Brexit Bulletins | September 28, 2016

Contractor insolvency in the Brexit climate

In the economic and political uncertainty following the Brexit referendum, there has been huge speculation about the impact on the UK’s construction industry.

Immediately following the vote we saw housebuilder share prices collapse, the pound weaken, and concerns surrounding the impact of Brexit on the supply of already scarce skilled labour. We have also seen suggestions that the current climate makes the UK property market more attractive to foreign investors, and that it may prove to be a boost for the construction industry in the longer term.

Given this uncertainty, developers need to be alive more than ever to the risk of contractor insolvency. Contractors are particularly vulnerable to fluctuations in the economy because of the time lag between pricing and carrying out the building works. In a period of economic boom, rising prices of commodities and fixed labour cut into contractors’ profit margins. In recession, although prices may be lower there is often lower demand and a higher risk of insolvency further up the chain.

Developers can never remove the risk of contractor insolvency, although it can be mitigated as far as possible by carrying out initial due diligence and checking the contractor’s covenant strength. However, steps can be taken to reduce the possible negative impact on the development from a contractor going bust mid-build.

The bread and butter of a developer’s protection will be the more traditional methods such as performance bonds, parent company guarantees, and collateral warranties with step-in rights from sub-contractors (which allow the developer or other beneficiary to take over the contractor’s role in sub-contracts in the event that the contractor is not keeping up its obligations), and these will generally be required by funders.

It is important to also consider how the structure of the development can lessen the potential impact of contractor insolvency. For example, if there are distinct elements or sections to a build, can risk be reduced by engaging multiple different contractors? Developers can consider sharing risk by entering into joint ventures, with the added benefit of the possibility of taking advantage of another party’s expertise or ability to provide funding. Using technology such as BIM from the very start of a project can prove vital in integrating and coordinating work in the event that a new contractor is drafted in to take over part-finished work following an insolvency.

Structuring a development carefully and imaginatively of course has potential benefits far beyond providing protection against contractor insolvency, and will allow developers to fully take advantage of their opportunities in the new post-referendum climate.