The Carillion Insolvency Effect
The collapse of Carillion has seen a devastating effect on the construction sector. From a legal perspective, this has highlighted a number of issues:
Retentions and payment
As discussed in our previous article (here) there are long-standing concerns within the construction industry that retentions are not released in a timely manner. This means the unpaid party (particularly a smaller contractors and/or sub-contractors) runs the risk of losing the retention entirely if there is an up-stream insolvency. Indeed, not only will these parties potentially lose out on retentions and payments which are already due and have been invoiced, but also those which are due to be paid either at practical completion or on making good any defects. This is now the reality for many of Carillion’s sub-contractors, who are relying on the Government to pay. Some sub-contractors have no assurance at all.
This re-opens a debate for the retentions system to be reformed or removed. In the meantime, money could be ring-fenced to protect sub-contractors from a situation where their money disappears with the main contractor. It is hoped that the Government consultation on retentions will ultimately seek to resolve these issues, either by way of stricter regulation or through separate escrow accounts for the monies to be held. The consultation closed on 19 January 2018 and we will update you on the findings.
Carillion reportedly used an Early Payment Facility, whereby sub-contractors could get paid earlier than the firm’s usual 120-day turnaround, (by certain partnered banks) in return for a fee. This system also stopped working once Carillion went into liquidation. Such payment systems therefore offer no further protection to reliant sub-contractors, who must continue to seek alternative security options.
Warranties and step-in rights
Collateral warranties are commonly used between an employer and a sub-contractor to create a direct contractual relationship between them.
One significant benefit of such warranties is that they will allow the employer to step into the shoes of the contractor, if the contractor becomes insolvent. In a situation like the Carillion liquidation, this would therefore enable the project to continue between the employer and the sub-contractors, such that the employer would then become responsible for payment of the works to the sub-contractor directly. Hopefully these contracts will have been used on some of the Carillion projects to enable those works to continue unencumbered.
We also advise third parties, including occupiers for whom employers are procuring construction works to ensure that they always enter into development agreements with the employer. The main benefit of such agreements is that they afford the third party a degree of control over the works during the construction phase. Most notably, this enables the third party to enforce the terms of the main contract and warranties against the employer. It also requires the employer to take action in the event of contractor insolvency.
Private Finance Initiatives have been around since 1992, but Carillion’s collapse has shown their limitations. Many are raising concerns over the high cost of private involvement in the public sector. Notably too, several contracts were still being given to Carillion even after they had issued a number of profit warnings!
Further investigation into the efficacy and transparency of PFI arrangements may now follow in the coming months.
If you have any concerns arising out of an up-stream insolvency, or if you would like any advice on how you can protect yourself against a future insolvency, please do get in touch.Back to Our Thinking →