Under Pressure: Struggling Supply Chains – Real Estate and Construction

In the construction sector solid cash flow throughout the supply
chain is the lifeblood of most projects, no matter what size, and
is arguably the single most important factor in ensuring that a
project reaches its conclusion. However, the cumulative effect of
various other factors such as Brexit, escalating global energy
prices, the outlawing from 1 April 2022 of the use of the red
diesel usage for construction plant, super inflation, higher
material and labour costs and the end of government COVID-19
support schemes has led to increased lending costs and smaller
profit margins. As such, the construction supply chain is likely to
come under ever increasing pressure in 2022.

When cash flow dries up significantly, it may become a trigger
point for insolvencies in the construction sector which in turn,
may cause devastation to organisations at all levels of the supply
chain. It was recently reported that there has been a steady uptick
in insolvencies in the construction sector from October 2021 to
December 2021 and some commentators have observed that the
construction sector faces a decisive 6 months ¹. In the latter part
of last year, we saw several construction insolvencies including
the likes of sizeable NMCN.

Where construction projects are likely to be affected by
insolvency, interested parties must take all relevant and necessary
steps to protect their position. Whilst insolvency situations in
the supply chain are almost always difficult, they do not
necessarily have to be catastrophic for other parties involved.
There are various contractual, commercial and practical steps that
parties (whether employers or contractors) might consider.

Pre-Emptive Measures

Generally speaking, the best way to reduce the impact of
insolvency is to plan for the event in advance of its occurrence
through contractual mechanisms. Given the turbulence predicted for
2022, this has become all the more important. Parties may wish to
consider the following pre-emptive measures at the outset of a
project.

• It may sound obvious, however, carrying out checks on the
  financial status of a party before entering into a contract is a
  good starting point.




• Consider obtaining a parent company guarantee to guarantee
  performance and / or cover liabilities and losses in the event of a
  party’s insolvency;




• Obtain collateral warranties from those parties with principal
  design or construction responsibilities to provide a contractual
  cause of action against those parties to ensure that multiple
  potential avenues for claims exist; Insurance cover may be
  available to protect against an insolvency event;




• Decide up-front how insolvency events should be dealt with and
  include express drafting in the contract to reflect that. In
  particular, how and when will the account be dealt with and what
  happens to unpaid sums;




• Define what an insolvency looks like. Contractual definitions
  of insolvency can vary from when a party enters into a formal
  insolvency procedure as mandated by the Insolvency Act or to
  something more flexible such as the failure to pay a debt that is
  due. Defining insolvency, should help to give certainty regarding
  the point at which insolvency rights and entitlements under the
  contract are triggered;




• Retention of title clauses may be a way of limiting the impact
  of insolvency upon unpaid suppliers and in that same vein, consider
  the use of vesting certificates which transfer title once payment
  has been made;




• Consider step-in rights in the event of insolvency;




• Don’t ignore early warning signs that a party may be in
  financial distress. For example, a failure to pay sums due on time
  or at all, unexpected suspension of work or a reduced workforce or
  public statements regarding profit warnings.

Reactive Measures

Should a party in the supply chain become insolvent, it is time
to consider carefully the existing rights under the contract. We
consider below some the reactive measures that can be taken.

• Be decisive and act quickly by checking the insolvency
  provisions in the contract. Does an insolvency give the other party
  the right to terminate the contract? If so, it is imperative that
  notices are served properly and promptly;




• Where does the account lie on termination? More often than not,
  the usual interim and final account provisions fall away and are
  replaced by termination account provisions. It is important to
  apply the correct regime otherwise notices and certificates may be
  invalid;




• Check what the contract says about making further payments to
  an insolvent party;




• Review the account and ascertain whether a proof of debt should
  be submitted;




• Consider whether there are any other ways to keep the project
  alive, for example, can fresh agreements be entered into for
  portions of the work?




• What happens to un-incorporated materials that remain on site
  and who holds title to those?

Insolvency is not easy for any party in the supply chain. In
addition to the pressures on the supply chain we identified at the
outset of this article there remain many others. For example, in
the years to come the construction sector will face considerable
challenges around sustainability and ESG (environmental, social,
and governance metrics) pressures which will create yet further
budgetary concerns for projects.Where insolvency occurs it is
important to be open minded and pragmatic insofar as the commercial
realities of a business may allow. Nearly all businesses will face
financial hardships at some point or another and whether that
business will be able to trade out of that hardship is often
impossible to predict. Nevertheless, provided that the strict terms
of the contract are always adhered to, it is worth considering
whether parties can work together and identify commercial solutions
that give businesses the best possible chance of survival. In the
construction space, it is very rarely in anyone’s interest for
a business to become insolvent. If the predictions for supply chain
pressure in 2022 come to fruition, it may be that the best solution
will be understanding and negotiation. That said, where an
insolvency is inevitable, parties must do what they can to protect
their position and mitigate their own loss.

Footnote

1.
Construction News, “Revealed: the 20 firms that went into
administration in December“, 11 January 2022.

Disclaimer: This Alert has been
prepared and published for informational purposes only and is not
offered, nor should be construed, as legal advice. For more
information, please see the firm’s
full disclaimer.