Insolvency in the construction industry is unfortunately never too far away and it would be surprising if anyone, at least indirectly, who is reading this article has not been affected.

As a sub-contractor who has carried out its work and chased invoices time and time again, what do you do when payment is not forthcoming and the main contractor goes into insolvency? Perhaps the sub-contractor refers to its retention of title clause in its sub-contract and breathes a huge sigh of relief. If it does, however, that relief can often be short lived. The example below (which unfortunately is often a reality) explains why.

  • Company A is a subcontractor who was contracted to supply and fit staircases at a unit (the Unit).
  • Company B is the main contractor who has been employed to design and build the Unit and has employed Company A.
  • Company C is the developer and has contracted with Company B to design and build the Unit.
  • Company A supplies and installs the staircases.
  • Company B then goes into insolvency.
  • Company C has paid Company B for the supply and installation of the staircases pre-insolvency.
  • Company A threatens to enter the Unit to remove the staircases that it hasn’t been paid for.

This example raises two important legal issues that regularly arise in the construction industry:

  • insolvency – what can a sub-contractor do against the employer when the middle man goes bust?
  • retention of title clauses – do they help?

Insolvency

Quite understandably, Company C will say: “why should I pay twice?” Company A’s debt claim is against Company B and not Company C because it had a contract with Company B.

Even if the contract had allowed for Company C to make direct payments to Company A, there would still be a risk of double payment. This is because the employer may not legally be able to deduct or recover the direct payment to a sub-contractor from a sum due to the insolvent contractor.

So, Company A – absent unusual wording in Company C’s contract with Company B - has no contractual relationship with Company C and therefore no claim against it for non-payment if Company B goes bust. Sub-contractors who are concerned about their employer’s solvency can take steps to protect themselves, such as by negotiating terms for upfront payment or putting appropriate security in place, but that requires steps to be put in place proactively.

Retention of title

Where suppliers contract to supply materials for building contracts, unless the contract expressly stipulates otherwise, the legal ownership in the materials will usually pass on delivery. Often, contracts will include clauses that seek to keep legal ownership in the materials with the seller until payment is received - a retention of title (RoT) clause. These clauses may be effective against a liquidator or trustee, so if Company A had such a clause in its contract with Company B, it could be of relevance here. However, as Company A was a sub-contractor, any RoT clause it had would usually only be binding on Company B, not Company C, unless Company C had specific notice of it and agreed to its terms.

In order for a RoT clause to be effective, it would have to be clear that it was the parties’ intention that title in the property was not to pass on delivery and that the materials were being held on trust until payment was made. And here, as the staircases would likely have been bolted down, it is arguable that the staircases were already an integral part of the Unit, which would likely mean that any RoT clause that did exist would no longer be applicable in any event - fixing the goods suggests they are no longer being held on trust even if those goods could be unbolted.

Accordingly, while a RoT clause can be effective in allowing a contractor to retrieve goods on site in the event of insolvency, it is less useful in a situation such as this: not only would Company C arguably not be bound by the RoT clause in any event, it is likely that Company A would have no right to enter the Unit to retrieve its goods without trespassing.

Conclusion

In this scenario, Company A finds itself in a tricky situation. It is not, unfortunately, an uncommon one.

While steps can be taken by a payee if a payer finds itself in financial difficulty – such as relying on RoT clauses, claiming under security arrangements that may be in place, or relying on other contractual provisions which may apply (such as the ability to suspend works or terminate) – this requires parties to spot the warning signs early to protect their position as soon as possible, and often requires thought to have been given to the potential for insolvency at the outset of the project.

This article is from the March 2020 issue of Cornerstone, our monthly newsletter for those working in the construction industry.