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June 2009

ABU DHABI BRUSSELS DUBAI FRANKFURT HONG KONG LONDON MADRID MILAN

MUNICH NEW DELHI NEW YORK PARIS SINGAPORE STOCKHOLM TOKYO WASHINGTON DC

Construction briefing

Contractor insolvency: early warning

signs, practical tips and contractual

safeguards

B u s i n e s s i m p a c t

An unfortunate but inevitable consequence of

today's faltering economic climate is the upward

trend of contractor insolvency.

If not properly planned for, the insolvency of a

contractor can spell disaster with projects left

incomplete, major delays and cost blow-outs.

To minimise the risks associated with contractor

insolvency, it is important to:

ensure that your contract protects you; keep alert for the early warning signs; and if concerned, act quickly to find out the

contractor's financial position and your

contractual options.

Forewarned is, as the saying goes,forearmed. Contractor insolvencies willalmost certainly increase in 2009, sokeeping a watchful eye out for the early

warning signs of a contractor in financialdifficulty will allow you to act quickly to

minimise any risks or damage to yourproject. This briefing provides a short guideon what to look out for, what action youcan take and what contractual safeguardsyou should consider when negotiating witha contractor at the outset.

Since most of the underlying principles will apply to

any contractor or project scenario you are dealing with,

the information in this briefing is general in nature and

is designed to cover the insolvency of many types ofcontractors who operate in a wide variety of industries,

from oil & gas to construction.

Early warning signs

The following are usually good indicators that a

contractor is in financial trouble:

Sub-contractors' demands:Have sub-contractors or suppliers begun to request

payments directly from you? This is one of the

more serious signs.

Requests for early payment and additionalfunds:Is the contractor requesting advance

payments to cover the cost of sub-contractors or

materials? This is also a definite sign of liquidity

problems.

Scarcity of work: Is the contractor worried abouta shortage of work? This may be a sign of possible

cash flow issues in the future.

Slow progress and missed deadlines:Decreasing activity? Project delays? These should

cause concern.

Staff changes:Employees' complaints about non-payment of wages and a reduced labour force are

signs that not all is well.

Disappearance of materials:Missing equipmentor materials may indicate trouble.

The early warning signs should set alarm bells ringing

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Persistent rumours: Gossip can often be a usefulsource of information.

Adopting a more "contractual" approach: Hasthe contractor changed its usual "informal"

approach and started taking a more "contractual"

approach to work?

Spurious claims:Has the contractor been raisingunjustified claims to increase the amount payable

to it?

Assignment: Has the contractor assigned (orasked for permission to assign) the proceeds of

your contract with it to its bank or another

creditor?

Contractor's accounts:Is the contractor late infiling its accounts or does its auditors' report

contain any qualifications?

Court judgments:Does a business informationreport on the contractor reveal any unsatisfied

court judgments against it?

Parent company:Is the contractor's parentcompany (or any other companies in the

contractor's group) showing any of the above

warning signs?

Seeing the signs?

Not all of the above warning signs will necessarily be

present and some of the indicators may be hard to

spot. If you suspect that your contractor is going

through some financial problems, you should not

ignore it approach the contractor about it.

However, bear in mind that sometimes rumours are

unfounded and may be spread maliciously, so you

should tread carefully and avoid doing or saying

anything that may inflame the situation or create

problems for the contractor which did not previously

exist.

At this stage, your aim is just to discover what is

going on and discuss with the contractor what needs

to be done to make sure that your project is

completed on time and within budget.

Failing contractor: practical tips

If, after you have talked with the contractor, you

believe that it is in trouble, what can you do?

There are two options either you continue to work

with the contractor or you find out if you can

terminate your contract with it.

First option: work with the contractor

If your project is almost at completion, it may be

cheaper and easier to stay with the troubled

contractor and nurse it through.

This may mean making extra or accelerated payments

to the contractor or agreeing to certain reductions in

the scope of work. You may also want to consider

making arrangements with the contractor for

payments to be made directly to sub-contractors (but

make sure that you obtain legal advice before doing

this so you do not end up paying twice for the same

thing).

Whatever you agree with the contractor during this

process, you should make sure that you:

minimise your exposure as much as possible; keep everything well documented; closely monitor the financial health of the

contractor going forward; pay attention to where any of your plant,

equipment and materials are located, take steps to

ensure that title to them passes to you upon

payment and make sure that they are not removed

by unpaid sub-contractors or other creditors of the

contractor;

maintain your own detailed records in relation tothe work that the contractor is doing for you; and

keep an eye on the contractor's own record-keeping and project reporting.

Second option: terminate

Many people will want to end their relationship with a

failing contractor as quickly as they can but this

approach can cause its own problems.

Firstly, in order to terminate a contract with a

contractor who is failing but not yet officially insolvent,

you will normally have to show either:

an authorisation of suspension of work by thecontractor; or

a failure by the contractor to proceed regularly anddiligently with the work.

Note that the latter can be hard to prove.

Secondly, the termination process will usually involve

a notice period which provides the contractor with an

opportunity to improve its performance. The contract

can only be terminated if there is no improvement.

There are many other issues to consider if you want to

go down the termination route, including the

following:

Any termination is likely to attract challenges andwill result in delays and disruption.

How are you going to get the project completed? Have you paid more to the contractor than the

value of the works completed and how much will

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you have to pay a new contractor to finish the

project?

What is the status of your agreements with thirdparties relating to the project and how will

termination affect them?

What if the contractor fails to co-operate with youfollowing termination? This may cause problems

with the assignment of sub-contracts and transfer

of project information, data and drawings.

Do you have "step-in" rights into the sub-contracts?

Have all necessary collateral and sub-contractwarranties been procured?

Are all performance bonds and parent companyguarantees in place? If so, you should investigate

how and when you can make a claim under themand the solvency of the provider; and

What ownership rights do you have in relation tothe plant, materials and equipment which the

contractor has been using for the project? How will

you prevent these from "disappearing"?

Importantly, you should always seek legal advice

before taking steps to terminate a contract because if

you terminate without justification, you run the risk of

being sued for damages on the grounds of a breach of

contract.

Contract clauses: protecting yourself

How can you protect your position at the start of a

project and reduce the impact of any contractor

insolvency occurring?

Many would suggest that when preparing a contract,

you should always assume that the contractor will fail

and proceed on that premise.

The serious consequences of contractor insolvency

mean that it is always advisable to obtain specific legal

advice on this topic before entering into a contract.However, just to give you a brief illustration of the

numerous contractual safeguards which should be

considered, we have prepared a "Contractor

insolvency contract checklist" below.

Importantly, though, before you even think about

what should be in your contract, it is vital that you

carry out financial checks to ensure that the contractor

in question is in good financial standing. If, following

your investigations, you have any concerns that the

contractor might be on shaky ground, you should

seriously re-consider whether you should be starting acontractual relationship with it.

Contractor insolvency contractchecklist

The following list is not exhaustive and should only be

considered as a helpful tool (as every situation will be

different), but in general terms, to safeguard your

position in the event of contractor insolvency, you

should make sure that your contract contains:

a wide definition of insolvency to cover as manydifferent default and business failure scenarios as

possible;

early insolvency triggers to give you as much timeas possible to consider your position if the

contractor's business starts to go bad;

no obligation to make payments to the contractorfollowing the occurrence of any insolvency event;

no automatic termination of the contract on theinsolvency of the contractor (to provide flexibility

and allow you to liaise with the contractor's

insolvency practitioner);

provisions in the main contract and sub-contractsthat deal with the passing to you of title to on-site

and off-site materials in the event of the

contractor's insolvency;

provisions which allow project continuation throughthe use of collateral warranties/third party rights

from sub-contractors (which should include "step-

in" rights);

payment clauses which ensure that you pay inarrears and only pay for the value of works

performed. If this is not possible (e.g. where an

advance payment needs to be made for a special

item), then consider securing the payment by

requiring an on-demand bond (although this will

involve a financial cost and the securing of a

vesting certificate);

provisions which give you the power to continuethe project after termination (including the rights

to use plant, equipment, materials and drawings,

but be careful in situations where the contractor

does not own them);

for extra protection, it is ideal to have a clauserequiring that the contractor provide you with a

performance bond or a parent company guarantee

(or both); in the construction industry, these are

considered to be "must-haves";

if you forgo requiring a performance bond at thestart, then you should consider whether you should

include a provision which specifies that the

contractor must provide you with a performance

bond on receipt of a written demand with a right to

terminate if it is not provided by a specifieddeadline;

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This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.Readers should take legal advice before applying the information contained in this publication to specific issues or transactions. For more informationplease contact us at Ashurst LLP, Broadwalk House, 5 Appold Street, London EC2A 2HA T: +44 (0)20 7638 1111 F: +44 (0)20 7638 1112www.ashurst.com

Ashurst LLP and its affiliated undertakings trade under the name Ashurst. Ashurst LLP is a limited liability partnership registered in England and Walesunder number OC330252. It is regulated by the Solicitors Regulation Authority of England and Wales. The term "partner" is used to refer to a memberof Ashurst LLP or to an employee or consultant with equivalent standing and qualifications or to an individual with equivalent status in one of AshurstLLP's affiliated undertakings. Further details about Ashurst LLP and its affiliated undertakings can be found at www.ashurst.com. Ashurst LLP 2009 Ref:12978945 26 May 2009

a provision that the contractor must ensure thatany sub-contracts are "back-to-back" with the

main contract so that the sub-contracts do not

contain any retention of title clauses in relation to

any materials being used by the contractor; and

if you will be paying for any off-site materials: a provision that the contractor is required to

identify clearly where any off-site materials are

to be manufactured or kept;

a provision that the contractor must ensurethat the off-site materials are stored separately

and clearly marked as your property;

a requirement that the contractor will provideyou with an on-demand bond before you will

pay for any materials being held off-site to

prevent any risk that such materials are notdelivered to your site; and

a requirement that the contractor provides avesting certificate from the owner of the off-site

materials and any intermediary owner

confirming that upon payment, title will pass to

you.

Conclusion

In an increasingly difficult market, it pays to be

vigilant. To protect yourself against the problems of

rising contractor insolvencies, you should ensure that

your contract contains suitable provisions to deal with

insolvency and its consequences, keep alert for early

indications that your contractor may be in trouble and,

if you are worried that your contractor is failing, adopt

a cautious approach before deciding what steps totake in order to minimise the impact.

Contacts

Marc Hanson

Partner, London

T: +44 (0)20 7859 1395

E: marc.hanson@ashurst.com

Carl Dunton

Partner, Singapore

T: +65 6416 9508

E: carl.dunton@ashurst.com

Alex Cunliffe

Partner, London

T: +44 (0)20 7859 3119E: alex.cunliffe@ashurst.com

Tim Reid

Partner, London

T: +44 (0)20 7859 1548E: tim.reid@ashurst.com