Contractor insolvencies are continuing in the construction industry in 2024. This follows recent challenges relating to supply chain issues, labour shortages, and increased material costs. Such challenges are part of the broader macroeconomic climate of high inflation and interest rates.

We outline below steps that a Principal can take at different stages of a project to mitigate the impact of Contractor insolvency on its project, and to protect its interests. 

Steps to mitigate Contractor insolvency risk

Pre-contract

As is the case in all commercial contracts, undertaking adequate due diligence prior to entering a construction contract is critical. Conducting company searches to reveal current or past filing of documents, late filings, and statutory demands against a potential contractor, are all important.

At the tender stage, a Principal may request that tenderers submit their audited accounts for the last three to five years, and that the tenderer provides a letter or undertaking from a proposed surety (ie a bank) that they will provide a bond on the required terms. Sureties will always have better insight into a contractor’s solvency than a Principal will be able to ascertain.

Contract drafting

It is important to consider the types of surety that may be required. For example, a parent company guarantee may be appropriate when the head office of the proposed Contractor has most of its assets overseas under a related entity (often in Australia but sometimes in tax havens further afield). If a performance bond is required,^[1] ensure that it is ‘on demand’. All guarantees and bonds should be provided to a Principal before any payments are made under the contract.

If Subcontractors are engaged, consider whether a continuity guarantee is required. Such guarantees allow a Principal to step into the shoes of the head contractor to make direct payments to the Subcontractors. This allows a Principal to continue works with minimal disruption, without the need to negotiate new agreements with each Subcontractor.

During the works

It is important to implement a robust risk management process to identify issues at an early stage, such as checking site progress and monitoring payments to Subcontractors.

Appropriate contract terms should be used regarding any advance payments for materials. If such materials are already in New Zealand, security interests should be registered on the Personal Properties Securities Register. If the materials are overseas, provision should be included for payment bonds.

At the point of Contractor insolvency

The initial step is to secure the site immediately, including securing the Contractor’s plant, equipment, and materials - the old saying, ‘possession is nine tenths of the law’ applies.

The next step is to consider the notices that a Principal should issue to the Contractor to secure rights under the contract, and position itself as a creditor in the liquidation. A notice directly to the receiver or liquidator should be sent after their appointment.

A Principal may wish to conduct an ‘audit’ to ascertain the status of the works, including, the cost to complete any remaining works, and to identify the key Subcontractors, plant, and equipment. It is also important to identify whether any insurance policies may respond in such circumstances.

Furthermore, a Principal should identify existing performance securities it holds, including, performance bonds, parent company guarantees, and retention monies.

Should a Principal resume possession or terminate?

A Principal can elect to either resume possession of the site or terminate the contract (subject to the specific terms of the contract). Both options have their advantages and disadvantages.

If a Principal resumes possession, the contract is kept ‘on foot’ and a Contractor is not relieved of any of its obligations under the contract.

If a Principal terminates the contract, a Contractor's obligations to complete the works comes to an end (unless it is contrary to the terms of the contract).^[2]

On termination, a Principal is entitled to claim full damages for a Contractor's default. Damages are available from the outset and can include items such as the loss of the benefit of warranties, which is often difficult to quantify. However, costs of completion are only available after final completion of the works and are limited to costs related to completing the works set out in the Contract.

Upon termination, a Principal will not be bound to complete the works and is free to alter the scope of the works including adding to, altering, omitting works, and entering new contracts.

Generally, if a Contractor is insolvent, or very close to insolvency, it will be preferrable to terminate rather than keep the contract on foot.

This article is general in nature, and we recommend that you get in touch with one of our experts for tailored advice relating to your construction contract.  

Thanks to Taumata Toki, Law Graduate, for his assistance with preparing this article.