Craig Bradshaw: Developers gain new edge as risks remain high

The changes, dubbed the “new” Construction Act and implemented through the Local Democracy, Economic Development and Construction Act 2009, came into force in England and Wales last month, with Scotland following suit on 1 November. Responding to these changes, the construction industry standard form contracts have also been updated.

While a contractor’s insolvency during a construction project could pose a major challenge, a developer can plan for such eventualities. From a practical perspective, the developer should reserve a right to terminate the contract and hire a new contractor to complete the works, where a contractor becomes insolvent. The developer is likely to suffer financial losses and the difficulty lies in recovering these losses from an insolvent contractor.

Commonly, the developer will have the right to make cash retention of typically 3 per cent from each monthly payment. Also, the contractor may have to provide a performance bond. While a cash retention will be relatively easy to access, making a claim against a bond is often more difficult and the developer will want to minimise the need for a bond claim. Ongoing assessment of the contractor’s payment applications is essential and will help ensure the value of the apparent work in progress is not eroded through overpayments having been made before the insolvency. The value of unpaid work in progress is to the developer the equivalent of cash in hand, which the developer will be keen to offset against some or all of the actual or forecast losses.

The value of this unpaid work in progress will depend on the periods for payment, the timing of the insolvency and the value of the works being carried out at the time. The developer has control over the time periods for payment and, with longer periods, there is the possibility of higher value unpaid work in progress. The downside is the contractor may price in the extended credit period.

Under the 2011 contracts, published by the Joint Contracts Tribunal and Scottish Building Contract Committee, there could be between 14 and 45 days of unpaid work in progress at any given time, which could represent a significant amount of the developer’s insolvency-related losses. Of key importance is being entitled to recover the value of the work in progress and the new Construction Act comes into play in situations where a monthly payment has become due to the contractor and it then becomes insolvent.

One scenario is where the insolvency occurs during the period when a contractual “pay less notice” can be issued. In these circumstances, to secure the value of the unpaid work in progress due for payment, the developer must notify the contractor in line with the contractual agreement. Failure to take the appropriate steps means the developer will lose the right to keep the value of the unpaid work in progress and be obliged to make the monthly payment to the insolvent contractor.

In an alternative scenario, where the insolvency occurs after the period when a “pay less notice” can be issued, the developer can only retain the value of unpaid work in progress, where the contract complies with the requirements of the new Construction Act. It is, therefore, essential to make sure the building contract addresses this particular issue.

The new act offers an updated framework, which has implications for the growing number of insolvencies in the construction sector. A key issue for both developers and contractors is to ensure the new terms are taken into account on new projects, to ensure their commercial interests are protected.

• Craig Bradshaw is a lawyer in the construction & engineering department of Maclay Murray & Spens LLP