Construction supply chain insolvency

Out-Law Guide | 22 Feb 2021 | 3:05 pm | 11 min. read

The economic impact of Covid-19 has brought into sharp focus the risk of supplier insolvency in the construction and infrastructure sectors.

Doing due diligence, understanding your rights under contract, and assessing how important a supplier in financial difficulty is to a project, and doing so quickly, are steps businesses can take to managing supply chain insolvency successfully.

Experts from Pinsent Masons, including those based in the UK and Middle East, will be exploring these issues in more detail during the global infrastructure law review of the year series of events taking place between 23 February and 4 March 2021.

The position in the UK

The construction and infrastructure sector in the UK has consistently seen the highest level of insolvencies across all sectors of the UK economy since 2018. Employers, contractors and their supply chain continue to grapple with very thin margins, rising costs and uncertainty due to the Brexit, as well as the considerable financial impact of Covid-19.

The government support measures for business across all sectors through the furlough scheme, business interruption loan schemes and protections against the use of debt recovery tools and winding-up petitions have helped avoid an avalanche of insolvencies to date. However, it seems inevitable that we will see an increase in the number of insolvencies throughout 2021.

The position in Gulf Cooperation Council (GCC) states

Despite continued, large-scale government-led infrastructure spending programmes across the GCC, such as Saudi Arabia's National Transformation Program as part of Vison 2030, the construction and infrastructure sector has suffered recently with a number of high-profile casualties; most notably the proposed liquidation of Arabtec Holdings in the UAE.

Similarly, certain GCC governments acted to prevent an immediate deluge of creditor-led insolvency petitions such as the UAE's amendments to its Federal Decree-Law No. (9) of 2016 concerning bankruptcy which introduced the concept of an "emergency financial crisis". During a period of emergency financial crisis, measures include the right for courts to postpone accepting petitions for creditor-led insolvencies. However, it has been announced that the emergency financial crisis period which related to the effects of the global pandemic will cease on 31 July 2021. As such, entities need to start planning for life after Covid-19-related relief measures.

Practical steps to assist with supply chain insolvency

If you are faced with a potential insolvency in your supply chain, there are a number of steps you can take to best protect your business, project or works from the impact of that insolvency:

Do your due diligence

Acting quickly to understand exactly the status of a company and a potential insolvency is key to informing your rights and next steps. With the rumour mill often in full flow, acting on incorrect information can lead to the wrong decisions being taken and potentially claims against you if you wrongfully terminate.

In the UK, using publicly available searches of the Companies Court insolvency records will confirm in real time the extent to which a particular entity is subject to insolvency proceedings, including the moratorium process under the Corporate Insolvency and Governance Act 2020. This, along with regular credit checks and Companies House alerts, will provide you with the financial and legal information to give you an early warning on a potential or actual insolvency, and provide critical time to plan how to respond to it.

Whilst there is often not the same level of publicly available information in many GGC states as there is in the UK, some diligence is possible and you should seek local law advice. For example, it is often a requirement to publish insolvency-related court decisions in newspapers or gazettes. Therefore, if a counterparty insolvency is expected, appropriate monitoring of such publications is advisable – particularly as the date of publication often triggers deadlines for filing your creditor claim.

Understand your contractual rights

Understanding your contractual rights and obligations upon an insolvency of a sub-contractor/supplier prior to it actually occurring will mean that you are in a position to react quickly and confidently when the insolvency occurs.

It is critical to check the insolvency termination rights to make sure that they capture the exact events that have occurred, if the decision is taken to terminate the sub-contractor's/supplier's employment. Wrongful termination could lead to a counter claim that you are responsible for a repudiatory breach of the contract.

In addition, it is important to understand what the provisions relating to title to goods and materials and post-termination rights under the contract are. Businesses should determine whether title in all goods and materials has passed to them, or if is there is scope for potential retention of title (ROT) claims to be raised against them, and if so, whether those claims can be defeated.

An assessment should also be made as to whether you are allowed to withhold payments, whether  you still need to serve a pay less/withholding notice, whether you can take custody of plant, materials, drawings and equipment, and whether there is a termination account mechanism to determine the overall claim in the insolvency – assuming the project/contract is completed by a replacement.

This can be important if you have the benefit of performance security by way of a bond or guarantee and are looking to assert a claim against the bondsman or guarantor.

What are the commercial drivers of the business?

Before any decision is taken as to how you should respond to a potential or actual insolvency, you need to assess the commercial drivers of the business. It is important to quickly understand what the payment position is under the contract, and to what extent there are outstanding payments due, or about to become due, to the sub-contractor/supplier.

It is also important to understand how critical this sub-contractor/supplier is to the project or works. Businesses should ask themselves whether the sub-contractor/supplier is providing a bespoke or specialist supply that cannot easily be procured elsewhere.

It is also important to determine whether the sub-contractor/supplier  holds materials or equipment offsite that are critical to the project or works, and whether it is more cost effective to reach an agreement with the sub-contractor/supplier or any appointed insolvency practitioner for the continued supply for a period, and if so, whether that is practicable. In this respect, an assessment should be made as to whether the entity still has the staff and capability to continue supply.

Insolvency practitioners may well be willing to reach an agreement for the continued supply of goods and materials post insolvency if the costs of the supply and an element of their costs for managing the entity's affairs are covered. However, any continued supply is likely to be procured on bespoke contract terms, and without the benefit of representations and warranties.

Act quickly

Overall, it is critical that you act quickly to implement some or all of the steps set out above when faced with a potential or actual insolvency. Doing so will give you the best chance to protect your business, project or works from the effect of an insolvency in your supply chain.

Delay can often see value erode and damage or disruption to a project or works, ultimately increasing your costs and losses arising out of the insolvency.

Co-written by Matthew Dyson of Pinsent Masons. Managing supply chain insolvency is one of the topics that will be addressed during the Pinsent Masons global infrastructure law review of the year series of events. The events are free to register for and address both sector-wide pivotal issues of global impact and local construction law issues affecting the infrastructure industry.