Main Contractor Insolvency – What about the sub-contractors?

Following the collapse of Carillion, a wave of articles on the impact of main contractor insolvency on developers flooded the construction and legal press. These provided welcome advice for employers but offered little information for the sub-contractors.

We consider what signals you as a sub-contractor should look out for, what action you can take in the event a main contractor becomes insolvent and how you can best plan for future projects.

Early warning signs

There are signs to be aware of which might indicate that a main contractor is in trouble:

• Its employees are not turning up to site or there is a decrease in labour on site.
• An increase in the number of defects in the works.
• The main contractor seeking to negotiate a variation in payment patterns with sub-contractors (or not paying some or all sub-contractors).
• The main contractor assigning the benefit of the building contract to a bank or other creditor.
• Late filing of accounts or annual returns at Companies House by the main contractor.
• Rumours in the press or from other sources about the main contractor’s financial position.

What if a main contractor becomes insolvent?

Checking the terms of the sub-contract is crucial should a main contractor become insolvent as these will dictate any ability to recover monies. The following is a useful list of considerations for you when facing the impact of a main contractor insolvency: 

• Suspending or terminating the sub-contract is generally provided for in the sub-contract and may seem the best course of action if a main contractor becomes insolvent. However, you should review your sub-contracts to ensure you do not wrongfully suspend or terminate your sub-contract. Depending on its provisions, if the main contract is terminated sub-contracts may be automatically terminated and the same may apply to sub-sub-contracts.
• All materials ordered and works completed by any sub-sub-contractor prior to the date of termination will likely require payment so it is crucial to consider taking action and suspending or terminating sub-sub-contractors if payment is not going to be forthcoming from the main contractor.
• If you have given a warranty in favour of the employer, it may contain a mechanism allowing the employer to directly employ you. Even if such a warranty isn’t in place, there is nothing to stop you from approaching the employer directly. You may have a strong bargaining position given that the employer is likely to want to ensure that the project continues with minimal disruption. It may also be possible to require the employer to pay outstanding sums as a requirement of entering into a new sub-contract with the employer and the terms of the warranty may require it.
• It is common for sub-contracts to contain retention of title clauses stating that ownership of materials will pass to the main contractor when the sub-contractor has been paid. It is important to be aware of when title passes up the contractual chain to ensure that you can recover materials for which title has not yet passed to the main contractor. Likewise, you have a right to recover equipment and tools provided you retain title to them. If your equipment remains on site and the site is locked, you could seek an injunction against whoever is controlling the site to enable you to recover your materials, tools and equipment.
• When a main contractor becomes insolvent, you will want to recover your retention money. The ability to recover may depend upon whether the retention has been held on trust in a designated bank account, so it is important to check this with the main contractor as soon as possible and ideally on the commencement of the works.
• Where you have design responsibility, the employer may have a right to use those designs to complete the project by virtue of the sub-contract or by a copyright licence which you have granted to the employer. However, some sub-contracts provide for copyright licences to be granted once all payments due have been received by the sub-contractor, so it is important to check that you aren’t giving away intellectual property before you need to.

How can a Sub-Contractor Protect Itself?

Ensure sub-contracts are properly drafted. All too often, sub-contract terms are unclear or worse, absent. Seek legal advice at the earliest stage and do not enter into sub-contracts where the terms are unknown.

• Be aware of what you are entering into. Onerous clauses such as “pay when paid” clauses could cost you dearly. Whilst a main contractor may not agree to the removal of certain clauses, being aware of these means you are less likely to be caught on the back foot if your main contractor becomes insolvent. Also, “pay when paid” provisions are only enforceable in certain situations so don’t take it for granted that the terms of the sub-contract can be relied upon.
• Where possible, ensure that your source of work is spread to minimise the impact of the insolvency of one main contractor.
• Undertake proper credit reference checks before you enter into contract with a main contractor. Just because the name is well known does not mean that it is well financed.
• Keep on top of your account and take advice quickly if you are not getting paid. Suspension, adjudication or issuing a winding up petition can all be effective tools, but it is essential to get the process right in each case so proper legal advice is key.
• Undertake regular contract audits and act upon any early warning signs. It is essential to consider the position and act quickly if you want to try to make the best of a bad situation.

At Myerson, we have recently expanded our Construction Team and can offer advice on all aspects of contentious and non-contentious matters. For more information on the range of legal services Myerson LLP can provide please call Myerson’s Construction Team on +44(0)161 941 4000 or email lawyers@myerson.co.uk.