A default with respect to a key contractor under a relevant subcontract (such as a construction contractor default under a construction contract) can present a significant risk to the Procuring Authority. For example, it may lead to a Project Company default under the PPP contract. It is important for the Procuring Authority to monitor these risks, particularly during construction. Termination of a construction contract during construction significantly increases the risk of a project.
The Procuring Authority should identify the risk of potential key contractor default as early as possible and monitor how the risk evolves. The risk register should provide a continuous assessment of the termination risk in terms of its likelihood, severity and potential mitigation measures. For example, the Procuring Authority can monitor the construction contractor's publicly available financial indicators.
The Project Company will typically require key contractors to provide a security package (that is, performance guarantees and/or appropriate agreed compensation, etc.) to mitigate the implications of the termination of a key contract.
The PPP contract may stipulate, in the case of termination of a key contract, that the replacement contractor will be required to be reputable and financially robust, have the requisite resources and experience to complete the works, and willing to agree to a construction contract on similar terms to the original key contract. These attributes will be important to the Procuring Authority to minimise the risk of poor performance by the key contractor.
The Project Company will seek to replace the key contractor as soon as possible to reduce the risk of a default event under the PPP contract, and to minimise any financial implications. This could lead to a choice of replacement contractor that does not meet the requirements of the Procuring Authority, and this process should therefore be managed closely by the Procuring Authority. Working with the Project Company to agree to the appointment of a new contractor will typically be in the best interests of the project and the Procuring Authority.
The ease of replacing a contractor will depend on a number of factors, including:
• The complexity of the construction or operations - for large, complex projects it will be harder to find a suitable replacement
• The market in which the key contractor is required to operate and how many equivalent contractors in that market have capacity
• The stage during which the insolvency has occurred: During the early stages of the construction phase, it may be easier to find a replacement; Conversely, during the operations phase, it may be easier to find a replacement if operations have already been running for a period of time
If the relevant contract has been signed by a joint venture of contractors, tied under joint and several liability, then the other member(s) of the joint venture will take over the obligations of the insolvent contractor. This may make the situation easier, and there is the potential for this problem to be resolved with little input from the Procuring Authority.
| EXAMPLE Construction long stop dates It is common that a failure by the construction contractor to meet a long-stop date agreed in the construction contract between the Project Company and the construction contractor will constitute a construction contractor default under the construction contract and entitle the Project Company to terminate that construction contract. The long-stop date signifies the final date that the construction contractor can complete the construction works before a default occurs. The Project Company will aim to ensure a construction contract default will not immediately trigger a Project Company default under the PPP contract and will have a corresponding longer long-stop date under the PPP contract to provide time for the Project Company to replace the original construction contractor and complete the construction works before a Project Company default occurs. Although the long-stop dates may be staggered in this way, the buffer periods may not be long enough to allow the Project Company to terminate and appoint a new contractor and complete the works before the Project Company default occurs. Instead, the buffer period provides useful breathing space for the Procuring Authority to open up dialogue with the Project Company to decide the approach to be taken that will be in the best interests of the project. Note, such discussions will require legal advice, particularly where termination rights are being waived. |
| EXAMPLE Insolvent construction contractor One of the members of the construction joint venture on a project in Europe became insolvent. The remaining members of the joint venture took over the work, which the Procuring Authority monitored carefully. |