Risks To A Successful Cntractr And Their Suppliers

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Local Authority Survival Kit on

Contractor Insolvency

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C:\Documents and Settings\sh12\Local Settings\Temporary Internet Files\OLK17\Local Authority Survival Kit on Contractor Insolvency April 2009.DOC

Overview

This note1 sets out practical guidance on a number of key issues for local authorities faced with the risk that their suppliers/contractors may be in difficulty or enter an insolvency procedure. Specifically, the following sections of this pack focus on:

Part 1: What is "Insolvency" and How do I Recognise it? Part 2: Prevention is Better than Cure: The Procurement Stage.

Part 3: Active Risk Management While Works Being Carried Out.

Part 4: What to do if an Insolvency Does Occur.

We have a national team who are highly experienced in advising on the matters raised in this note. If there are matters of specific concern to you or if you would like to discuss the contents of this note with us further, we would be happy to talk with you. Contact details appear towards the end of this note.

Nicholas Dobson

nicholas.dobson@pinsentmasons.com

1_I_{am indebted to Pinsent Masons Banking and Insurance Partner, Richard Williams, who was the substantive author of} this note.

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Part 1: What is "Insolvency" and How do I Recognise it?

An "insolvency procedure" includes any of the following. The terms are often wrongly used interchangeably in the media but determining which procedure a company has entered is important as the powers and aims differ:-

Administration – This is the most common of the insolvency procedures. The contractor still exists legally and can still trade. An administrator (an accountant) will be appointed who will act as agent of the company and can do all things that the directors can do. The directors will no longer be involved in the operation of the contractor's business. Your contract is probably NOT automatically terminated and the administrator may continue the contractor's business and continue to carry out the contract or sell the contractor's business as a going concern and seek to transfer to your contract to a purchaser. The administrators will write to all creditors and likely inform you he has been appointed in respect of the contractor. A key characteristic is that as the purpose is to give a protective period to rescue the business a moratorium exists preventing any legal proceedings to be continued or commenced against the company without the consent of the administrators or permission of the court.

Liquidation/Winding up – Whilst the contractor will still exist legally it is unlikely that it will continue to trade. A liquidator (an accountant) will be appointed who will act as agent of the company and can do all things that the directors can do. The directors will no longer be involved in the operation of the contractor's business. Your contract MAY automatically terminate (the contract will need to be checked). The liquidator is unlikely to carry on the business or the works under the contract and will be more concerned to recover assets of the contractor to be sold to third parties. The liquidator will write to all creditors and likely inform you that he has been appointed in respect of the contractor. Legal proceedings cannot be continued or commenced against the company in liquidation without the permission of the court.

Administrative Receivership – You are unlikely to encounter an administrative receiver due to a change of law. The contractor still exists legally and can still trade. An administrative receiver may only look to recover assets of the contractor and may not wish to continue with the sub-contract. Your contract is probably NOT automatically terminated. The administrative receiver will write to all creditors and likely inform you that he has been appointed in respect of the contractor. Legal proceedings cannot be continued or commenced against the company in liquidation without the consent of the court. There is no restriction on commencing or continuing legal proceedings.

Company Voluntary Arrangement ("CVA") – The contractor still exists and in most cases will continue to trade. The directors will also continue to operate the business. The CVA is merely a method of compromising the company's debt by agreement with its creditors. Your contract is probably NOT automatically terminated. The CVA document will confirm whether it is intended that the contractor will continue to trade. If you are a creditor of the company then the directors will write to you with a proposal to compromise the debt. More than 75% of unsecured creditors in terms of value must consent to the CVA. Any restrictions on continuing or commencing legal proceedings will be contained within the CVA document. It is likely that there will be such a restriction in relation to compromised liabilities. Note that if you are a creditor and you do not receive notice of the proposed CVA then you will still be bound by the CVA subject to the right to challenge the CVA within 28 days of

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Part 2: Prevention is Better than Cure: The Procurement

Stage

The best way to protect against insolvency is to ensure that you are prepared as much as possible for the insolvency of a contractor. There are various steps that can be taken prior to contracting with a contractor to ensure that you in the best possible position to deal with the situation.

PRACTICAL STEPS

Prior to contracting with a new contractor there are certain practical steps that can be taken at the outset.

• Do obtain copies of statutory accounts. If in doubt, Legal Services can advice how you can get hold of these. Your contact at Pinsent Masons will also be happy to assist if necessary.

• Do ask the contractor for more detailed (and audited if possible) management accounts, projections and cash flows. These will give you a much better understanding if they are up to the job than the more dated information at Companies House.

• Do consider the group structure and obtain financial information regarding the group. This will help you to understand whether the contractor has a financially secure parent.

• Do look for potential danger signs such as large acquisitions, large projects and high staff turnover. Such signs may suggest that the contractor may have spread themselves too thin or have their focus elsewhere and may therefore be a warning that you should not enter into the contract.

• Do consider industry sector vulnerability issues.

• Do investigate the current workload of the contractor and whether the project will overload their capabilities. This will help you understand whether the contractor can deliver what is being promised.

• Do consider whether the scope of the contract is appropriate for the contractor by reference to previous experience and annual turnover. This will help you understand whether the contractor can deliver what is being promised.

• Do consider whether any upfront expenditure on plant and equipment required will put a strain on its cash flow. This will help you understand whether the contractor is financially capable of taking on the project.

• Do consider who is being engaged to perform significant elements of works further down the supply chain. If those involved are part of the same group then the checks above will apply. If at arms length the same checks regarding capability should be carried out with each "critical" contractor.

• Do consider methods of performance security. A parent company guarantee (PCG), a performance bond, retention, escrow accounts, or vesting agreements or clauses may be appropriate.

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OWNERSHIP OF EQUIPMENT AND MATERIALS

Do not agree retention of title clauses in relation to goods and materials supplied by contractors. This will ensure ownership of equipment and materials passes to you as early

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as possible (usually delivery) and prevents an insolvent contractor and other companies in the supply chain from claiming ownership of equipment and materials that are required for any particular project.

Do bring equipment and materials onto site on a construction project and fix them as early as possible. Where the materials are already fixed, they cease to be the supplier's property and become

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part of the land by operation of law. Where the item is fixed, even if only slightly, the Company claiming title has the burden of proving that the materials are not sufficiently fixed to have become part of the land.

Do insist upon an express term that title to unfixed or off-site materials passes on payment. Note that if the goods are fixed after express notice is given of the right to t

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itle and that notice is given before title otherwise passes (see next paragraph) the person fixing them can be sued in tort for converting the goods: in practice this will probably mean being liable to pay for them.

Do consider the position in relation to goods being supplied from further down the supply chain. Where materials are provided by a supplier pursuant to a sale of goods contract (i.e. there is no substantial fixing element), and you pay the contractor for them in good faith and without notice of any retention of title clause in the supplier’s terms and conditions, ownership of the materials may be able to be claimed under section 25 of the Sale of Goods Act 1979 (buyer in possession after sale) even if the supplier has not passed title to the contractor. Payment of a certificate issued under a main construction contract which specifically refers to the goods i

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n question is sufficient to pass title to the employer if the main contract also specifically provides for title to pass on payment of a certificate. Tracking the goods through the valuation process is therefore key.

Do insist upon a vesting certificate where offsite goods have been paid for. This will protect you against any claim

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by the insolvent contractor claiming ownership of such goods and materials. There is however no substitute for actually bringing the goods onto site where they can be secured against

"self-• Consider obtaining an off-site material bond from the contractor if the goods are particularly valuable or key to the project.

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Part 3: Active Risk Management While Works Being

Carried Out

WARNINGSIGNS

• Do continue to monitor the financial viabil of the contractor and other key suppliers. This will assist in your becoming aware of warning signs as early as possible so that protective action can be

• Do

ity

taken as early as possible.

continue obtaining regular audited management accounts and perform regular financial

g signs. due diligence. This will assist in identifying warnin

• Do look out for the following "warning signs":-

o requests for up front or pre-payments or reduced retentions;

o late payments, delay tactics for payment, claiming against retentions;

ce with agreed schedules;

n price;

• Do

o attempts to alter payment terms;

o not delivering in accordan

o using avoidance tactics;

o unexpected attempts to negotiate o

o rumours and market intelligence;

o failure to file statutory accounts on time; or

o complaints about slow or non-payment from the supply chain.

inform Legal Services and the relevant Director/Head of Service as soon as you become aware of any warning signs. They will be able to advise in relation to self help methods.

• Do encourage an open dialogue to ascertain whether you can assist in any way. Intervention need not be an aggressive action (depending on the level of risk involved in the potential insolvency) but should be instigated by an initial informal meeting to identify the risks to the contractor and the project and to identify whether your assistance is required. Early intervention can help to avoid a

• Do

distressed situation turning into a crisis.

not wait for an insolvency to occur. This will be too late to take preventative steps or putting together a contingency plan.

• Do obtain any information you can concerning the financial viability of the contractor and

maintain strong internal reporting mechanisms – Much of the key information may already be

reaching some parts of your authority but not reaching the ears of those who can do something with it. Consider who in the authority has contact wi your contractors and the contractors further down the supply chain. Are they the right people? Are they aware of the importance of reporting relevant information to the right people internally?

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• Do take clear minutes of any meeting and if possible agree them with the contractor.

• Do instigate full monitoring of progress o works and valuations including the taking of dated f photographic records. This will help you ascertain the impact the problem is having on the project.

• Do consider any retention agreements in the event that you are aware of any "warning signs". In the event of a formal insolvency, consideration should be given as whether there are any retentions and how these should be utilised. It is likely that any loss suffered by you above and beyond the value of the retention fund may not be recovered from the contractor as such loss is likely to be unsecured (save for where a bond or guarantee has been provided). In the event of a contractor insolvency it should be noted that the Administrator or Liquidator is likely to try and obtain payment of any retention or due payments for work already completed, particularly the second half of the retention if the works

• Do

are already practically complete.

build strong relations with your suppliers. Consider how likely is it that they would speak to you difficulties. Consider whether you can improve this.

openly in the event of

CONTINGENCY PLANNING

• Do consider a contingency plan to protect against the insolvency of the contractor as soon as you become aware of any "warning signs". If it is considered likely that the contractor will be placed in receivership, liquidation or administration, or a CVA, it is essential that a contingency plan is prepared for the outstanding contract works to be carried out by other contractor(s) and/or you directly (if necessary) or for you to step into the shoes of the employer or call upon any third party security. However, although a contingency plan is essential it is also important to ensure that any steps taken by you prior to termination of the original contract do not amount to a breach of that contract. It is also important to check that the relevant event has actually occurred and obtain evidence. An attempt to terminate where the grounds have not actually arisen is likely to be a repudiation of the contract. A repudiation enables the relevant party to terminate instead and bring a substantial claim for damages against you. A classic example is relying on hearsay that an insolvency has occurred when it has not yet occurred (even if it may be imminent). Where required by the main contract, you must also seek

ontract. approval from the employer/contract administrator for any placing of a replacement c

• Do identify companies in the supply chain that are critical to a development.

• Do review your contract terms. You should have a clear understanding of what contractual terms apply between the parties and particularly as regards what terms will apply in the event of an insolvency (particularly payment, passage of title and risk, set-off, assignment and termination). What law and jurisdiction applies to the contract? Has this paperwork been signed by both parties? Are there competing sets of terms? How confident are you of which terms apply? Do you have tooling or other materials on-site with the supplier which need to be recovered? What does the paperwork say about this?

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• Do get your paperwork in order. Ensure that you have a complete set of contractual documentation which ideally gives you a wide range of options to intervene early but at least allows you to implement your preferred exit strategy for the relevant contractor. This should include, as a minimum, the ability to terminate and re-source services at the earliest opportunity and to recover any of your materials in the hands of the supplier without delay.

• Do get your reporting systems in order. It is simply good practice to ensure that your procurement and finance teams are familiar with the risks in your supplier base, the early warning signs of distress and how to spot them, what to do in the event of a 'problem'.

• Do ensure that you have clear trigger points at which your staff know that specific action

should be taken.

• Do plan your exit strategy. The options available may depend on each contractor and the circumstances that they face. However, if your business is exposed to certain key contractors who are at risk you must ensure that you have considered which option will work best in relation to these contractors and how you will implement it. These may

include:-o Appointing a new contractor. The risk of contractor insolvency can be reduced or removed if you have a viable alternative which can be implemented quickly. Consideration should be given to the lead times for supply and how these fit with existing works. Be careful, re-sourcing may be in breach of existing contracts.

o Providing additional funding. A more formal and longer-term alternative to payment acceleration which may be of more value to your contractor. Similar risks over non-payment on insolvency will apply, so it is worth considering whether you would be able to take any security (such as a charge over plant or property) in return.

o Terminating the contracts with your contractor. This may only be available to you if the terms of the contract permit it. Careful consideration and advice should to be taken as to whether termination is possible and the best strategy.

o Recovery of your assets. You may have supplied tooling to your supplier or they may be

using certain assets under licence. Equally, they may have materials on-site which belong to you. The terms of any applicable contract will strongly influence your ability to recover these items – as indeed may the nature of any insolvency procedure which has been implemented.

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SOURCES OF INFORMATION

If you become aware of any of the "warning signs" mentioned above, you can obtain useful information from the sources detailed below:-

• Winding up petitions. A petition to wind-up a supplier demonstrates creditor pressure and is presented on the basis of an undisputed debt which the petitioner claims the supplier cannot pay. If successful it will lead to the supplier being placed into compulsory liquidation. Once a petition has been advertised this may be a turning point for the fortunes of the contractor as the world at large is notified of its difficulties. Details of any petitions filed in England and Wales, including:

o the name of the petitioner and their solicitors;

o the size of the debt;

o the location of the court;

o the case reference number; and

o the date of the next hearing or any winding up order made

can be obtained by calling the Central Index at the Royal Courts of Justice in London on +44(0)906 754 0043.

• County Court Judgments. A CCJ is a court order requiring the payment of a debt. It may be early evidence of non-payment of creditors and perhaps the pre-cursor to a winding up petition or other insolvency proceedings. Details of how to find out if your suppliers have any outstanding CCJs can be found, on payment of a fee, via the Registry Trust as follows:

o Tel: 020 7380 0133

o Web: www.registry-trust.org.uk

o Address: Registry Trust Ltd, 173-175 Cleveland Street, London, W1T 6QR

• Companies House. All UK-registered companies are obliged to file details of significant events affecting them during their lifetime, including the commencement of any formal insolvency proceedings. Contact details, together with a link to a basic, free websearch facility can be found at www.companieshouse.gov.uk.

• Late/qualified accounts. All UK-registered companies are obliged to file accounts at Companies House (more details are expected of larger companies). The inability of a contractor to file accounts on time or with a clean 'going concern' bill of health may be a signal that matters affecting its ability to continue to trade solvently may be present.

• London Gazette. Public notices affecting UK-registered companies (including many formal steps in insolvency proceedings) are often filed in a publication called the London Gazette. A search can be made against a company name for free online via the following website: www.gazettes-online.co.uk.

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Part 3: What to do if an Insolvency Does Occur

Options Available to you if an Insolvency occurs

Inform your Director, Head of Service,

the Head of Legal Services and the Chief

Finance Officer immediately

Termination

Novation

Assignment

Appoint an

alternative

contractor

Actions to take whatever option is taken

Consider third

party security

Record the state of

the Work

Contact the

Administrators or

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OPTIONS TERMINATION

In most cases of contractor insolvency termination is likely to be the best option to mitigate the delays being caused to the main contract programme.

• Do obtain legal advice if termination is being considered. As mentioned above, termination on insolvency will be an option if it is so expressly stated in the contract. In addition advice should be sought to ensure that you have no greater liability to any party if the contract is terminated and another contractor appointed.

• Do review the contract to ensure that any requirements are complied with before the contract is terminated. There may be formalities for termination which must be strictly followed. Termination may also be automatic or requires any further steps to be taken i.e. service of notices. An attempt to terminate which does not comply is likely to be a repudiation of the contract and give rise to a substantial claim for damages from the contractor.

NOVATION OR ASSIGNMENT

• Do ascertain as soon as possible what the intentions of the insolvency practitioner are and whether they intend to novate or assign the contract. The Administrator's role is to realise assets as quickly as possible for maximum gain so he may seek to negotiate a novation or

assignment of the contract or main contract. Whether this is a viable option will clearly depend upon the extent to which the works have been completed, the value of any WIP, the value of the completed development (if an employer), uncertified claims, amounts paid and amounts due and payable, any retentions, whether the new contractor will take on responsibility for the works and whether the contract itself contains any restrictions on transferability i.e. an outright restriction or a restriction requiring consent.

APPOINT A REPLACEMENT CONTRACTOR

• Do ensure that any costs incurred in appointing a replacement contractor are reasonable. Sub-contractors and suppliers may by way of ransom insist on receiving outstanding sums (or at least part of them) as a condition of continued supply.

• Do not make any form of preference payment to suppliers or sub-contractors owed money by the insolvent contractor. This is in order to protect your right to recover monies from the Liquidator/Administrator and/or offset the costs incurred against monies due to the contractor. Paying sub-contractors directly will not reduce any payments that are due from you to your contractor. In addition, this may affect your ability to set-off such sums against any claim that you may have against the insolvent contractor for any failure to carry out the contract as a result of the insolvency.

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• Do not deal with goods that the insolvent contractor has claimed ownership to. You risk being the subject of an injunction or sued for damages if you do anything to interfere with those ownership rights such as denying possession or fixing the goods.

ACTION TO TAKE WHICHEVER OPTION IS TAKEN

• Do notify your Director, Head of Service, Head of Legal Services and the Chief Finance Officer. You should notify immediately upon becoming aware of the insolvency of the contractor. Steps should be taken immediately to assess the implications on other projects.

CONSIDER THIRD PARTY SECURITY

• Do consider the nature of any bonds. Is the bond an "on demand bond" or a "default bond"? Is it a "payment bond" or "performance bond"? It is imperative that before the bond is called you check the terms of the bond to ensure that any required formalities are followed. If it is an “on demand” bond then there are likely to be requirements such as a letter with authorised signatories that there has been a default under the contract and that specified losses have been suffered. If the bond is a "default bond" you will most likely have to establish that a breach has occurred and a loss suffered. This may require court proceedings against the surety.

• Do check that an "insolvency event" is a default. The terms of the bond should be considered as to whether insolvency is expressly stated to be a calling event. Even then unless the contract provides for losses to be payable as a result of an insolvency a default bond is unlikely to be callable until there is a breach. Check the terms of the contract to see what is payable following termination on insolvency and when.

• Do make a call under the bond. Give the bondsmen as much detail as possible regarding the nature of the contractor’s default and your anticipated losses. As mentioned above if the bond is a default bond then you are unlikely to be able to recover payment under the bond until default and loss has been established, which is often once the final account has been settled and/or the works completed.

• Do keep records. In order to establish the extent of the losses incurred and that such losses are reasonable, records should be kept to be provided to the bondmen.

RECORD THE STATE OF THE WORK

• Do prepare a statement as to the state of the works. As soon as possible a statement should be prepared (in conjunction with the client's team and contractor, where possible) comprising:-

o a value of the works executed up to the date of appointment and termination (if the contract has been terminated) including all variations. It is important to separate work fixed/unfixed;

o a detailed statement of defective works and/or works not completed in accordance with the contract and the proposed remedial works;

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o an inventory of all goods and materials on site for eventual incorporation;

o an inventory of all plant, tools and temporary buildings on site for construction purposes, and where possible identify any hired items;

o all payments that have already been made and any payments that are due and payable to the contractor;

o a statement of the net liability of one to the other – you should seek legal advice in relation to any potential set off rights: these are complicated where insolvency exists;

o the amount still notionally to be paid for the subsequently executed outstanding works set against the actual total cost of their completion (inclusive of rectification and maintenance); and

o the value of any liability to the contractor for claims and the like, together with the amount of any claims against the contractor from you or other contractors, and LAD’s where applicable;

• Do attempt to get the statement signed by the contract administrator, relevant quantity surveyor and contractor (where possible). It should also be sent by recorded delivery to the Liquidator or Administrator. It is vital that the Liquidator or Administrator, surety (if any - see below) and employer, where applicable, are kept updated with the financial effects of the insolvency. Failure to do so may affect the recovery of monies due to you.

• Do prepare coloured up drawings identifying the completed contract works. These should be signed by you, the contract administrator and the contractor (where possible) as a true record. If considered appropriate, photographs (which should be dated) should be taken for record purposes.

CONTACT THE ADMINISTRATOR OR LIQUIDATORS

• Do try and open discussions with the Administrator or Liquidator. An Administrator may wish to continue to perform the obligations under the relevant contract and may, in the case of a contractor insolvency be in a position to close out the works. You should also bear in mind that the contractor may be entitled to payment for works already performed although if the contract is terminated the right will likely only arise after the contract works have been completed (see 29.6.3 of DOM/2 or 7.7.3 of JCT D&B Contract 2005). It is important to ascertain the Administrator's/Liquidator's intent and secure the best result for you. An Administrator has wide trading powers and will be concerned to ensure the best outcome for the creditors which may involve a sale of the business as a going concern. A Liquidator on the other hand is simply concerned with shutdown and realisation of the assets.

• Do send intermediate statements of accounts to the Administrator or Liquidator (and surety) where appropriate to register your claim as a creditor.

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YourPinsentMasonsContractorInsolvency Team Contact Sheet Jonathan Jeffries DDI: 0113 294 5281 E-mail: jonathan.jeffries@pinsentmasons.com Mobile: 07767 224101 Matthew Brown DDI: 0113 368 6513 E-mail: Matthew.Brown@PinsentMasons.com Mob: 07789 941238 Fran Button DDI: 0113 368 6513 E-Mail fran.button@pinsentmasons.com Mob: 07733 022508 Richard Williams DDI: 020 7490 6246 E-Mail richard.williams@pinsentmasons.com Mob:07879 486291

Or contact Nicholas Dobson as follows: DDI: 0113 225 5465

E-mail: nicholas.dobson@pinsentmasons.com

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This note does not constitute legal advice. Specific legal advice should be taken before acting on any of the topics covered. LONDON BIRMINGHAM BRISTOL LEEDS MANCHESTER EDINBURGH GLASGOW DUBAI BEIJING SHANGHAI HONG KONG T 0845 300 32 32

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