Insolvency in the construction industry: hope for the best, prepare for the worst

Insolvency is a common issue in the construction industry. While newspaper headlines frequently focus on the top ten to 15 large contractor insolvencies, this is not reflective of how insolvency impacts the industry as a whole.

In all construction projects, there is a long tail of smaller contractors that are adversely impacted by an insolvency event that occurs further up the chain. As a result, when parts of the supply chain fall apart, the tremors can be felt by large sections of the industry.

This was the focus of a seminar hosted on 6 June 2019 by Osborne Clarke, in collaboration with consultants Turner & Townsend. The aim of this seminar was to discuss some of the most endemic problems in insolvency within construction and, importantly, to identify ways in which both employers and contractors can anticipate and react to insolvency events.

What is insolvency?

There are several different types of insolvency. Two of the most commonly encountered forms within the construction industry are liquidation and administration.

• Liquidation is a terminal procedure, whereby the company will almost always cease trading and the appointed liquidator is responsible for realising and distributing the assets of the company to its creditors in the appropriate order of priority according to statute.
• Administration, by contrast, is not necessarily terminal and the company may continue to trade during administration. Pre-packaged administrations offer a seamless transfer of the assets of the company in administration to a purchaser: the administrator is appointed and on the same day disposes of the assets to the purchaser so that trading can continue under a different owner.

Insolvency raises its head in many ways, but that does not necessarily mean the 'writing is on the wall' – businesses can be restructured and survive.

What does it mean to be insolvent?

Insolvency, at its core, means that a company does not have sufficient assets to meets its liabilities and is unable to pay its debts as they fall due. However, identifying the precise tipping point when a company becomes insolvent can be a particular challenge in the construction industry.

The industry is cash rich, but there can be long debtor-day periods until the money is received by the intended final recipient. All this floating cash means it is difficult to pin-point a moment when a company has become insolvent.

As a result, it is all the more important to be vigilant for the warning signs of insolvency.

What are the warning signs?

The reality is that it can be very challenging to anticipate and identify insolvency warning signs in the supply chain. Financial information becomes outdated very quickly, so it is not always commercially wise to rely on this information.

However, there are steps that can be taken to help identify the warning signs:

• Communicate and work closely with supply chains, as open and honest dialogue will help maintain a good relationship before and, if an insolvency occurs, after the event.
• Be alive to site-specific warning signs, such as fluctuations of labour, delivery delays affecting progress, employee departures, and generally any significant departures from a contractor's normal progress and practices.
• Look out for commercial signs, like spurious or frequent claims/disputes and over-valuation of works.

Often, the key is an accumulation of these factors, rather than just one or two which may simply be due to a challenging project and may not necessarily precipitate an insolvency.

How early should a company that may be impacted by an insolvency start to prepare for that event?

It is good to get involved as early as possible – it is far better to have relevant protections and measures in place, rather than reacting to an insolvency as it happens. If insolvency occurs and there are no protections in place, companies may end up wasting time and resource chasing money that they will never be paid.

Ultimately, some of the best protections available are in the form of everyday good project management practices. These include:

• Maintaining up-to-date records.
• Keeping on top of the progress of the works.
• Maintaining open and regular dialogue with contractors in the supply chain.
• Assessing and being aware of defects.
• Ensuring payment notices are served properly and in the correct form.

How will technology impact insolvency?

Technology can offer great benefits to the construction industry. Artificial intelligence, drones and wearables are just some of the tools that can give a more transparent and up-to-date view of project progress. These can assist with spotting early warning signs that, if left uncorrected for a longer period, could have evolved into much graver issues.

However, technology has still yet to make a significant impact on the industry as a whole. In some cases, introducing new technology can amplify issues if contractors struggle to get to grips with the latest innovations. For example, off-site manufacturing could lead to more risk on employers because they are paying for assets that they have not yet been placed on the site.

Construction is generally regarded as an aggressive industry. The focus on the bottom line can often lead to more familiar management and procurement approaches being adopted, which can dull the appetite to introduce new technology into the construction process.

Be prepared

The best ways to protect yourself against an insolvency event are to put in place positive relationships with your contractors and sub-contractors, and adopt good project management practices so that if an insolvency event strikes you have the records and resources to pursue a claim if necessary.

If insolvency happens, wherever you are in the supply chain, keep an eye on the strategic prize: completion. How you deal with insolvency will impact your ultimate goal and the best steps to take to work around the event and keep the project on track.