Insolvency: For Better or Worse

The Contractor goes belly up - so what is a client to do? Its a problem. You are left at the alter after having had such high hopes for a happy future. You thought that you were together for better or for worse. The contract to a certain extent will tell you what you can and cannot do i.e. a sort of pre nuptial dealing with termination and payments however some of the more practical issues to think about includes warranties, defects, payment, site, plant, bonds, subcontractors and form of insolvency:

Warranties for design - were they executed what is the status of design and what is left to be done and is the design any good?

Defects - a thorough inspection and take plenty of photographs, what also about latent defects?

Payment - accurate valuation so that you don't overpay those that abscond and know for sure what extra its going to cost you (there may be untold liabilities)

Site - secure it & make an inventory of what is left just in case Contractor his creditors or supply chain decide to break-in, yes it happens!

Plant - what is owned or hired you can retain the Contractors owned plant & equipment

Guarantees - is there a parent company guarantee to call on depends if the insolvent company is a subsidiary or not. In some cases the parent company may want to finish off the work?

Retention- what is held? No need to release it to the Contractor just yet it may come in handy

Bonds - can you call-in any bonds for performance which may be conditional or on demand or perhaps there is a bond for advance payment (such as materials off site already paid for)

Subcontractors and suppliers - are they owed money? Talk to them and find out where they stand - they may co operate but often it depends how much they are owed by the Contractor?

Materials - do you have title to the goods that have been left on the site, has it passed to you or does retention of title clauses in various subcontracts cause you difficulty and what about goods off site if they are not clearly marked and or vested?

Insolvency - what is the position in terms of debtors/creditors is the company bankrupt, is their an arrangement with creditors or is the company in administration?

Yes I am afraid that it all has a bearing................

I once advised a client on this same situation for an office block. The Contractor had finished the structure (just about) but had not started the fit-out works. Defective works and design issues (relating to poor Consultant design) were the most difficult issues to sort out. Warranties and bonds were useful provisions in the contract that (even if not called for) tended to focus the mind.

"You thought you were together for better or for worse"

So how do you get the job finished I hear you ask? I suggest that a client considers all the procurement options and assesses the risk. Look at the pros and cons - long and hard. If you want a quick start and to minimise cost (aiming for lower overhead and or or fee) I would think about open book with use of a target with fit-out let as works packages. Its not everyone cup of tea though. You need to think about the complexity of the work and the expertise necessary to finish the job and ask yourself if the Contractor will add enough value to make it worthwhile you paying his fee?

If you are one of the more capable clients, what we like to call the "intelligent client". Perhaps you want to manage it for yourself (and employ a jolly good Project Manager and Client Representative to boot). This will give you control you need so long as you want to hold the risk.

But if this is a little bit ambitious you may prefer to go out to tender for a good management Contractor (that you will pay a fee too) to manage the fit-out works for you. All in all its not a great position to be in so if you are the Client:

"....lock up your site, check what forms of bond
guarantee or warranty you have and most important of all don't overpay the Contractor!"

Acts of God

Is there any merit of including a Z clause in the NEC3 TSC for Force Majeure?

It was an interesting debate and after giving this some thought my response is "no". One chap thought that the NEC3 "ECC" guidance might lead you to the conclusion that a provision similar to the ECC "prevention" clause (19) is required in the Term Service Contract (TSC), refer to the NEC3 guidance on page 73. However the publishers will be quick to remind us all that the guidance has no legal standing and quite right too.

Force majeure are sometimes referred to as acts of God (which, if you ask me is a little harsh on God whatever your religious views may be). If there was a risk register for God is it really something that he is in full control of (if you happen to think that he exists) or does man as custodian of the earth have any responsibility to mitigate or prevent events? These sorts of event typically cover events such as earthquake and floods. Before we all get carried away lets think about the likelihood of the event occurring and the impact of the relevant risk. If you are dealing with services provided adjacent to the coast then flooding may be highly probable and present a high impact. It was mentioned to me that under the TSC the service is never complete. I am not sure that this is correct as it seems very likely that a Contractor could be prevented from providing the service in whole or in part by an event that is completely beyond his control such as a strike or civil commotion. I think the common law principle of frustration might apply but this is another debate and will leave this to a lawyer. It seems to me that force majeure events such as floods or earthquakes or strikes are beyond the control of the parties and likely to prevent the Contractor from providing the services to the Affected Property.

The listed Compensation Events may provide some form of cover for typical force majeure events i.e.: a strike on the underground may prevent the Employer from providing access to the Affected Property or the effects of a flood may lead to a change to the Affected Property but I do not think that the contract is contemplating this. I am more inclined to think that force majeure events should be identified in the contract and dealt with separately "if" it is decided that they are Employer risks.

It is fundamental to decide upon what the force majeure risk is, who is best placed to manage it (if anyone) and whose owns it and the contract needs to make it clear otherwise you may end up in a dispute. The NEC3 TSC provides the flexibility (to allocate risk in this way) and that is a good thing. The contract aims to be fair so that we do not ask a party to carry any risk that he can do nothing about.

A Network Rail contract (bespoke) that I have seen refers to vandalism and terrorism as force majeure events and it states the following:

"15.5. As soon as practicable following the notification described in paragraph 15.3, the Parties shall use all reasonable endeavours to agree appropriate terms or modifications to the Development Programme to mitigate the effects of the Force Majeure Event and to facilitate the continued performance of the Framework Agreement or any Services Contract."

Sounds like a bit of a bit of a muddle to me - its not very clear about the risk, who is best placed to own it (and insure for it), the events include risks such as terrorism and and how do the parties deal with any costs if they wish to resume providing the service?

"What is the point of asking a Contractor to hold the risk for terrorism attacks on the underground when he clearly has no control over it?"

The Employer will almost certainly end up paying a massive premium for it and in any event is more likely to end up in a dispute with the Contractor.

If you are not sure about this, it is possible to add an Employers risk event to the contract (clause 60.1.(12) provides for this) and for clarity you add the event to the Contract Data (Part 1). Note also the typical list of force majeure events that are already listed as Employer risk events provided in clause 80.1 such as "civil strikes riots and commotion" but there is nothing to stop you adding to this list. You will see that these are referred to as Employers risk. Note the event is then mentioned again in termination clause 80.1.

"It would simply be nonsense to pass this sort of risk to the Contractor - in my experience, it simply does not work"

It is also important to consider other ways that these types of risk might be dealt with. It is important to consider insurance availability for flooding, for example. Insurance should be left to the significant Employer risk events that the parties can do little or nothing to prevent? I do not think you would want to insure and pay premiums for events that it' possible for the Contractor to mitigate and or prevent? It is a good idea to think about the sorts of risk event that might occur and to ensure that it is clear in the contract who owns it and how it is dealt with if it materialises. Lets not rush to add any more Z clauses to the contract as most Employers already have far too many of them. In my view there is so much you can do with a well considered risk register. Its a good place to make clear how you are going to deal with risk.

If you are interested in following David Bowen then please take a look at Twitter.

Frameworks 2011 "Back in Fashion"

It's official framework contracts are still in fashion, despite the impact of the recession. Clients recognise that in 2011 with tender prices on the floor frameworks deliver tangible benefits including added value.

"There is some sign of a rush to procure - surprising as it may seem"

Clients are aware that there are bargains to be had, they are in no doubt (as also indicated by BCIS end of 2010 statistics for construction) that the current tender prices are low. If you are a Client and have recently secured new framework Partners then you will know this from benchmarking.

The reality is that Contractors are desperate for work. There is not a lot of it around. The longer term commitment provides continuity and that may just be enough to see them through the tough times.

Frameworks v One-Off Tenders

Clients know when they are onto a good thing. I understand this as a client myself procuring a loft conversion for our 1950s bungalow. I have had 4 prices back and very competitive they seem. What is more, they say they will finish in just 3 weeks. Marvellous! Ahhh but you and I know that a risk with a one off tender is..... Will they deliver or is it all hot air? I am minded to not hold my breath, waiting for a claim for extras to materialise.

That's a risk you take with one-off tendering and when you have lowest price as the key driver.

Frameworks do not always work well as they could. There are some lessons to be learnt. They can preclude competition by aggregation and this squeezes out the smaller players. The UK construction industry seems to be good at this. It needs to work hard through its statutes and government procedures to ensure that we give the smaller players and start-ups the same opportunity. We must maximise the opportunities for fair competition. It cannot be correct that many smaller businesses are precluded from the competition on the basis of turnover, the number of employees or whether it has an environmental policy or not. Industry should work hard to provide genuine opportunities for new businesses and enterprise. If smaller providers can evidence capacity and the ability to deliver the works and or services, whether it is in part or in whole then they should be able to compete. Frameworks do not always provide for this. They need to be more inclusive and provide better opportunities for the smaller players to compete on a level playing field, the principles of equality must apply.

Frameworks Have Changed

If you are in a framework there can be too much at stake especially if its an alliance between 8 authorities. That's the way it should be. If the Contractor falls out with 1 it risks falling out with all. The continuity and opportunity for work provided by frameworks still trumps one-off tendering. Not least the commercial and relational benefits which can accrue. Frameworks in 2011 are tougher as there is no guarantee of getting any work. That's the way it should be, the Contractor should be made to work hard to secure opportunities.

"No more guarantees. He should be in it to win it".

Frameworks should not be a soft option and the rigour bought by competition should be harnessed to create a commercial tension. Frameworks in 2011 look very different. They have improved and that has to be a good thing.

Surviving the recession with NEC3

This article was posted in NEC3 Newsletter 46 April 2009

David Bowen of Lexius says there have been a few negative comments in the media recently about collaborative working from disgruntled construction-industry commentators feeling the pinch. However, the reality is that partnering in tough economic times is only unwelcome news for lawyers – parties are far less likely to end up with a costly dispute when they decide to collaborate. There are a lot of wise clients out there who, unlike the commentators, have realised the benefits of collaborative working though a recession. They are not ready to throw in the towel just yet. True, these are testing times for everyone, but parties that work collaboratively seem to be weathering the economic downturn better than most. Here are some of the reasons why.

Quicker delivery
Collaborative working supported by accurate targets and robust open-book accounting systems delivers works and or services much quicker than traditional priced contracts – including private-finance-initiative schemes. At times when many public authorities are trying their best to bring forward spending, they would do well to consider collaborative working with target-cost and or cost-reimbursable options, including the NEC3 Engineering and Construction Contract (ECC) and Term Service Contract options C or E. These price options provide a quick route to market and deliver probity for public expenditure.

Managed risk
NEC3 contracts enable clients to identify, allocate and manage risk. When times are tough and there is increasing uncertainty, focusing attention on construction risk and managing it sensibly is a good thing. This is not a time to bury heads in the sand. If there is a risk register in a contract it should be used, not ignored! It is all too easy simply to ‘pass the risk parcel’ and allocate risk 100% to one party or the other.

Now is not the time to start dumping risk as it will be paid for through delays and/or increased costs. This is what happens in a traditional priced contract. Transferring a risk that cannot be managed or mitigated does not make any sense. It might also be the last straw that drives a supplier into bankruptcy and the client will be left to pick up the pieces. Adopting a sensible approach to risk management is even more important in tough times like these.

Cost transparency
In a credit crunch it is good for clients to know what they are paying for and to have better cost predictability, so that clients know how much they are going to end up spending. Why grant a licence to print money when money is in short supply? Cost-reimbursable contracts such as NEC3 ECC options C, D and or E combined with good open-book accounting provide clients with visibility of what they are going to pay and when they are going to pay it. For example, if there is low inflation and even deflation, they will only pay for goods at current market rates.

The same cannot be said for traditional fixed-price contracts. Clients may end up paying a premium and, even if they have price-adjustment indicators (perhaps using the retail price index), these may not reflect construction prices and will probably not compensate them for any loss. With good open-book accounting there will be no nasty surprises with claims appearing out of thin air. No one can try to charge more for something under NEC3 contracts because there is a robust audit trail and clients can rely on provisions in the contract for disallowed cost.

Quality suppliers
Traditionally, construction supply chains were selected by lowest price and this had the tendency to throw up some very bad results. The outcomes were often loss-leading bids leading to disruption, delay, disputes and claims. We should not forget the past: before the advent of partnering, the construction industry was indicted for delivering too little, too late and at too much cost. Let us not return to the bad old days. Users of collaborative NEC3 contracts should continue to
ensure that suppliers are selected on qualitative criteria for overall ‘value’ and not merely the lowest price. This is all the more important as clients develop long-term relationships with their supply chain.

Guaranteed rewards
It is no use if contractors and their supply chains go bankrupt – there will be no winners. But if it does happen and the client is using a target-cost reimbursable contract, it will be better off than if it had used a traditional priced contract. The reason for this is that the client will only pay for legitimate proven defined costs. They will tend to pay less where termination occurs. Other traditional contracts with fixed-rice mechanisms pass more of the risk onto the contractor but in the end it is the client that pays. Collaborative working using NEC3 ECC options C, D and E guarantees a percentage for profit and overhead (direct / subcontract fee). In uncertain times, a guaranteed fee is good for business and good for the economy, helping to maintain a measure of confidence in construction markets.

Construction is a high-risk activity so the last thing suppliers (and their banks) need at times like this is to put their overhead and profit at risk. Target-cost contracts with pain or gain incentives can strike a sensible balance between risk and reward, but the contractors can at least see that they will earn profit provided that they perform.

This article has been written by David Bowen (April 2009), for more information see his website at whichcontract.com.

Lexius Limited ("Lexius") is a business serving the construction community, providing first class contract knowledge to corporate clients, lawyers, contractors, subcontractors, consultants and busy professionals including architects, engineers, project managers, quantity surveyors, academics and students.

Lexius was the idea of David Bowen who is a Director of the company. David possesses over 24 years experience in both civil engineering & building construction and is a CEDR accredited mediator. He has broad experience including procurement, commercial, contracts, training, partnering, mediation and from time to time provides legal support.

As a dual qualified individual, he possesses a strong balance of professional qualifications & construction experience. David holds a masters in Law and is a contracts specialist and has considerable experience working with most standard forms of contract. He also specialises in collaborative working and has published papers on contracts and partnering in national construction journals.