Construction is risky business. Poor cash flow and tight margins mean contractors are often balancing a tightrope. 16% of all insolvencies in the UK are in the construction sector. The market remains volatile, so this statistic is not likely to decrease any time soon.
For developers and main-contractors, this means you need to keep a constant eye on your supply chain. However, sometimes even with early warning or interventions, insolvency happens mid-project. In these cases, what are you to do?
Options for Insurance
As is often the case, preparation can be key. Early in project planning, you will likely consider what an insolvency in your supply chain could do to your project. There are ways to insure against some of these risks, but you’ll need to weigh up what is best for your circumstances.
Contractor Arranged Insurance - Often developers rely on contractors to be insured. Construction All Risk is a common policy we look at in detail in this article. This type of insurance policy usually lapses in the event of a contractor insolvency.
Employer Arranged Insurance - An Owner Controlled Insurance Programme (OCIP) is a bespoke policy that can be taken out by the property owner. They cover a wide range of risks, and typically cover the requirements of standard form contracts such as the JCT. Most importantly, this type of policy avoids reliance upon multiple contractor policies.
What happens if a contractor goes bust during the project?
First step is to check your construction contract. Most standard contracts will set out your options in the event of insolvency. Under JCT contracts, you usually have the right to terminate the contract. However, it is important you take advice on your specific position, as termination can be fraught with legal risks. At Merlin we have good links to law firms and advisors who can help you terminate a contract without exposing your business to unnecessary risk.
Next it is vital that you secure the site. The contractor is usually responsible for maintaining site security, but this will not be the case if you terminate your contract. It is likely that the site contains expensive equipment. You also become responsible for ensuring the site is safe in accordance with the Construction (Design and Management) Regulations 2015.
Now it is time to check your insurance policy. Depending on the type of policy you hold, you’ll be entitled to (and responsible for) different things. As mentioned above, if the contractor held the insurance policies you may also find you are no longer covered. If cover lapses at the point of insolvency, you will need to find alternative cover until a new contractor with appropriate insurance can be appointed.
Continuing the Works
When a contractor becomes insolvent part-way through a project, one of the biggest challenges is continuity. Appointing a new contractor is rarely straightforward. Not only will you incur additional procurement costs, but questions often arise around responsibility for existing works. For example, a replacement contractor may be reluctant to take on liability for defects in the work already completed, so you will need to consider whether your insurance arrangements cover this risk.
Performance bonds can provide a layer of protection. Typically set at 10% of the contract value, they are designed to compensate the employer for some of the additional costs incurred in replacing a main contractor. In practice, however, they are not always straightforward. The contractor’s balance sheet and financial standing will be scrutinised before a bond is issued. If the contractor’s position is weak, securing a bond can be difficult or costly.
Delays are another inevitable consequence. Determining liability for programme slippage depends on the contract terms and the timing of the insolvency. Employers will need to review whether they can recover losses under delay-in-start or business interruption cover, or whether the cost sits with them.
If insolvency occurs after completion but during the defects liability period, matters can become even more complex. For example, who is responsible for rectifying defects if the original contractor no longer exists?
Collateral warranties can also provide some additional security. Where they exist, warranties from subcontractors, consultants or designers may give employers a direct contractual route to pursue others in the supply chain for defective work, even if the main contractor is insolvent.
Another area to consider is professional indemnity (PI) insurance. These are typically “claims made” policies, which means the cover must be live at the time a claim is notified. However, if a contractor has gone into insolvency, their PI policy is often no longer in force, leaving employers unable to recover through that route.
Latent defects insurance can provide a safety net. Unlike PI or contractor warranties, it is a first-party insurance product taken out for the benefit of the building owner, providing cover for major defects that emerge after completion — regardless of whether the contractor is still solvent.
Get expert help
Ultimately, contractor insolvency is disruptive, costly, and complex. While insurance can provide valuable protection, it is no substitute for early planning, careful contract drafting, and expert guidance. If you find yourself facing an insolvency situation mid-project, seeking advice from both legal and insurance professionals at the earliest stage will give you the best chance of limiting delays, controlling costs, and protecting your investment.
If any of this is an area in which you need advice, get in touch with one of the team at Merlin today. We'll be happy to help.
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