The liquidation of Carillion, announced on 15 January 2018, will have far-reaching consequences for the construction sector. The failure of Britain’s second largest contractor impacts employees, suppliers and clients. In many cases, hardship will result.
What are the issues faced by clients when a contractor becomes insolvent?
Project owners with buildings under construction by such companies will be concerned, and with some justification.
Where joint ventures (JVs) are involved it is likely that JV partners will pick up the insolvent partner’s share of the work, under the joint and several provisions of the contract.
But for projects where the insolvent company was the sole contractor, the situation is more complicated.
New contractors will be sought to take over the projects in order to see them through to completion. It is not certain that other contractors will accept the same terms as were originally agreed by the insolvent company; indeed in the case of Carillion, a number of CEOs in leading contractors have made this point clear.
Potential project delays
Project owners will face delays as new contractors are sought and terms negotiated for the completion of the works. Original budgets are likely to prove inadequate, leading to additional costs, not to mention the inevitable delays in project completion.
For buildings previously completed by a contractor which has become insolvent, there may also be concerns for the tenants. Tenants will typically have full repairing leases, which means the tenant is responsible for the costs of rectifying defects arising during the tenancy.
A common part of the construction security package is the collateral warranty. This is a legal structure that aims to transfer to the ultimate tenant the obligations owed by the contractor to the building owner under the construction contract. This allows the tenant to sue the contractor directly in the event of the tenant incurring any costs arising from the contractor’s negligence in building the project.
In the absence of such collateral warranties, the tenant would not be able to sue the contractor. With the liquidation of Carillion, for example, any collateral warranties it has provided will be worthless.
On many projects, in addition to warranties being provided from the contractor to future tenants, warranties are also provided by the designer, who often acts as a sub-consultant to the contractor, or other significant sub-contractors.
In the event of contractor liquidation, tenants suffering costs for repair of building defects might have no option but to look for recompense directly from the designers or sub-contractors.
However, this is possible only if the defect arises from design defects (or the specific work of a sub-contractor) and, even then, if negligence on the part of the designer (or sub-contractor) can be established. It is also likely that these warranties may be subject to monetary caps.
Inherent defects insurance (IDI) also known as latent defects insurance (LDI), offers an alternative form of protection for the costs of rectifying defects that manifest in the form of damage for up to 12 years post completion. IDI is not fault-based and is provided by a secure third party, the insurer.
We expect to see a spike in the number of IDI policies taken out, as building owners and tenants become more aware of the limitations of collateral warranties.
For new projects, obtaining IDI is likely to prove relatively straightforward. For recently completed projects or partly completed projects, the situation is more complex.
Typically, IDI insurers seek to become involved at the beginning of a project. They rely heavily on the assurance of control engineers who visit the project during the course of construction to satisfy themselves the building is being built to the correct standards.
This assurance is not possible for completed buildings and might only be possible to a limited extent for partly completed buildings. Nonetheless for building owners or tenants concerned about this issue, it is worth opening a dialogue with specialist IDI brokers, as it may be possible to design a bespoke solution to obtain IDI coverage.
Owners should bear these considerations in mind when seeking to replace an insolvent contractor on partly completed projects. The coverage provided by IDI will help deliver a more complete security package to future building users
Talk to a broker
Dealing with the fallout caused by contractor insolvency is time-consuming and stressful. Contact your construction insurance broker to discuss the risk and insurance issues, and to talk you through your options.
For more information about IDI insurance, please contact Naresh Dade, Construction Partner, Global Projects Group on 020 7528 4024 or email firstname.lastname@example.org
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