Insolvency in construction

Insolvency in construction

Sadly we are hearing of more and more construction firms becoming insolvent albeit unsurprising in many cases given the challenges faced. Being particularly susceptible to market changes, the construction industry has seen more insolvencies in the last five years than other sectors across the UK. The collapse of construction giant Carillion in 2018 demonstrated cashflow issues can affect businesses of all shapes and sizes. It resulted in the loss of over 3,000 jobs at the company itself and affected 75,000 people working in the supply chain.?

Here, we have considered the most common reasons for construction insolvency, warning signs and how to protect your position if insolvency strikes.

What is insolvency?

• A company's inability to pay debts or
• The value of a company's liabilities being greater than the value of its asset

Each can result in a company being placed into liquidation?or administration. When this arises, the aim is to recover any available assets to generate proceeds which can be distributed to creditors to satisfy their debts.

Common causes of insolvency in construction:?

Invoicing -?

There is an unavoidable lag between work being completed and payment being received which can result in cash flow issues - ultimately late payments or bad debts where work is unpaid contribute largely to insolvency. Invoice regularly and ensure effective processes to collect monies are put in place to help avoid this.?

Profitability -?

Particularly of late, profitability is an issue. The construction sector is highly competitive and often, the lowest tender wins meaning margins are low. With added unexpected delays and the increase in cost of materials and labour, this can often knock profits significantly.?Additionally, if you're holding too much stock, it becomes a drain on cash flow and can lead to selling inventory at a reduced price cashing further drop in expected cash.?Keeping an eye on cash flow forecasts based on regular payments in and out will help identify and highlight a shortfall in cash and where this is likely to arise.?

Chain -?

When there are several contractors in a chain, the domino effect can also have great bearing on insolvency. I.e. if a party higher up in the chain becomes insolvent this will undoubtedly affect sub contractors who are reliant on the income and completion of works by others.?Undertaking thorough checks of parties involved prior to entering in to a contract is crucial.

Summary of the warning signs of insolvency

• Cash flow issues
• Late/non-payment of supply chain invoices/employees' wages
• Official announcements to shareholders/the market regarding financial performance
• Late filing of accounts/annual returns at Companies House
• Unsatisfied County Court Judgments or High Court Claims being issued against them
• Suspension of work without explanation
• Change or removal in personnel from the project unexpectedly?
• Attempts to negotiate changes in payment terms

Protecting your business from supply chain insolvency in advance

When negotiating contracts and throughout, contractors should seek professional advice and consider:

• Obtaining references/credit checks. Taking note of other party's financials, prior to contract negotiation can provide a good indication of stability?
• Contractual clauses including 'Pay when paid' clauses, Retention of title (ROT) clauses, Suspension/termination clauses – professional legal advice and specialist drafting would be required?
• Collateral warranties. These create a direct contractual relationship between contractors, consultants or subcontractors and the employer
• Parent company guarantee (PCG). The contractor's parent company can guarantee the performance of the contractor in the event of its insolvency. The parent company would become liable for amounts due to the employer if the contractor does not complete the works. Where the parent company remain financially viable and hold additional assets this is an option
• Records & house keeping. Maintaining full records demonstrating the losses arising out of the insolvency, eg an inventory of materials and equipment on site (especially what has been paid for), can help protect a party's interests if insolvency does occur
• Dispute Resolution. Indentifying & addressing issues prior to the other party becoming insolvent can be the difference of being paid prior to the insolvency and ending up in the queue with little prospect of a return. Obtain advice on dispute resolution options prior to impending insolvency because adjudications cannot be pursued against a company in liquidation/administration.
• Communication. Your interests will always be considered and arranging agreements with debtors to spread payments can help avoid insolvency occurring

Useful resources -?

The Gazette's?data service?can help you identify up to date information relating to your supply chain partners, helping you anticipate potential problems and minimise risk exposure.

Companies House - https://www.gov.uk/government/organisations/companies-house

Creditsafe - https://www.creditsafe.com/gb/en.html

Construction News - https://www.constructionnews.co.uk/