Batten down the hatches!
21 November 2022
Anyone with access to the news will be aware that the UK economy is experiencing rocky times, with a recession having likely already begun.
So, what are our top five tips for clients about to place a construction contract in an economic downturn?
- Do your due diligence. What is the financial strength of the party you are contracting with? Are you confident that they (and their sub-contractors) are financially solvent and have cash reserves to weather a storm? Is your proposed contractor experienced in the relevant area of construction and not working outside of its comfort zone? Do you have the funding in place with enough contingency to allow for increased costs?
- Evaluate your security requirements. Bonds have become increasingly expensive, but that expense may now be well worth the available cover. Ask your contractor to obtain quotes, and look at what the likely costs would be if the contractor was to become insolvent part way through a build. Is a parent company guarantee available either as an alternative, or in addition, to a bond? It may not be beneficial in the event of a group insolvency, but it could allow you to recover losses in the event of insolvency of the subsidiary you are contracting with – and contractors do not have to pay a premium for providing one!
- Consider the use of fluctuations provisions. Most standard contracts have fluctuations provisions, which have historically been very unpopular with clients looking for cost certainty. However, well drafted, they may provide you with some certainty (or at least an upper limit) and may in fact secure a reduction in the contract sum payable (by way of reduction of a risk premium). Contractors will not need to allow for material price inflation when calculating their initial price, so clients will only be liable for cost increases actually incurred; subject to any cap which the parties may agree.
- Consider timescales. The wave of insolvencies seems to have begun (the Insolvency Service statistics for September show that company insolvencies were 16% higher than in the same month in the previous year). Anecdotally, we understand that in the construction industry this is partly due to contractors being unable to provide the labour and materials to allow them to meet completion dates. Can you allow for a more flexible/longer programme, stepped liquidated damages, or even liquidated damage-free periods? This may reduce the financial burden on the contractor/ supply chain, assisting them to remain solvent and complete the project.
- Cash is king. Look at your payment provisions and think about the timing of valuations and the number of days you actually need to pay the contractor (being reasonable of course, to be Construction Act compliant). Ensure that you hire an experienced employer’s agent/project manager to actively manage the contract and assess every payment application. If you do agree to make an advance payment to a contractor (which may be required to secure goods early, at a lower price), should you secure that payment with an advanced payment bond? Vesting certificates should be considered for any payments made for off-site materials, to help prove ownership in the event of contractor insolvency. Agree an acceptable level of retention (used to provide security against defects or supply chain insolvency) with your contractor.
In conclusion, having frank and open discussions at the negotiation stage with your chosen contractor about risk, costs and programme, and ensuring that is accurately reflected in the contract is nearly always the best way forward, and even more so in a tricky economic climate.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at November 2022.