Dealing with Contractor's Insolvency in Construction Contracts – Nigerian Law Perspective

This article by Dr. Kubi Udofia discusses some of the consequences that arise from a building contractor's insolvency, while also examining remedies and buffers which an employer may bring to bear to mitigate losses and minimise disruptions, resulting fro

N"UNDER COMMON LAW, INSOLVENCY DOES NOT CONSTITUTE A FUNDAMENTAL BREACH OF CONTRACT, WHICH ENTITLES AN EMPLOYER TO TERMINATE THE CONTRACT. A LIQUIDATOR MAY OPT TO PERFORM THE CONTRACT"

igeria’s construction sector is a vital economic growth driver. The sector provides physical infrastructure in relation to power, roads, rail, bridges, real estate, industries which drive industrialisation and economic growth. The Nigerian Institute of Building claims Nigeria’s construction industry is worth around US$69billion and employs 5% of Nigeria’s 180 million people. In its last released Labour Productivity Report (Q3 of 2016), the Nigerian Bureau of Statistics, estimated that Nigeria’s workforce stood at 80,669,196. The construction sector’s workforce thus, constitutes 11.65% of Nigeria’s total workforce. Nigeria currently has an infrastructure deficit of $300billion and the 30-year Integrated Infrastructure Master Plan, launched in 2014, projects that Nigeria will require roughly $3trillion for infrastructure development over 30 years, to close the infrastructure gap.

The above highlights the importance of a stable construction sector and timely project delivery. A contractor’s insolvency may result to allocation of insufficient resources, compromise in the quality of work, increase in defects, substantial time and cost overruns, default in related contracts and subcontracts and non-completion of the project. A contractor’s insolvency will adversely affect a range of parties, including its employer.

Employer’s payment obligations

Payment provisions are vital in construction contracts. Depending on parties’ agreement and the nature of the contract, payment may be in advance, conditioned on completion of work, based on the amount of work done, contingent upon milestones etc. An employer will understandably be concerned, where a contractor who has received advance payment becomes insolvent. Such employer may become an unsecured creditor, if the contractor becomes insolvent, with little hope of receiving dividend.

Advances to contractors may be secured by parent company guarantees (PCGs) and advance performance bonds (APBs). An employer may require an undertaking from a parent or affiliate of the contractor, to guarantee the performance obligations of the contractor. Upon a contractor’s insolvency, its employer must be cautious not to act in a manner which may discharge a guarantor of its obligations. Depending on the terms of the PCG, such acts may include employment of a new contractor, variation of the contract without required notices/consents, termination of the contract etc.

An employer making advances may require the contractor to provide an advance payment bond (APB). A typical APB will provide for payment of the employer by the bond issuer of up to an agreed amount if the contractor becomes insolvent. APBs provide an additional layer of security given that they are usually provided by third parties who would not be affected by the contractor’s insolvency. From an employer’s perspective, it is advisable for APBs to be on-demand, to ensure payment immediately on demand and without preconditions.

An employer may also employ a retention fund clause, which would typically require the employer to retain a percentage of each payment, as a buffer, against insolvency resulting

to non-completion. A retention fund is purely a personal monetary obligation which does not constitute a trust. The employer merely holds back money as opposed to setting same aside: MACJORDAN CONSTRUCTION LTD v BROOKMOUNT EROSTIN LTD

(1992) BCLC 350 at 359-360. Accordingly, a retention fund may not provide foolproof protection to an employer upon its contractor’s insolvency. The funds may be regarded as having already been earned by the employer and ought to be turned over to the liquidator. Retention may therefore constitute fraudulent preference or breach the pari passu rule.

Payment of subcontractors

The risks of time and cost overruns may be mitigated, where an employer retains the services of subcontractors upon the contractor’s insolvency. Retaining subcontractors may be difficult where a contractor had defaulted in payments. Such payment defaults can be reduced by requiring contractors to include a “pay-when-paid” clause in subcontracts. This will require a subcontractor to be paid within a specified period after the contractor has been paid; reducing the risk of such monies being trapped in subsequent insolvency proceedings.

An employer may also adopt direct payment clauses, which will authorise the employer to make direct payments to unpaid subcontractors, where the contractor defaults. Direct payment clauses convert an employer’s duty to pay contractors into a right to pay subcontractors and setoff the equivalent amount against sums due to the contractor. However, direct payments made three months prior to commencement of the contractor’s liquidation, may constitute fraudulent preference: s.495 of Companies and Allied Matters Act, 2004 (CAMA), s.46 of the Bankruptcy Act, 1979. Further, direct payments made after the commencement of proceedings may violate the pari passu rule and may be void pursuant to s.413 of CAMA: MERCHANTILE BANK OF NIGERIA v

NWOBODO (2000) 3 NWLR (Pt 648) 297 at 318H. Accordingly, an employer making direct payments to subcontractors, should obtain an undertaking by the subcontractors to indemnify the employer against any liability the employer may have to pay a similar amount to a liquidator.

As a viable alternative to direct payment clauses, a trust can be created in favour of subcontractors. An employer’s advances to a contractor for the specific purpose of paying subcontractors, but which has not been paid to them at the time the contractor becomes

insolvent would be held on a resulting trust in favour of the employer: BARCLAYS BANK

v QUITCLOSE INVESTMENT (1970) AC 567 at 580. The money will not fall into the insolvent contractor’s estate and a liquidator will have to pay back the money to the employer: CANARY WHARF CONTRACTORS LTD v NIAGARA MECHANICAL SERVICES

INT’L LTD (2000) 2 BCLC 425 at 433-4. An employer may also negotiate for collateral warranties from the contractor. The collateral warranties should include “step-in” rights entitling the employer to step into the contract between the contractor and sub-contractors, upon the latter’s insolvency. Such step-in rights will enable the employer to work on the same terms the contractor agreed with sub- contractors; minimising time and cost overruns.

Plants and Materials on Site

To avoid disruption of work when a contractor goes bust, an employer may employ vesting clauses, which provide that ownership of materials and plants shall transfer to the employer once they are brought on site: HART

v PORTHGAIN HARBOUR CO LTD (1903) 1 Ch 690 at 694-695. Care must be taken to avoid a re-characterisation of the vesting clause as a charge. Whether the vesting clause has the effect of transferring ownership, is a question of construction of the clause: In re Cosslett

(Contractors) Ltd (1998) Ch 495 at 506. Where the clause provides for transfer of ownership upon a contractor’s liquidation, it may be void for breach of the anti-deprivation rule: In re

Harrison (1880) LR 14 Ch D 19 at 25. The anti-deprivation rule invalidates contractual provisions designed to remove assets from the estate of an insolvent upon liquidation: BELMONT PARK INVESTMENTS PTY LTD & ORS v BNY CORPORATE TRUSTEE

SERVICES LTD & ANOR (2012) 1 AC 383. Where there are retention of title clauses in favour of the contractor, a liquidator will have a rightful claim to the plants and materials. However, where the materials have been incorporated into the project or affixed to land, they become assets of the employer. The principle quicquid plantatur solo solo cedit (i.e. whatever is affixed to the soil belongs to the soil) will apply: ORIANWO v OKENE (2002) 14 NWLR (Pt 786) 157 at 193E-F. Whether an asset remains a chattel or becomes part of the land depends on (i) the degree of annexation to the land, and (ii) the object of the annexation: ELITESTONE LTD v MORRIS & ANOR

(1997) 2 All ER 513 at 518 and 519.

Termination Under common law, insolvency does not constitute a fundamental breach of contract which entitles an employer to terminate the contract. A liquidator may opt to perform the contract as was the case in In Re Toward (1884) 14 QBD 310. However, it is common for parties in construction contracts to make insolvency an event of default, entitling the solvent party to terminate the contract. An example of this can be seen in the Multilateral Development Bank’s harmonised edition of General Conditions made in collaboration with the International Federation of Consulting Engineers - FIDC (June 2010). Further, the contract may empower the employer, upon the contractor’s insolvency, to withhold monies until (i) the works have been completed, (ii) all defects liability period has expired, and (iii) all defects have been rectified.

An employer may also terminate its contract on the ground of repudiatory breach. A repudiatory breach is a fundamental breach that entitles the injured party to terminate the contract, and sue for damages: SAKA v IJUH (2010) 4 NWLR (Pt 1184) 405 at 405D-E. Repudiatory breach may either be due to inability or unwillingness of the contractor to perform its obligations. Insolvency does not constitute repudiatory breach, given that the liquidator may decide to continue and complete the contract. Accordingly, an employer who seeks to rely on repudiatory breach as a basis for termination, must proceed with caution to avoid incurring liabilities for breach of the contract.

Conclusion An employer may adopt diverse contractual measures to insulate itself from, or mitigate, the adverse effects of a contractor’s insolvency. It is expedient to incorporate the safeguards into the contract from the outset, as opposed to doing so on the eve of insolvency, to reduce the risk of breaching certain principles of insolvency law.