Main Contractor Insolvency: Dealing with the Fallout - 5 Key Tips

In what's news to very few working within the construction sector, main contractor insolvency is on the rise. Fresh statistics from the Insolvency Service, released on 19 November 2024, show that the construction industry is, for the 12 months up to September 2024, top of the sectors in terms of number of insolvencies, accounting for 17% of all company insolvencies in England and Wales, with over four thousand cases.

High interest rates, inflation, high and unpredictable costs of goods and labour, low profit margins, cashflow issues and failed M&A processes are some of the contributing factors. In the last 12 months, we have seen numerous examples of main contractor insolvency, each bringing its own set of unique but also common challenges. 

As we approach the end of 2024, we are taking stock of our experience advising on the client side of construction projects by setting out our top tips for tackling main contractor insolvency on a live project, and ways to mitigate the risk for future projects. In this article, we focus on dealing with the fallout from main contractor insolvency on a live project. A second article will follow shortly, offering insights on how to protect against and mitigate the risk of main contractor insolvency.

Insolvency takes many forms, each with its own processes and procedures, but it is entry into administration that we have seen most commonly causing our clients' live projects to grind to a halt this year. Often, the writing is on the wall. Market intel is common, but other examples include delays to the works that would normally be avoided or dealt with efficiently, and the ubiquitous non-payment of sub-contractors and the wider supply chain. 

Insolvency During Works

The issues will vary in their seriousness and complexity depending on the stage and value of a project. Dealing with a prospective tenant, as well as the providers of development finance, adds stakeholder management to an already complex situation. 

To keep this practical, let's take an example: you are the developer of a new mixed-use but predominantly office building in central London. Works are well underway and around 65% complete at the point when the main contractor files for administration. The administrators have, as is typically the case in our experience, confirmed that the company has ceased to trade and no further work will be undertaken. Without further trading, it is not expected that any buyer will be found. The value of the works is £80,000,000 and outstanding payments are due to the main contractor for pre-administration works. Signs of distress were apparent for weeks, with issues including key sub-contractors reporting non-payment and the unauthorised removal by sub-contractors of specialist equipment from the site. Your contract is a JCT Design and Build 2016 (amended) and a performance bond is in place. 

What are the 5 key considerations at this point?

1. First things first: check the contract. This sounds obvious but it's crucial to understand your contractual position straight away and before taking any decisions. Most JCT Design and Build contracts will allow the client to terminate if the contractor becomes "Insolvent" and in the context of administration, this is usually at the point the contractor has entered administration, but it could be earlier i.e., when a notice of intention to appoint an administrator has been filed. Being clear on what has happened (e.g., through court searches) is crucial to understanding your contractual rights.
   
   We have facilitated introductory calls between clients and administrators upon their appointment so that clients can start an open dialogue with administrators. Many clients prefer to exercise rights to terminate quickly in order to draw a line under the current arrangements with the main contractor, and doing so allows you to secure the site and consider who will take over as principal contractor in order to complete the works (see point 4 below). Be sure to check the terms of any performance security in place. Any parent company who has provided a guarantee is likely to also be in distress and/or a formal insolvency process, but this will not always be the case. If you have the benefit of a performance bond, take legal advice as to its terms and take steps to put the surety on notice of a future claim for your losses. Check also whether consultancy appointments have been novated to the main contractor and whether you should, where possible, be exercising any step-in rights to resume control over those appointments.
   
   
2. Check the status of any unpaid invoices and cease making all payments. Most JCT Design and Build contracts are beneficial to the client by providing that no further sums become due (for now) upon the main contractor becoming Insolvent. The client can also benefit from the contract expressly providing that the client is not required to pay sums that have already fallen due (i.e., any sums that are subject to a valid invoice issued pre-administration), but this is only the case if a pay less notice in respect of such sums has been issued or the contractor's insolvency took effect after the last date on which a valid pay less notice could have been served.
   
   Timings are important here, so take the time to carefully check the position and prioritise the service of any pay less notices on the main contractor and the administrators. The risk of failing to serve a pay less notice within prescribed timeframes is that the administrator could choose to launch a "smash and grab" adjudication in order to pursue monies, although any decision would be difficult to enforce. Payments should cease because the result of the administration is that the additional costs and expenses of completing the works can be taken into account as part of the balancing exercise once the works have been completed and so such amounts may never actually be required to be paid to the administrators.
   
   
3. Secure, quantify and collate. Once in a position to secure the site, you will need to ensure the site is safe in accordance with the Construction (Design and Management) Regulations 2015. The site is likely to contain expensive equipment, so you need to consider the adequacy of your security arrangements.
   
   A key priority will be quantifying exact project costs so you can work up a revised budget as soon as possible. You will also need to ensure that the works are insured (as insurance maintained by the main contractor will likely have ceased once it entered administration).
   
   The main contractor is likely to be under an obligation to provide key documentation including its design documents and assign to you the benefit of any agreements for the supply of goods and materials to the extent possible. This should be implemented as soon as possible. Where your project is caught by the regime for higher-risk buildings under the Building Safety Act 2022, it will also be important to take stock of the documentation you are required to keep up to date during the works to facilitate efficient interaction with the Building Safety Regulator.
   
   
4. Continuing the works. In the above scenario, you have no choice other than to complete the works. We are often asked whether the administrators would be in a position to complete the works. In our experience, that is incredibly rare and so it is important for you to have your own plan and to consider the impact on your timeline to practical completion.
   
   A key priority will be considering how to go about achieving this contractually – do you want to engage a replacement design and build contractor? Or are you amenable to other options, such as construction management or management contracting? These three procurement routes are very different, each with well-known pros and cons. The merits of the respective options will depend on context: have you secured incoming occupational tenants? Is there a lender providing development finance (with the potential that the main contractor insolvency is an Event of Default) who needs to be updated and managed? What is your appetite for changing course (are you accustomed to using different procurement routes and do you have the necessary expertise and capability)? If engaging a new design and build contractor, ascertain at the outset the appetite of any potential replacement to accept design and workmanship responsibility for work done to date: never assume this will be easily achievable.
   
   
5. Payment to sub-contractors. You are likely to come under pressure from key sub-contractors to make them whole for payments not received from the main contractor, particularly those who know they are critical to completion of the works and also those owed significant sums of money. The realities for the supply chain can frankly be grim: administrators often confirm on appointment that unsecured creditors such as sub-contractors may not recover anything for their unsecured claims so main contractor insolvency puts sub-contractors at risk and can frequently be the cause of insolvencies further down the chain.
   
   Exercise caution here and do not rush to agree to make any direct payments. If you do want to make direct payments, this should only be done (i) after seeking legal advice in order to ensure you can assess the risk of the administrator contending that direct payments do not discharge debts you owe to the main contractor under the building contract (the risk here being that you become liable to make double payments – one to the main contractor, another to the sub-contractor) and (ii) while you may have a contractual nexus with a sub-contractor via a collateral warranty, this will not deal with the issues you will want to address now: such as a contractual commitment from the sub-contractor to agree to be re-engaged either as a sub-contractor to the replacement main contractor, or as a trade contractor / works contractor if you are changing procurement routes.
   
   We have also seen situations where the client takes an assignment of the sub-contractor's claim against the main contractor in return for making the direct payment although query if such an assignment would result in any distribution from the administration in any event.

The above is by no means exhaustive, but we have aimed to highlight some of the key practical steps you can take when faced with a real risk that is unlikely to go away anytime soon. 

The Ashurst team advising on these types of situations combines cross-practice expertise in construction, insolvency, development finance and contentious construction to provide a solutions-orientated approach for what are often very time sensitive situations. If you would like to discuss these issues further, or need any advice, do get in touch. 

For further information take a look at our podcast series on construction insolvency by following this link.

Authors: Simon Clarke (Partner, restructuring and special solutions) and Matt Pearson (Counsel, real estate construction).