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There are few signs of an immediate upturn in the fortunes of the construction industry, with the sector doggedly holding on to the top spot in insolvency league tables. Against this backdrop, recent updates to the JCT and NEC3 contracts, alongside amendments to Part 2 of the Housing Grants, Construction and Regeneration Act 1996, (the ‘new’ Construction Act), have implications for employers looking to recover insolvency related losses.

The new Construction Act particularly comes into play where a payment has become due to the contractor and it then becomes insolvent

Dealing with the news that a contractor has run into financial difficulty is always difficult. Having explored all other options, the employer may have no choice but to terminate the contract, in order to complete the project. Ahead of this decision, however, there are a number of practical steps the employer should address, including valuing the works that have been carried out, reviewing the need to notify a claim to any bondsman, obtaining relevant documentation from the contractor, contacting important suppliers and assessing the best way of bringing in a replacement.

At the point of a contractor’s insolvency, it is likely some unpaid work in progress will have been generated. Being able to recover the value of that work in progress is the equivalent of having cash in hand to set off against the employer’s actual or forecast insolvency losses. In many cases, the employer will also have cash retention.

So how does the employer recover the value of that unpaid work in progress?

The new Construction Act particularly comes into play in situations where a payment has become due to the contractor, either an interim monthly payment or a final payment after the final account has been agreed, and it then becomes insolvent.

One scenario is where the insolvency occurs during the period when a contractual ‘pay less notice’ can be issued. In these circumstances, to secure the value of the unpaid work in progress that is due for payment, the employer must serve a suitable ‘pay less notice’ on the contractor in accordance with and within the time scales set out in the contract. Failure to serve the notice means the employer will need to make the payment to the insolvent contractor by the ‘final date for payment’. Where the insolvency occurs towards the end of the period when a ‘pay less notice’ can be issued, problems can be expected, as there will be limited time to issue a suitably drafted ‘pay less notice’.

It might be possible to address the timing issue by drafting the contract so that in the event of contractor insolvency the ‘final date for payment’ is automatically extended by a specified period. This would have the effect of extending the period during which the necessary ‘pay less notice’ can be issued and, therefore, reduce the risk of the employer failing to issue the notice by providing extra time. This would require bespoke amendments to be made to the 2011 editions of the main JCT and SBCC contracts and the NEC3 Engineering and Construction Contract.

Where the insolvency occurs towards the end of the period when a ‘pay less notice’ can be issued, problems can be expected

While clause 8.7.3 of the 2011 JCT Design and Build contract contemplates contractor insolvency during the construction period - it does not expressly contemplate a contractor insolvency occurring around the time of the final payment in which circumstances a ‘pay less notice’ would need to be issued under clause 4.12.8 - a prudent employer might be inclined to make a bespoke amendment to cover this off.

In an alternative scenario, where the insolvency occurs after the period when a ‘pay less notice’ can be issued, the employer can only retain the value of unpaid work in progress, where the contract contains a clause complying with section 111 (10) of the new Construction Act. It is, therefore, essential that the building contract addresses this particular issue. The 2011 editions of the main JCT contracts contain suitable clauses responding to section 111 (10).

The amendments to the NEC 3 Engineering and Construction Contract to implement the new Construction Act do not introduce drafting to specifically address new Section 111(10) and there is no existing clause that specifically addresses the point in the way described in the new Construction Act. To avoid any question mark as to whether the NEC3 Engineering and Construction Contract provides an employer with suitable protection employers using the NEC3 Engineering and Construction Contract should consider including a suitable bespoke clause as part of the Option Z conditions.

Craig Bradshaw is a lawyer in the construction and engineering department of Maclay Murray & Spens