Mitigating Insolvency Effects In The Supply Chain

Key points

Current statistics show that insolvencies in the construction industry are on the rise The liquidation of Carillion and the administration of Interserve highlight the importance of understanding the impact of a contractor's or a supplier's insolvency Parties should be able to recognise the warning signs and indicators of an imminent insolvency, so steps can be taken promptly to minimise the impact Adjudication proceedings are unlikely to assist where the defaulting party is in liquidation or administration Insolvency in the construction industry is once again in the headlines. The liquidation of Carillion and the administration of Interserve (as well as several other high-profile tier 2 and 3 contractor insolvencies) have highlighted how important it is to be alert to the signs of insolvency in the supply chain on a construction project.

Cash flow can suffer greatly as a result of an insolvency in any part of the project, no matter when in the project that insolvency occurs. Each participant is reliant on the party above it in the chain to properly (and promptly) pay for work carried out. Most building contracts provide for stage payments meaning all sub-contractors will have to carry significant work in progress until they are paid. Financial difficulties suffered by just one party in the supply chain can stop the cash flowing down that chain - ultimately causing loss to many other parties involved in the project. Depending on where in the chain the financial difficulty occurs, there may be an option for further external funding or a request for shareholder equity. However, such options are unlikely to be available to the majority of the trades and businesses involved in delivering the project.

Insolvent contractor/sub-contractor

The impact of an insolvent contractor or sub-contractor in a construction project can be far reaching. A contractor insolvency can lead to:

work not being completed in accordance with relevant timescales; poor quality workmanship and the emergence of defects in the work as 'corners are cut'; a delay to the works while a new contractor is appointed (assuming the works have not been completed at the time the insolvency occurs); and third parties losing the value in any collateral warranties they may have had with the insolvent contractor. There are a number of ways that an employer could mitigate these risks or minimise its losses. For example, the employer might choose to terminate the contractor's contract, as we discuss below. Alternatively the employer could make a claim under the Third Parties (Rights Against Insurers) Act 2010 against another party's insurer directly, where the defaulting party has become insolvent. This might help a party where, for example, latent design defects have arisen after the works...