In this second blog in our series on JCT contracts and insolvency we consider the contract documents and provisions that can be used to mitigate the risks of insolvency in the construction phase. Click here for our first blog on the pre-construction phase.
The JCT contracts provide for the contractor to procure a performance bond or parent company guarantee in a form identified in the Contract Particulars. Ideally the contractor would be required to obtain an on demand bond from a bank or bondsman for a maximum amount of normally 10% but occasionally 15% of the contract sum, although a bond conditional on establishing a failure to perform may be more realistic in the market. A parent company guarantee can provide some security in the event of contractor insolvency as, if the contractor defaults on their obligations, the parent company is required to remedy the breach. This is only effective though if the parent company remains solvent.
Collateral warranties can be required under the JCT building contracts from the contractor and its sub-contractors to purchasers, tenants and funders and also from sub-contractors to the employer. In the event of contractor insolvency, claims can be brought against sub-contractors or consultants involved in defective work that have provided such warranties. “Step in” rights within collateral warranties will allow the employer or funder to step into contracts to replace the insolvent party and enable completion of the project.
Half of the retention percentage that is deducted from amounts due to the contractor under the JCT contracts is released upon practical completion and the other half on certification of making good defects. As retentions can be considerable amounts, this can lead to cash flow issues for contractors. If the retention is held on trust, as in the unamended JCT contracts, this can protect the contractor in the event of the employer’s insolvency (or a sub-contractor in the event of contractor insolvency) as the retention does not form part of the employer’s assets. The employer may wish to amend these provisions however so that they have access to these retention amounts in the event of contractor insolvency.
The JCT Project Bank Account Documentation (PBA) is designed to be used with the JCT forms of building contract with the aim that using a PBA will help to protect cash flow to sub-contractors, particularly in the event of the insolvency of the contractor or the employer. The monies in the account are generally held on trust and can only be paid out to the beneficiaries named in the agreement. If properly established so that a secure trust is set up, the monies in a PBA will be protected in the event of the insolvency of the employer and/or the contractor, as the money held in the account is ring fenced by nature of the trust.
Other JCT contract provisions that should provide protections in the event of insolvency include obligations for the contractor not to remove plant and materials from the site and that ownership of plant and materials should transfer to the employer when an interim payment includes the value of these items. The JCT contracts contain comprehensive provisions dealing with termination on the insolvency of either party and it is a requirement that the sub-contract conditions include that a sub-contract should terminate on termination of the main contract. The provisions in relation to sub-contractors could be amended to include obligations to pay sub-contractors in a timely manner and provide evidence of payment.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.