Navigating Contractor Insolvency: Termination isn’t Always the Solution

The collapse of ISG has left many building projects in limbo. Joanna Rees, Construction Partner with Blake Morgan, explains why termination isn’t always the best option and offers practical steps to safeguard projects and supply chains.

Contractor insolvency is very stressful for clients who have commissioned a building project. One day, the site is alive with activity; the next, rumours swirl, equipment is removed, and the site stands abandoned, leaving the client wondering how to secure it. This scenario recently unfolded in Wales with the insolvency of ISG, highlighting the challenges that contractor insolvency presents to private and public clients.

For many, the immediate impulse is to terminate the contract, believing this will offer some level of protection. Yet, terminating a contract in such situations can often cause more harm than good. Here, we examine why termination should not be the go-to response and discuss how clients can protect their interests without cutting ties prematurely.

The limits of termination: Why it’s often a hollow right

In many cases, terminating a contract with an insolvent contractor does little to safeguard a client’s position. Although termination might provide grounds to seek recovery for extra completion costs, the client becomes an unsecured creditor with minimal chance of recovering anything. This is clear in the case of ISG, where administrators have confirmed that unsecured creditors are unlikely to recover any funds. Termination may protect a right, but in such cases, that right is often worthless.

Keeping contracts alive: The step-in solution

A better approach than termination is for clients to consider “stepping in.” Construction contracts often include provisions allowing a client to step into the contractor’s role, maintaining the main contract and keeping the supply chain intact. By triggering these provisions, the client can facilitate a novation – a legal mechanism to transfer the contract to a replacement contractor. This preserves continuity, ensuring that work continues without dismantling the project structure.

Public-sector clients must know their obligations under the Public Contracts Regulations 2015. Yet, quick action is essential when publicly funded projects are vulnerable to weather damage or other risks. In Cardiff, for example, the local council successfully novated ISG’s contract to an existing subcontractor on an interim basis. This allowed the council to arrange for payments to subcontractors while beginning a retender for the completion of work through the SEWSCAP Framework. This stabilised the project and prevented major financial shocks for local small and medium-sized businesses in the supply chain.

The challenges of finding new contractors

Finding a new contractor can be costly and time-consuming if termination is pursued. The Carillion insolvency, a major case that affected sites across the UK, showed that abandoned projects can take months to resume. Restarting requires a new contractor to procure a new supply chain, often with inflated costs due to rising material prices. Thus, keeping the original contract alive, where possible, can mitigate these delays and cost rises.

Project bank accounts: Added protection, but with limitations

All publicly funded projects valued over £2 million in Wales must use Project Bank Accounts (PBAs). While PBAs facilitate timely payments to subcontractors, their use in insolvency cases can be complicated. Funds within a PBA are held in trust for contractors and any supply chain members who have signed a Joining Deed, meaning they do not become part of the insolvent estate. This arrangement provides some protection to subcontractors – but only if all necessary signatures are in place, which can sometimes be challenging to secure.

Practical steps for clients facing contractor insolvency

To effectively navigate contractor insolvency, clients should prepare well in advance by incorporating protective measures into their contracts and responding strategically to early warning signs.

Here are some steps to consider:

1. Include novation provisions: Ensure your contract includes obligations for novation if the contractor becomes insolvent. This allows for continuity by transferring contracts to a new contractor without starting over.
2. Review warranties for step-in rights: Consultant and subcontractor warranties should also provide for step-in rights in case of contractor insolvency. These provisions enable the client to assume control without dismantling contractual relationships.
3. Develop a pre-emptive strategy: When insolvency rumours circulate, prepare a response plan rather than rushing to terminate. A calculated approach can safeguard the project’s structure and allow a smoother transition.
4. Engage with the supply chain: Communication is crucial. Notify the supply chain promptly and advise them not to terminate their contracts with the main contractor. A terminated contract cannot be novated, closing off critical options for the client.
5. Secure warranties early: Ensure warranties are executed at the start of work. This may feel overly contractual when everything runs smoothly, but a well-documented warranty can be vital during insolvency proceedings.
6. Monitor PBA joining deeds: If a PBA is in place, confirm that all subcontractors have signed valid Joining Deeds. Without these, they lack protection from the PBA, leaving them vulnerable if the contractor becomes insolvent.

The takeaway

While contractor insolvency presents a significant challenge, clients who resist the instinct to terminate outright are better positioned to mitigate risks and maintain project continuity. Careful contract structuring, early response planning, and thoughtful use of step-in rights can provide viable alternatives to termination, helping to protect both project outcomes and the wider supply chain.