Slide rules: duties for directors of contractors in financial trouble

Catherine Welch (left) is a partner in the construction and engineering team, and Tom Llewellyn a partner in the dispute resolution team, at law firm RWK Goodman

With the government’s COVID-19 furlough scheme and other forms of support now long gone, contractors near the edge of a financial precipice are no longer able to suspend economic reality. They now face the inevitable consequences of managing lump-sum contracts while inflation costs for goods and materials are rocketing, material shortages continue and energy bills are increasing. If that wasn’t enough, supply-chain volatility and insufficient numbers of skilled workers are tangible problems.

Contractors’ financial wellbeing should be at the forefront of the minds of all parties involved in construction projects.

Developers are well versed in undertaking robust interrogation of contractors’ finances before they are appointed, but they need to keep their eyes open during the construction phase for signs that contractors may be experiencing increasing financial difficulties. This could include regularly reviewing contractors’ accounts, assessing delays to the works caused by sub-contractors failing to turn up, and hearing whispers on the industry grapevine about delays to sub-contractors’ payments.

Two options to take control

If a contractor is facing collapse on a live project, the developer usually has two main options to take back some control.

First, the developer could terminate the relationship and engage a replacement contractor to complete the works. In practice, however, another contractor might not be able or willing to take over the works within a reasonable timescale, resulting in delays to the project programme, rising costs and potentially significant risks with the extent of the replacement contractor’s warranties for the works.

“Although developers have a strong interest in keeping a struggling contractor afloat, at least until their project is complete, they should think carefully before providing additional financial support”

Alternatively, the developer may be willing to financially support the struggling contractor through to the end of the project.

However, although developers have a strong interest in keeping a struggling contractor afloat, at least until their project is complete, they should think carefully before providing additional financial support to contractors when it may be too late to rescue them from an inevitable insolvency. But if the developer does make a timely financial intervention, it could avert a contractor’s collapse.

The developer could agree to shorten the payment cycle to improve the contractor’s cashflow or implement direct payments to sub-contractors. The contractor should be on its guard, however, for how this will affect its own rights and obligations in its contract with the developer, and in its sub-contracts.

What can directors do?

For the contractor’s company directors, receiving additional financial support from one developer and/or prioritising payments to chosen sub-contractors may have wider implications. While the contractor’s directors will generally owe a duty to the company, when insolvency looks likely their duties change and then they owe duties to all creditors of the company over all other obligations. The contractor’s directors have a duty to minimise losses to creditors and to manage the assets of the company accordingly.

Directors of a company at risk of insolvency must decide whether to continue trading, enter the company into liquidation or administration, or to appoint receivers. The directors must carefully evaluate the correct course of action at the appropriate time, and do so with the help of professional advisers at the earliest opportunity.

The directors cannot defraud creditors, dispose of assets for less than they are worth, place one creditor in a better position than others (their duties are owed to all creditors) or pay out company funds improperly. If directors are found to have acted improperly when a company faces insolvency, they can be held personally liable and be disqualified as a director.

Directors need to be mindful of provisions in the Insolvency Act 1986, including wrongful trading (s.214), fraudulent trading (s.213), misfeasance (s.212), transactions at an undervalue (s.238) and preferential transactions (s.239). While these sections will not apply unless a company enters liquidation, they concern the conduct of directors prior to that point.

When a contractor faces potential insolvency, directors should be aware of their obligations to the company’s creditors and the provisions of the Insolvency Act, and take professional advice before deciding on the future of the business. They cannot seek to trade out of difficulties if such an outcome looks unlikely.

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