Limiting Flow-on Effects of Contractor Insolvency

You are the subcontractor and supplier of tiles to the cladding contractor on a major commercial construction project. Midway through the project, one of your payment claims is not paid. Some weeks later, you learn that the cladding contractor has had a receiver appointed. You have unpaid payment claims outstanding and have delivered tiles to the cladding contractor which are yet to be installed. What can you do?

This is a not unfamiliar scenario in today’s economically challenged construction industry. Unfortunately, by the time disaster hits it is often too late to do much about it. However, there are advance steps you can take to lessen your exposure – steps that will start before you even enter into a contract.

Review your standard terms of business
Too often companies rely on standard terms and conditions that have seen them through in flush times but that fail to protect them in bad times. Good terms of trade are the backbone of any business, particularly one where you part with possession prior to being paid.
One of the key steps in protecting yourself is to establish a security interest in the goods you supply, and the right to payment. A security interest, if effectively established, will give rise to the right to register your interest on the Personal Property Securities Register and, provided registration complies with the rules created by the Personal Property Securities Act 1999, you will have elevated your position from that of an unsecured creditor to that of a secured creditor.
So, how in practice do you achieve this? Set out below are the key points you will need in order to take advantage of the rights available to you under the Act:

• Your terms of trade must include a security interest which, if you are supplying goods in trade, will be a “retention of title” provision;
• Your terms must be in writing and signed or assented to in some way by the customer for your security agreement to be enforceable against a third party; and
• You must register your security interest on the PPSR within the relevant time frame. A security interest will only give you priority as against later registered secured creditors if you have registered in time. The timing rules that apply to registration are complex – the safest course is to register as soon as you enter into a contractual relationship with a customer and prior to parting with possession.
• Accuracy is a key aspect of registration. Registration can be invalid if it is seriously misleading, or defective if the name or details of the debtor (customer) are not accurately recorded. Ensure you use the tools available to you, such as checking company details with the Companies Office (www.companies.govt.nz) prior to registration.

Further areas to consider when reviewing your terms of trade are:-

• Do you supply more than one type of goods? For example, goods which are used as equipment and/or tools, together with certain items that are used in construction? If so, do these different types of goods need to be dealt with separately?
• Where goods are used in construction and lose their original identity, will your security interest continue in the finished goods or proceeds?
• To avoid the mixing of your goods with those of third parties prior to use, do your terms require labelling and separation?
• Have you included rights to enter and re-take possession of goods for default?
• Is the delivery address the address of the construction site? If not, where will your goods be if you need to re-take possession?
• Are you entitled to enter on to the property of a third party to re-take possession?

Keep Goods Segregated on Site

Once the project has started there are additional practical steps you can take to reduce your exposure to losses.
As indicated above, a useful term to include is an obligation to keep any goods supplied separate from those of third parties, and clearly labelled. This should enable quick and efficient identification and recovery of goods if you need to re-take possession or notify a receiver or liquidator of goods in which you have an interest.
As you would know, however, many construction sites have specified delivery points, often linked to small and cluttered storage areas where goods are kept prior to use. Similar goods are often stored together, sometime resulting in the mixing or loss of identification.

There is little point having reviewed your terms of business, established a system of registering your security interest on the PPSR, but then allowing your goods to be intermingled with like goods supplied by a third party. Do not take for granted that the customer will in fact keep your goods segregated. Visit the site, request access to the storage facility where your goods are held, and ensure the customer is complying with its obligations.

Never sit on an unpaid payment claim

Having implemented the above steps, it remains important to be alert to signs of financial stress on the party you have contracted with. Make sure you have regular billing cycles and never sit on an unpaid payment claim. If a payment claim is not timely paid in accordance with the terms of your contract, the Construction Contracts Act gives you the right to serve a notice of intention to suspend works. This will give your client five working days to pay you. If they do not pay, you can suspend work and so limit your future exposure to losses. Insisting on being paid as you go and not permitting the build up of a balance that is owed to you may also lessen your exposure to having payments clawed back in future insolvency proceedings.

In the case where you have contracted with an intermediate contractor, you should consider copying the head contractor on any notice of intention to suspend. This will alert the head contractor to problems down the line and, depending on the circumstances, may enable you to negotiate directly with them for future payments or a guarantee of the same.
While no one can be fully insulated against losses from doing business with a company that goes insolvent, the above are practical steps that prudent subcontractors can take in the current economic climate so as to reduce their exposure.