Recent press reports have highlighted the possibility of contractors getting into financial difficulties. This e-briefing explains what is involved and what practical steps can be taken to reduce your risks and limit the inevitable disruption resulting from a contractor "going under".
What can happen if a contractor gets into significant financial difficulty?
There are three main scenarios to consider:
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Refinancing: the contractor may be able to arrange extra finance and continue trading as normal;
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Takeover: by another organisation either buying the shares of the contractor or buying its business; or
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Insolvency: of which there are a number of different kinds of procedures, but the most common are administration and liquidation.
What are the implications if your contractor is in financial difficulty?
You cannot usually terminate a contract just because the contractor is in financial difficulty. However, if this leads to performance concerns, these should be managed actively. You should operate the contractual mechanisms to deal with poor performance, in case you need to rely on them to terminate the contract at a later date.
If the contractor’s shares are bought by another company, the contract will still continue. The only basis on which you can terminate the contract is if there is a "change of control" provision that gives you this right.
If the contractor’s business is bought by another company, your contract will not automatically transfer to that company. Transferring your contract involves the original contractor, new contractor and the client signing a "Novation Agreement”. Where the contract was procured via OJEU, the change of contractor is often regarded as a "substantial change", meaning that a new OJEU procurement is needed. Where the costs of the new contract are to be recharged to leaseholders or tenants through variable service charges, leaseholder consultation may also be needed.
Most contracts either allow the client to terminate the contract or terminate automatically if the contractor becomes subject to insolvency proceedings. You should check your contract carefully to see which applies.
If you terminate the contract, or it is terminated automatically, you will probably need to continue the works/services. The options are either to bring the works/services in-house or to appoint a new contractor.
In either situation, interim measures should be considered, which may be different from the long-term solution. In devising both the interim and long-term solutions you should consider:
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Is leaseholder consultation needed and, if so, what is the appropriate consultation procedure?
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Does TUPE apply, which staff does it apply to, and what are the pensions implications?
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Does either your interim solution or long-term solution require an OJEU procurement? If so, what is the best way of complying with the EU procurement rules (for example can you use a buying club for the short-term contract)?
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What are the financial and reputational risks, and which option manages them best?
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What are your delivery responsibilities to stakeholders, such as customers and tenants?
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What are the likely views of your regulators and what is the best way to maintain your reputation with them?
There are also practical issues in relation to the financial position under the contract, including issues such as outstanding payments, loss and expense/compensation event claims, termination payments, retentions and the ability to claim under a performance bond or parent company guarantee.
What practical steps can I take now?
It is not possible to finalise your strategy until you have seen what happens to your contractor. However, preparation now will put you in a better position to manage the process if your contractor is taken over or becomes subject to formal insolvency proceedings. These preparations should include some or all of the following steps:
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Find out the numbers and roles of the staff employed on the contract and their terms of employment.
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Make copies of all valuable (paper based or electronic) data in the contractor’s possession.
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Check the terms on which the contractor is using any of your equipment and/or premises and check you can recover it on termination.
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Identify any of the contractor’s equipment which you would need to have transferred to you on termination, and check the contract provides for this.
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Check the contract is up to date and reflects any changes you have agreed (so that, if there is a claim, the contract documents reflect the current agreement).
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Start to plan for as smooth a transfer as possible by:
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identifying how long the contract has left to run, its value for that period and whether EU procurement and/or leaseholder consultation would be needed for a new contract. If so, start to prepare drafts of the tender and contract documentation so you can re-procure quickly; and
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preparing your short and long-term strategy. Do you have the ability to take the works/services in-house? Could you line up another contractor? If you can take the works/services in house, do you and your staff have appropriate training and qualifications and have you all necessary licences and registrations (e.g. Gas Safe, CIS) in place?
What traps do I need to avoid?
There are a number of things to be careful about:
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Make sure you do not yourself default under the contract, otherwise the contractor or its insolvency practitioner may be entitled to terminate the contract for your breach and claim substantial damages from you.
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Do not simply stop passing work to the contractor unless the contract allows you to do this. This could be treated as client default.
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Do not stop paying the contractor unless you have a contractual right to do so, and make sure you serve a withholding notice where you need to.
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Do not pay subcontractors direct unless you have a clear written agreement to this from the contractor. If you do pay subcontractors direct without the main contractor’s agreement, you may also have to pay the main contractor the same amount.
The above points are not exhaustive, and in many cases are just the starting point for your preparations and investigations. Each contract needs to be considered on a case-by-case basis depending on its value, length, subject matter and terms.
If you would like to talk through any of the issues in this e-briefing please contact Richard More or another member of our Construction and Procurement Team. Our specialists work closely together to ensure a joined up approach which addresses your commercial, procurement, employment, housing and regulatory legal needs. Our practical insight and experience of handling such matters will ensure an efficient and effective approach is achieved every time.
Richard’s contact details are:
We are also holding a seminar on "Maintenance contract nightmares and how to avoid them" at 2pm on 15th September which will deal with some of the above issues. For details of this please click here