The legal implications of a main contractor going bankrupt are relatively simple. In terms of contractual relationships, a bankruptcy will have the following effects:
- First, the contractor will stop carrying out any work – this will be a breach of contract between the Client and main contractor
- Second, the contractor will stop paying his sub-contractors – this will be a breach of contract between the main contractor and sub-contractor.
There are two or three key structures that can be put in place to protect against contractor insolvency and they are generally standard on most large projects.
- One common option is a performance bond so that money can be claimed from a guarantor bank at short notice, often simply on-demand.
- A second and very common option is to obtain collateral warranties from as any many different people engaged on a project as possible. This will enable a direct claim to be made against these people in the event of a problem arising.
- A third option is to obtain a parent company guarantee – this is useful where a large contractor is using a regional subsidiary or special purpose vehicle to carry out a project.
However, these normally don’t take effect until conclusion of a project. Thus, they are useful in the event of latent defects, but are of limited use if a main contractor becomes insolvent in the middle of a project. There is no way for a developer to completely insulate himself from loss flowing from contractor insolvency which is why the selection of the contractor in the first place is probably the most important step of all.