Bankruptcies in the construction industry are increasing – how to prepare for the contractor’s bankruptcy?

The contractor’s bankruptcy affects the employer and subcontracting chain significantly

It is typical for the construction industry that contractual obligations are assigned to subcontractors further down the contract chains. This phenomenon is also evident in industry statistics concerning bankruptcies. With long contract chains, the main contractor’s bankruptcy can easily lead to several liquidity problems in the subcontracting chain, and its spillover effect can even extend to other operators in the industry.

When the contractor undergoes insolvency proceedings, the situation is also difficult for the employer. If the contractor is declared bankrupt, the works may at worst cease immediately, in which case the construction will not be finished or the warranty repairs completed. Securities during the construction and warranty period provide a certain level of security, but they are cold comfort if the works end at an early stage or there are a lot of defects. It is essential that the employer continuously observes the situation on site, for example, by discussing with the contractor’s representatives or actors in the subcontracting chain. Following credit information registers is also important.

Impacts of a bankruptcy on the continuation of a project

At the beginning of bankruptcy, the estate administrator takes possession of the bankrupt company’s assets on behalf of the creditors. In accordance with the Bankruptcy Act, the bankruptcy estate has the right to commit to a contract that the debtor has entered into but not performed, typically also to construction contracts. However, the estate will only commit to contracts with a positive cash flow and easily available workforce, so in practice, the estate can rarely continue construction after the beginning of bankruptcy.

Can the employer minimise losses?

In case the contractor becomes bankrupt, it is important for the employer that the agreed payments reflect the completion rate as accurately as possible. One central legal remedy in the event of the contractor’s insolvency is withholding payments. The payment to be withheld can correspond, for example, to the liquidated damages or the amount of work necessary to repair defects.

In any case, it is important for the employer that the project can be completed without additional costs and delays. Back-loaded payments or withholding large amounts of payment, which may seem advantageous for the employer, may lead to the opposite outcome. In contrast, depending on the situation, it may be justified to try and support the contractor in difficulty so that the works can be completed without interruption.

In the event of the contractor’s insolvency, it is also a good idea to investigate potential arrangements to ensure that the subcontractors’ works can progress. This is the case in particular when the subcontractors are carrying out the most important remaining works and the main contractor’s decreased solvency threatens to jeopardise the project’s progress. However, amending contract terms afterwards is always associated with risks, so any arrangements that support the contractor or that relate to the subcontractors must be planned and agreed carefully from the perspective of both contract and insolvency law.

If the contractor’s bankruptcy is evident, it is usually necessary to start looking for an alternative contractor before the bankruptcy proceedings are commenced to avoid additional costs and delays.

Even though an improving outlook is not yet in sight for the construction industry, it is only a matter of time before the economic cycle picks up.