Picking up the Pieces. Incomplete developments and the challenges of boom and bust!

Niav O’Higgins

Partner and Head of Construction & Engineering, Arthur Cox

 

Introduction: 

Construction is one of the sectors most severely hit by the recession, not only due to the banking crisis and the meltdown in residential property development, but also as a result of the government debt crisis and the consequent mothballing of a number of significant public sector projects, both PPP as well as traditional projects which have not been able to proceed due to lack of funds.  As the recession deepened, a number of the larger players in the sector were pushed into receivership or liquidation, notably, Pierse Construction, McNamara Construction, Bowen Construction and McInerney Homes. Others have since fallen by the wayside and both contractors and construction professionals, including architects and engineers, continue to struggle in the current economic environment. Construction remains the sector which has suffered by far the greatest percentage of insolvencies[1] in the past 5 years.

But are fortunes showing signs of change? In response to the banking crisis, in 2009, the National Asset Management Agency (“NAMA”) was established, with a key aim of managing bank debt by removing non-performing development loans from the Irish banking sector and releasing finance back into the economy.  In recent months, there have been discernible signs that there are moves to finish out some partially built developments (in order to realise their value), whether through a NAMA appointed receiver or other insolvency professional appointed under private security arrangements.  There are also encouraging signs that funds will be made available for some public sector projects.

From Boom to Bust? New issues to contend with 

So what are the issues that you need to be aware of when a developer or contractor goes bust? How do the standard form contracts manage this doomsday scenario and what rights or obligations do you have as employer or contractor? And if you are considering entering into a contract for the completion of an abandoned development, what do you need to be aware of in terms of the potential liabilities that you may be assuming? This article provides an overview of some of the key issues that can arise and that you should look out for in these times of crisis.  A key lesson that we have all learnt from what occurred in Ireland is if a party to a contract takes on more than they can chew, this can contribute to the project failing, with repercussions for all involved.

The first issue to check: what are your entitlements in the event of your contractual counterparty experiencing an insolvency event? Most standard form contracts used in Ireland in both the public and private sectors provide that an event of insolvency will entitle the other party to terminate the contract. Absent this express right, insolvency will not necessarily give rise to a right to terminate, although it is likely to result in the insolvent party falling into material default of one or more of its obligations (for example, non-payment or non-performance) which default may then trigger an entitlement to terminate.  Most contracts then set out the consequences of termination (for insolvency or default). In the event of the employer’s insolvency, this may include providing the contractor with a lien over goods and materials delivered to site pending payment of outstanding monies.  In the case of an insolvent contractor, they will generally be required to vacate the site, leaving all plant, goods and materials in situ to be available for completing the works. Such a contractor will have no right to receive further payment until the works have been completed by another contractor and the additional costs of the same assessed and deducted from monies otherwise due.

Possession of the site can be a key factor in determining how the insolvency will, in fact, impact the rights and obligations of the parties. In the case of employer insolvency, it is not unusual for the contractor to retain possession of the site, notwithstanding the contractual provisions, pending resolution of payment issues and this can create a real headache for receivers or liquidators. There is also the risk that goods or materials on site or even fixtures attached to the site will be removed, by either the contractor or sub-contractors on account of unpaid monies.

Where the contractor has become insolvent, the first challenge for the receiver/liquidator will be ensuring that the contractor vacates the site promptly, and that the site is secured. This is necessary not only to protect the works completed to date and all goods and materials that may have been delivered to site, but also for ensuring that the site can be kept safe and not create a danger for third parties, including trespassers, in the vicinity of the site. Disgruntled sub-contractors who may have been stood out of monies for some time often seek to assert retention of title claims, and unless and until the site is secured, they will be able to return to site to remove their goods and materials.

A second key aspect to be checked following an insolvency event is the extent to which the performance undertaken by the defaulting party has been otherwise secured. In the case of an insolvent contractor, the employer should consider whether there is a bond which may provide some funds to assist in completing the works. Is there a parent that can be called upon under a guarantee to assist in discharging the contractor’s obligations (although where the subsidiary is in difficulty, this may extend to the entire group)? Are there collateral warranties from parties, including professionals (under a design & build, for example) or specialist sub-contractors in respect of core elements of the works? Are there contracts to which the employer can step into to facilitate the completion of the works? The answer to each of these questions may impact the choices available to a party wishing to find a way to continue with the works.

Stepping into the Unknown – Completing incomplete Projects

There are a number of issues that can face a party stepping in to complete a partially finished building, but at their heart is an understanding of the various risks presented by the incomplete works and the determination of the party willing or able to assume those risks.  Clearly, the party taking on the responsibility for completing out a development will need to ensure that all appropriate surveys and investigations are undertaken as to the design and construction of the works which have been completed to date, as well as the consequences of the structure having been left incomplete for an extended period, for example, through the impact of the elements on a structure that is not watertight, or the removal of certain elements of the works under retention of title provisions, and the consequent damage to the works.  Almost always, however, there will be a ‘black hole’ of information, namely, elements of the works which cannot be fully assessed and in respect of which there is no party willing to assume responsibility (for example, foundation works, where the contractor and or specialist sub-contractor has become insolvent  – a new contractor will not take on the risk of what they cannot see or investigate).

Once the state of the incomplete works has been assessed, consideration can be given to the way in which risks associated with those works should be allocated. In some instances, a completion contactor may be willing to take on responsibility for the entirety of the works, where, for example, the key sub-contractors involved in the original works are also involved in the completion works and are able to stand over their original works. In other instances, a completion contractor will only accept responsibility for the works that it carries out and the entire responsibility for the earlier works will sit with the employer.  In the majority of instances, the line setting out the risk allocation will be drawn somewhere between these two extremes.  Where the line is drawn, however, may impact the ability to get external funders to invest in a project.

Other options which may be available to a receiver / liquidator (whether NAMA appointed or otherwise) may be to procure sample remedial works to fix defects identified in the incomplete works, the extent of which cannot be fully assessed until these are opened up. This allows not only the full extent of damage to be more fully assessed, but also gives greater certainty as to the remedial and completion works which will be required and the costs of the same.

Conclusion 

With the downturn in the economy, the construction sector has had to deal with the fall out of key stakeholders finding themselves in very real financial difficulties, which many have not been able to survive. The tides may now slowly be turning, but there are still significant challenges facing the industry players in the years ahead. Meeting those challenges demands that lessons be learned: employers, contractors and consultants alike have all been reminded of the need, in embarking upon any project and in entering into contracts setting out their respective rights and obligations, to carefully assess the risks associated with their involvement in each particular project.  The risks need to identified and considered (including the risks associated with particular counterparties), contractual obligations need to be understood and above all, a sensible approach taken to the optimum allocation of the risks between them. Any party can agree to accept a risk, but if that party is not in a position to meet the challenge should the risk materialise, this can have negative repercussions for all involved in the project.