Tools to weather an insolvency storm in the construction industry
It has been over a week since one of the major players in the UK construction sector announced its insolvency. The news caused widespread panic in the construction industry and beyond. The effects are wide reaching and continue to unfold, however now that some of the dust has settled, this article considers tools that may be available to construction parties, by virtue of the Housing Grants, Construction and Regeneration Act 1996 (as amended) (“the 1996 Act”), to weather the ensuing storm.
Pay when paid provisions
The 1996 Act recognises the importance of regular cash flow to the contractor in a construction project, particularly downstream. One of the ways in which the 1996 Act aims to achieve this is through its prohibition on conditional payments. S.113 determines that any contractual provision making payment to the payee conditional on the payer receiving payment from a third party, known in the industry as a “pay when paid provision”, is ineffective.
But what happens when a third party upstream becomes insolvent leaving the payer without the means of paying the payee downstream? Does the payer still have to cough up? S.113 of the 1996 Act contains a carve-out for this scenario by permitting a pay when paid clause to operate when the third party has become insolvent. Where such a provision exists, a sub-contractor could potentially avoid having to pay out sums due to a sub-sub-contractor where the main contractor has failed to make payment to it by reason of insolvency. Not all contracts contain such a provision so it is important to check your contract before considering withholding payment.
Suspending the works
Part II of the 1996 Act further recognises that a contractor cannot be expected to perform its obligations under a contract where it is not being remunerated. Practically, this means that if a main contractor has not paid a sub-contractor sums which are due, the sub-contractor is entitled to down tools until payment is forthcoming. In order to exercise this right, the payee must first give at least seven days’ notice to the payer of its intention to suspend performance.
Terminating the Contract
There is no express provision in the 1996 Act, nor is there any common law right, that allows parties to terminate a construction contract by reason of insolvency. Whether or not a party has the right to terminate a construction contract by reason of a party’s insolvency will therefore depend on the contractual provisions.
Tips for using the tools:
- Read your contract and be clear on what can and cannot be done under the contract. It is the most obvious and common tip, but in an insolvency situation parties can react on instinct and forget what the contractual provisions allow.
- Exercise caution when withholding payment from a payee downstream by reason of non-payment from an upstream third party payer. Only if the upstream third party payer is insolvent, and the contractual provisions allow, may you consider withholding payment from the downstream payee.
- Do not work for free! If as a payee, you have not received payment for sums due, consider suspending the works to avoid racking up further potentially irrecoverable costs.