RICS draft guidance note - Subcontracting (1st edition)

Appendix 5: Key considerations when a subcontractor becomes insolvent

This is general guidance to consider in each specific case.

Evidence of insolvency

  • Obtain formal evidence that the subcontractor is insolvent, such as:
    • notice given by the insolvency practitioner
    • notice given in the Gazette
    • documents available from Companies House.

The subcontract

  • Check the terms of the subcontract to determine:
    • the right to terminate
    • the consequences of termination
    • whether the main contractor is entitled to secure materials and plant
    • whether the main contractor can require the subcontractor to assign the benefit of sub-subcontracts
    • the right to use design, intellectual property, etc.
    • the right to make direct payments to sub-subcontractors
    • rights of set-off (under the subcontract, cross-contract set-off, etc.).

Termination of the subcontractor's employment following insolvency

  • Check whether termination of the subcontractor's employment due to insolvency is automatic (this is unlikely).
  • Consider the pros and cons of termination.
  • Prior to termination, the main contractor should:
    • check whether the approval of a third party (e.g. the employer) is required for termination
    • check the subcontract works on site are secure
    • check the main contractor can take possession of the subcontractor's materials on site
    • check the main contractor can take possession of the subcontractor's materials off site (e.g. pursuant to the terms of the subcontract or a vesting agreement)
    • check the subcontractor has provided all guarantees and bonds
    • check the subcontractor has provided all collateral warranties required in favour of third parties
    • check the subcontractor has provided all collateral warranties required in favour of the main contractor (e.g. warranties from sub-subcontractors)
    • check the subcontractor has provided copies of sub-subcontracts.

Practical measures

  • Make records of the progress of the subcontractor's works, and the materials and plant on site.
  • Where it is lawful to do so, secure the subcontractor's materials (on site and off site) and plant.
  • Where applicable, notify the subcontractor that it is required to assign the benefit of its sub-subcontracts to the main contractor.
  • Assess the risk of claims from sub-subcontractors regarding retention of title and conversion.

Security

  • Consider the main contractor's rights and remedies under:
    • a parent company guarantee (including whether the guarantor is obliged to complete the subcontract works or simply pay damages arising from insolvency)
    • performance bond
    • advance payment bond
    • retention bond
    • materials off site bond
    • letter of credit
    • project bank account
    • any collateral warranties (e.g. a right to step into sub-subcontracts)
    • director's guarantee or indemnity
    • insurance policies.

Financial matters

  • Perform a valuation of the subcontract works, materials on site and off site, etc.
  • Record the effect of the insolvency on the progress of the main contract works.
  • Record the losses suffered by the main contractor as a result of the insolvency.
  • Prepare an account in accordance with the subcontract.
  • Check whether any monies are held in trust or in escrow.

The insolvency practitioner

  • Attend creditors' meetings.
  • Liaise with the insolvency practitioner to establish:
    • whether it intends to try to rescue the business or sell it as a going concern
    • its intentions regarding the subcontract
    • whether sufficient money will be available to pay creditors.

Completing the subcontract works

  • Consider the commercial advantages and disadvantages of ensuring the completion of the subcontract works by:
    • novating the subcontract to a replacement subcontractor
    • appointing a replacement subcontractor under a new subcontract
    • using the main contractor's own resources.