The construction industry continues to feel the savage effects of the recession, with public sector cuts likely to accentuate the existing shortage of work for contractors. One consequence is that tender prices are still falling. From the developer's viewpoint, 2011 may present a good opportunity to take advantage of competitive tender prices in relation to both new build and refurbishment projects, if the necessary finance is available.

Suicide bidding

However, the rates of insolvency within the construction industry remain high in comparison to other economic sectors. Voluntary insolvencies leapt 20% in the first quarter of 2011. It has been widely reported that some companies have resorted to 'suicide bidding', whereby unprofitably low tender bids are submitted by contractors in order to win work. While low bids may appear superficially attractive, the likely consequence is aggressive claims for additional payment once work has commenced and/or the potential insolvency of the contractor during the course of the project. Suicide bidding is thought to have contributed to the untimely demise of some high profile companies within the industry. Increasing material and wage costs are also placing additional strain on contractors, so the risk of contractor insolvency should not be underestimated.

Appointing a contractor

Consequently, it is important not to accept a tender simply on the basis of lowest cost, particularly in the care homes sector, where it is crucial that a building can satisfy the requirements of both residents and the regulatory authorities. You, as the developer need to know that the chosen contractor can deliver the necessary quality and does not need to cut corners or exploit inevitable variations in the design in order to make a profit on the job.

As a developer, you should:

  • conduct thorough due diligence on the financial strength and relevant experience of tendering companies;
  • investigate the availability of parent company guarantees and performance bonds and check on the existence and availability of insurance;
  • obtain collateral warranties from sub-contractors; and
  • ensure that the terms of the building contract provide adequate protection in relation to the quality, cost and intended completion date of the project.

Warning signs of Insolvency

You should remain vigilant during the project for the warning signs of contractor insolvency. These include fewer people on site, a lack of progress with the construction works, defective workmanship and requests for additional payment by the contractor. Industry rumours about the contractor's financial stability and complaints from unpaid subcontractors can also be valuable sources of information.

You may need to make a difficult judgement call regarding the extent to which you are prepared to support a contractor in financial difficulty; for example, by waiving or postponing your right to claim damages for delay or by agreeing more generous payment terms. The alternative may be termination of the building contract. However, until the contractor is formally insolvent, terminating a building contract for poor performance can be risky as the contractor may argue that the termination was unjustified and attempt to claim damages for its lost profit on the job. Engaging a replacement contractor following termination will also lead inevitably to additional costs and delay.

This dilemma illustrates why it may be a false economy to accept an unusually low bid at the tender stage. While direct payments to sub-contractors may present one possible way forward, there are particular legal difficulties associated with this course of action and professional advice should be sought.

Steps following Insolvency

Once the building contract has been terminated by insolvency, there are some important steps that should be swiftly taken:

  • secure the site to prevent unpaid creditors from removing materials until ownership has been established. The site must also be made safe for visitors and adequately protected against damage by the elements;
  • arrange for a valuation of work completed at the date of termination and an audit of materials on site; and
  • ensure that adequate insurance arrangements are in place.

Be prepared

These issues will be all too familiar to many of those who have been involved with the construction or refurbishment of care homes in recent years. If you have so far avoided contractor insolvency during your own development projects, 2011 is shaping up to be another turbulent year for the construction industry so precautions are advisable.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.