Default by Contractor).

This termination right may arise prior to a formal insolvency scenario. Formal records of such matters will also be critical when valuing the works for the purposes of the termination final account, particularly where the Employer has had to otherwise instruct another contractor to rectify defects under clause 2.35. If, as in this scenario, materials do not arrive on site immediately, check if they have been designated as Listed Items or if there are any specific amendments to the terms which enable you to withhold payment until such time as materials are delivered. Proactive management of the Contract is essential and will invariably put the Employer in a better position should an issue such as insolvency arise.

Rachel Murray-Smith is a partner and Clare Mendelle a Professional Support Lawyer at Sharpe Pritchard LLP


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