Insolvency

Insolvency occurs when a corporate entity is unable to pay its debts. Insolvency is the general term
applied to a number of different possible scenarios depending on the legal form of the contractor which
determines the type of insolvency arrangement and practitioner.
For corporate entities it is likely to be an administrator, administrative receiver, official receiver or
liquidator that will be appointed to deal with the insolvency. On insolvency the contractors obligation to
carry out & complete the works is usually suspended. The contractor is required to give notice of
insolvency (Anon., 2009).
Definition
In citing section 123 of the Insolvency Act 1986, Baram (2014) defines insolvency as inability to pay
debts. This occurs when a company is unable to pay its debt when it falls due or its liabilities exceed that
of its assets.
Insolvency termination, without a proper appreciation of the financial status of an organisation can have
detrimental consequences. In such volatile environment, all it takes is a rumour of potential financial
difficulty for it to trigger a chain of events that ultimately can make a solvent company insolvent. It is also
important to bear in mind that termination without proper cause is a breach of contract in itself, entitling
the other party to compensation Baram (2014). In citing (Perar BV v General Surety & Guarantee Co.Ltd
(1994) BLR 72, CA.) Baram (2014) points out that Insolvency is not a breach of contract as default unless
it is expressly provided for.
Ensuring appropriate procedures in place for the tender process, correct choice of standard form
of contract suitable to the particular project and realistically appraised and assessed financial
modelling are all examples of good practice which go some way in protecting the Employer.
Express provisions that can help protect the employer from contractor insolvency include:
ending an obligation to pay the insolvent contractor further payment until the work is
complete, e.g. clause 8.5.3.1 of JCT Design & Build Contract (DB 2011);
allowing an alternative contractor to complete the Works and recover or set off costs
against the insolvent contractor such as JCT Clause 8.7;
allowing the Employer to make direct payment to the sub-contractor.
Factors making construction companies insolvent
The factors that make construction companies vulnerable to insolvency as provided by Cartlidge, (2009)
include:
The large number of sole traders, often set up during times of plentiful workload with little
regard to how the business will cope in leaner times. The majority of work is now carried out by
subcontractors, who will be squeezed by the main contractors when times get tough and this may
force them into liquidation
The practice of winning work via competitive tendering with unsustainable profit margins, in the
hope that proffit can be generated during the contract through extra works or claims for loss and
expense
The volatile nature of demand for construction works, making it hard to secure continuity of
work
Taking on too much work and being unable to carry it out because of insufficient cash flow to
purchase materials or hire labor.

The process of insolvency
A combination of delays in payments and impatience from creditors can lead to insolvency. This is only
possible when the contractor has inadequate working capital to overcome cash flow difficulties. The
reason why most small firms have poor credit ratings is due to the reliance on borrowed capital.
Unprofitability
An immediate cause of insolvency is failure to achieve the desired rate of return on capital invested. This
is usually the minimum return necessary to keep the capital in place and satisfy the shareholders.
Cash flow problems
Cash flow problems and shortage of working capital speeds up the downfall of an unprofitable and
inefficient outfit. They can in extreme circumstances push efficient and profitable firms into insolvency.
The construction projects generally being long in duration with a system of interim payments involved
may at times cause cash to be tied up in unresolved claims and variations. The contractor will require
considerable working capital in form of credit or overdraft facilities up to a point where the project
becomes self-financing.

Causes of construction insolvency
The common causes of insolvency in the construction industry as provided by the PPB Advisory,
(2013) include:
Competition and eroding margins
a period of significant growth in the industry has been followed by low work volumes.
Competition is intense and builders are undercutting each other to win work.
Inadequate scoping and costing strategies
due to the industry-wide focus to minimize upfront costs, including reducing the cost of scoping
documentation, there is a greater risk and tendency for disputes about project costs. Poor project
costing practices, deficient variation management and substandard management information
systems can exacerbate this risk.
Poor cash flow management and financial decision making
Lower work volumes create additional pressure on cash flows and expose poor cash flow
management practices. End customers are slower to pay, meaning builder and subcontractor cash
flows are squeezed further. Contractors further contribute to insolvency by means of investing in
non-core assets and making uncommercial loans to related entities.
Poor financial accounting practices
Firms that not correctly account for retention monies are seen to typically withhold a portion of a
subcontractors payments until the work is completed or the defects period has passed. In
addition, larger contractors with multiple jobs may be propping up one job off the success of
another which clearly demonstrates a lack of financial transparency.

Indicators of insolvency
Once work has started and the contractual relationships have been documented, there are various
indicators of insolvency that parties should look out for (Davies, 2009):

A slow down on site and/or of service delivery.

Late payment, either by the client, or by a main contractor to sub-contractors.

Requests for advance payment and/or early payment (again due to an inability to cash flow work over the
period between contractual payments).

Unexpected claims, claim building and withholding payment on the basis of these.

Direct contact by those lower down the contractual chain, with regards to non payment by intermediaries.

In the event of any of the above indicators, there are various options to procure project delivery prior to
formal insolvency proceedings. The position that should be adopted, however, is that insolvency will
follow and that the entity in financial difficulty should be helped, but not to the detriment of, or at the risk
of, the party lending assistance.
Remedies for insolvency
The winding up of a company, through liquidation is not always the best option considering the chain
reaction it may cause. Therefore a number of other rescue mechanisms which may be considered may
include Administration and Receivership;
Administration
Definition
Administration allows a business to continue trading while offering protection from action
brought by creditors. It can mean the rescue of a business as efforts are made while it continues
trading to sell the business and assets. When a company is facing financial difficulties, it can be
placed into administration. This means that the affairs, business and property of the company
will be managed by a person appointed for that purpose (Association of Business Recovery
Professionals, n.d.).
Circumstances which push a company into administration
When a company is facing financial difficulties it can be placed under administration. This
means that, during the period for which it is in administration, the affairs, business and property
of the company will be managed by a person ('the administrator') appointed for that purpose.
The administrator must be a licensed insolvency practitioner (Association of Business Recovery
Professionals, n.d.).
A company goes into administration when it is believed that business may be rescued and may
survive as a going concern. The company will be run on a day-today basis by the administrator.
Once a company has gone into liquidation an administration order cannot be made but once an
administration order has been issued, no liquidation or winding up procedures can be
commenced (Cartlidge, 2009).
Administration does not need to result in the winding up or liquidation of a business. An
administrator is appointed by the court, creditors or the company itself. Furthermore, the
administrator takes on a broad scope of duties and literally takes over those duties which were
previously held by directors. He or she sees to the operation of the company in order to comply
with the administrative order of the court. It may be to liquidate the company and it may also be
to turn financial matters around within a given timeframe, usually 12 months, in order to bring it
back to being solvent. (Business Recovery and Insolvency Practitioners, 2013)
Purpose of administration

The administrator must perform his functions as provided by the Association of Business Recovery
Professionals (n.d) with the objective of:
rescuing the company as a going concern, or
achieving a better result for the company's creditors as a whole than would be likely if the
company were wound up (without first being in administration), or
Realizing property in order to make a distribution to one or more secured or preferential creditors.
How a company can be placed into administration
According to the Association of Business Recovery Professionals (n.d) a company may be placed
into administration by the following:
an order of the court, on application by, amongst others, the company, its directors, one
or more creditors, or, if it is in liquidation, its liquidator;
without a court order, by the direct appointment of an administrator by the company, its
directors or a creditor who holds comprehensive security of a type which qualifies him to
make such an appointment
Receivership
Definition
If a company is in financial difficulty, a secured creditor or court order may put the company in to
receivership. A company goes into receivership when an independent person (the receiver) is appointed
by a secured creditor, or in special circumstances by the court, to take control of some or all of the
companys assets (Australian Securities & Investments Commission,, 2008).
A receiver will then be responsible through his/her staff will be responsible for collecting and protecting
any assets and investigating the causes of the bankruptcy or winding-up (Cartlidge, 2009).
Purpose of receivership
According to the Australian Securities & Investments Commission, 2008, the powers of the receiver
are set out in the charge document and the Corporations Act 2001 (Corporations Act).
A receiver is usually appointed by a secured creditor such as a Bank for the purpose of ensuring
that the secured creditor gets paid. Therefore, a receiver acts only for the benefit of the secured
creditor for whom it was appointed and not all creditors (Hill & Martin, 2010). Therefore , the
receivers role should include:

Collecting and selling enough of the charged assets to repay the debt owed to the secured creditor
(this may include selling assets or the companys business).

pay out the money collected in the order required by law


Liquidation vs receivership
Both liquidation and receivership are a sign that a company is going through financial trouble. It can be
seen that in both cases, management of a company is taken away from the directors and senior staff and
put in the hand of someone else. When this is done, both the receivers and liquidators have to look after
the special creditors and file progress reports (Hardy, 2009).
In the case of receivership, it involves a creditor stepping in and receiving a companys income which in
actual sense means intercepting and confiscating a companys assets. A creditor is allowed to take income
and proceeds of asset sales until such a time that the debt owed is repaid in full.
On the other hand, a liquidator is seen to owe allegiance to no one in particular. He is there to bring in all
the companys assets, sell whatever he can at the best available price and then divide all the proceeds of
sale among all creditors on fair and equitable basis (Hardy, 2009).
The power to put a company into receivership is most commonly found in loan documentations you get
from finance institutions. When these institutions agree to lend money to the company, they take some
form of security so as to increase their chances of being repaid.
A company can be in receivership and liquidation at the same time, but the liquidator takes a back seat
while the receiver remains in charge and only takes over when the receiver steps out of the picture.
However while the receiver remains in charge, he only has the same powers that the same powers that the
company had. Liquidators on the other hand have much more extensive powers as compared to
receivership (Hardy, 2009).

Liquidation
Definition
Liquidation is a process under Company Law that results in the company ceasing to exist (Anon., 2014).
This refers to the winding-up of a company. Trading usually ceases upon liquidation. The assets of the
company are collected and used to offset liabilities.
There are two categories of liquidation voluntary liquidation and compulsory liquidation. Voluntary
liquidation can be either members or creditors voluntary liquidation. Compulsory liquidation is the
result of a court order for a company to be wound up. This is usually because the company is unable to
pay its debts.
A liquidator will be appointed to take control of the winding-up of the business. For compulsory
liquidation this will, in most cases, be the Official Receiver (Ramus, et al., 2006).
Liquidation is the process of selling the companys assets in order to raise money to clear the contractors
debts. Once sold, the proceeds will be distributed in strict order as follows (Cartlidge, 2009):

Liquidation vs administration
Liquidation is the winding up of a business that will cease operations while administration is the
appointment of an administrator who may or may not seek liquidation. Liquidation can be sought even
when a business is solvent but administration is ordered when the company is insolvent. Liquidation is the
final phase of a business but administration may be an interim phase intended to bring the company back
to solvency.

Percy Bilton v. Greater London Council (1982)
Bilton contracted with the Greater London Council (GLC) to erect a housing estate. The
contract was dated 25 October 1976, and was substantially JCT 63. The original
completion date was January 1979. The nominated subcontractor for the mechanical
services went into liquidation on July 1978. By this time the contract was already running
40 weeks behind the programme. A new subcontractor was nominated, but subsequently
withdrew before starting work. A new nominated subcontractor was not appointed until
December 1978. The programme for this meant that the work would not now be
completed until January 1980. Various extensions of time were granted and the extended
completion date became February 1980. However, the contract was not completed by that
date and thereafter the GLC deducted liquidated damages. The House of Lords held that
the withdrawal of a subcontractor is not a fault or breach of contract on the part of the
employer, nor is it covered by JCT 63 clause 23. The architects clause 22 certificate was
valid and the GLC was entitled to deduct liquidated damages
North West Metropolitan Regional Hospital Board v. T A Bickerton Ltd (1976)
This case placed the responsibility of renomination with the architect rather than the
contractor, after a nominated subcontractor had defaulted. A nominated subcontractor went
into liquidation before they had completed their work. The main contractor then requested the architect
under the terms of the contract (1963 edition) to appoint a new firm as a
successor to this nominated subcontractor. Because a new price was required, and that this
was likely to be a higher price, the employer suggested that the contractor was responsible
for completing this work in any way, but to the approval of the architect. This may result
in the contractor doing the work themselves or subletting with approval, but that any extra
cost must be borne by the main contractor.
The 1963 edition of the form of contract is unclear on this point, but the case was
decided in the contractors favour. It is the architects responsibility to renominate in the
event of default, and the employer is therefore obliged to pay the additional cost of the
new firm employed. JCT 80 clarified this point along the lines of this decision.
Tyrer v. District Auditor for Monmouthshire (1974)
A firm of contractors who went into liquidation had been employed upon several contracts
by a local authority. The local authority found that this firm had been overpaid on interim
certificates. The district auditor established that overpayment was due to the negligence of
the quantity surveyor, in accepting excessively high rates for work carried out and failing
to check simple arithmetic. The auditor then surcharged the quantity surveyor for the
sums that he was unable to recover from the liquidator. The quantity surveyor appealed on
the grounds that he had undertaken his duties in the capacity of an arbitrator. The court,
however, rejected this appeal stating that there was nothing to show that the appellant was
in quasi-judicial position when carrying out his duties here.

case of Vigers Sons & Co Ltd v Swindell28 where, under a contract which
permitted direct payment of sub-contractors on the main contractors default, the
main contractor went into liquidation and the contract was taken over by one of its
directors. The architect instructed sub-contractors to lay flooring and promised that
the employer would pay for this. It was nonetheless held that the architect had no
authority to commit the employer in this way and that, since the employer had not
ratified (adopted) the architects action, the sub-contractors could not recover
payment from the employer.













References
Anon., 2009. Contractor Insolvency Contract Risk Management, Canada: Turner and Townsend.
Anon., 2014. Collection Manual: Liquidation of Companies and other Company Law issues, s.l.: s.n.
Association of Business Recovery Professionals, n.d. Administration:a guide for unsecured creditors,
London: Rescue Recovery Renewal.
Australian Securities & Investments Commission,, 2008. Receivership: a guide for creditors, s.l.: s.n.
Bahram, D., 2014. Insolvency in construction contracts. [Online]
Available at: http://www.thenbs.com/topics/contractsLaw/articles/Insolvency-in-construction-
contracts.asp
[Accessed 5 august 2014].
Business Recovery and Insolvency Practitioners, 2013. Real Business Recovery. [Online]
Available at: http://www.realbusinessrecovery.co.uk/definition-liquidation/
[Accessed 4th august 2014].
Cartlidge, D., 2009. Quantity Surveyors Pocket Book. 1st ed. London: Elsevier Ltd.
Davies, J., 2009. dealing with insolvency in the construction industry, London: Forsters.
Hardy, M., 2009. Company, Commercial and Business Law, Auckland: Geoff Hardy.
Hill, K. & Martin, S., 2010. CREDIT MANAGEMENT IN AUSTRALIA, AUSTRALIA: s.n.
PPB Advisory, 2013. ADDRESSING INSOLVENCY IN THE CONSTRUCTION INDUSTRY. [Online]
Available at: https://www.ppbadvisory.com/insights/d/2013-05-21/ppb-advisory-insights-addressing-
insolvency-in-the-construction-industry-may-2013
[Accessed 4th august 2014].
Ramus, J., Birchall, S. & Griffiths, P., 2006. Contract Prctice for Surveyors. 4th ed. Oxford: Elservier.

References