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Insolvency
What are the options available and mechanisms that a contractor should have in place to
safeguard its interests in the event of its employer becoming insolvent? MARTIN PRESTON* of
Norton Rose provides a guideline.
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become due to the contractor under the building contract. An employer would probably be
reluctant to place the entire contract price in an escrow account but an alternative would be for
the employer to place an amount equal to the next anticipated payment certificate into the escrow
account and for the account to be replenished after each payment has been made from it.
The contractor will need a right to suspend performance of the works under the building contract if
such funds have not been replenished so that it does not incur the costs of carrying out the works
without the certainty of knowing that funds will be available to pay the next payment certificate. In
certain jurisdictions, the escrow agreement will need to be drafted with care to ensure that
payments into the escrow account are not set aside on an insolvency as preferential payments to
creditors or as a result of any moratorium preventing the exercise of rights on an insolvency,
thereby depriving the contractor of the protection that that account is intended to provide.
Another option is for the employer to provide to the contractor a performance bond or letter of
credit for a certain amount, which the contractor could draw against if payment was not made. As
with the escrow account, the contractor should have a right to suspend works under the building
contract if there is a call under the performance bond or letter of credit and either it is not
replenished to its full amount or the unexpired portion is less than the anticipated value of the next
payment certificate. It will be important to ensure that the performance bond is drafted so that the
contractor can draw upon it when required. This will depend on whether it is an on-demand or
conditional bond and, if conditional, on the conditions that need to be satisfied before a call can be
made. Further discussion of performance bonds can be found in my article in the February 2007
edition of Gulf Construction.
If the employer has a parent company, then another option may be to seek a parent company
guarantee, such that the contractor can obtain payment from the parent company if the employer
fails to meet its payment obligations under the construction contract. This option may prove more
attractive to an employer as the cost is less than that of funding an escrow account or providing a
bond or letter of credit, although equally the parent company may not want to be exposed to the
liabilities of one of its subsidiaries in this way.
From the contractors perspective, a parent company guarantee will only be of value if the parent
company has the financial ability to meet any claims made against it. The contractor will therefore
have to conduct due diligence on the parent company and to ensure that it is aware if there is any
deterioration in the latters financial standing, the parent company would be unable to meet its
obligations under the guarantee. In this case, the contractor will want to ensure that alternative
security for the employers payment obligations is put in place.
Gulf Construction
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I love this blog. Thanks for the great information. I have it bookmarked and
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