Legal Insights

Cash is king: tendering for a construction project during a pandemic

By Sefton Warner, Ben McLeod

• 26 May 2020 • 3 min read

The coronavirus pandemic has seen a significant economic downturn, with a lengthy recession likely for the coming months. On both existing projects and future projects, protecting the projected cash flow will be a paramount concern.

To date, industry publications dealing with COVID-19 have tended to focus on a party’s entitlement to an extension of time or to suspend work (usually as a result of a force majeure event), or to terminate the contract for frustration.

But what other steps can contractors take during these unprecedented times to protect their cash flow?

How should the contractor best position itself in a market where cashflow is tight, in order to complete a project profitably (or with losses minimised?)

In the first of a series of articles on these issues, we provide our thoughts on conducting pre-contract due diligence on the client’s capacity to pay and to carefully negotiate terms relating to payment in the age of COVID-19.

Due diligence on client’s capacity to pay

Before entering into a construction contract with a principal (other than perhaps a government department with a more reliable ability to make progress payments) consider the client’s capacity to pay. This can be achieved by requesting records of the client’s financial capacity and by conducting credit checks.

In particular if the client proposes to enter into a contract using a project specific entity (as opposed to the general business entity of the client) or a trustee, consider whether:

  • the project specific entity is the owner of the land on which the works will be carried out (or if not, what arrangements are in place to ensure access);
  • the other relevant project documents (such as the planning permit or an agreement for lease, if any) are in the name of the project specific entity; and
  • whether any bank funding is being provided to the project specific entity, in which case a direct deed with the lender is likely to be required. While such a deed does not guarantee funding to the project, it sets in place incentives for the lender’s to exercise their step-in rights and ensure the project achieves completion.

If there is a range of different entities being proposed, and there is no reasonable explanation for the use of the different entities, this may be an early warning sign of a client’s capacity to pay.

Carefully negotiate contracts

When tendering for and finalising any construction contract, consider whether the current circumstances warrant special terms that will provide more payment certainty, including:

  • whether expedited payment terms are justified for particular components of the works, such as a broader category of offsite plant and equipment for which payment is to be made prior to delivery to site and incorporation into the works;
  • ensuring that there is a right to suspend and/or terminate promptly for non-payment or insolvency of the client;
  • ensuring that the client cannot assign the construction contract to a third party without consent (or proof being provided to the Contractor that the incoming party has the capacity to pay);
  • while staying within the bounds of security of payment requirements, considering the alignment of the payment terms between the client and the contractor on the one hand, and the contractor and subcontractors on the other hand; and
  • as a form of minimising exposure to subcontractors, including the power to suspend and terminate for convenience.

Keep an eye out for the next article in this series discussing some risks and opportunities for contractors to be mindful of when completing a project in the age of the coronavirus.

Maddocks has produced guides on legal issues raised by the coronavirus which may be of interest, and we encourage you to share these with colleagues who may also find them useful.

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