Insolvency in the construction industry is not just isolated to contractors, sub-contractors and consultants. Industry and economic pressures can affect all parties, including at times employers, therefore it is equally important for contractors to carry out due diligence when bidding for projects and to consider contractual mechanisms that can be put in place to protect against non-payment by the employer and insolvency risks.
Contractors should be especially alive to such concerns where projects are of a complex nature and significant value, requiring substantial upfront cost and resourcing, and where the employer entity is a SPV with little to no (obvious) financial standing.
Due to increased insolvency in the industry, contractors are becoming equally risk averse and more frequently asking employers to enter into escrow agreements. An escrow agreement governs the operation and management of an escrow account (sometimes referred to as a 'holding account'), where an agreed sum is deposited upfront by the employer. The escrow account is then managed by a nominated escrow agent, usually a solicitor.
Escrow accounts are most commonly used to release monies from a ring-fenced account only in the event of employer default on payment under a contract. They can, however, be used to pay all sums which are due to a contractor under a contract.
Although this provides the contractor with a sense of payment security by ring-fencing amounts due, consideration must be given to the cashflow implications for the employer, which may not be practical. If a project is funded, consideration should be given as to whether funder approval is required and whether there is drawdown on funding in stages relative to the progress of the project.
It may not always be possible to secure the full amount due under a contract at the outset.
As escrow agreements are tripartite agreements between the employer, contractor and escrow agent, it is important that they are carefully drafted in order to protect the interests of each individual party. The absence of standard form escrow agreements has meant they are more often than not bespoke in form and drafted by experienced solicitors.
The construction law committee of The City of London Law Society (CLLS) has, however, attempted to bridge the gap by publishing a form of escrow agreement based on variety of examples used within the industry.
It is drafted on the basis that sums are paid from the escrow account on employer default and it assumes that the underlying contract is JCT Design & Build 2016. It can, however, be easily tailored to suit other standard or bespoke contract forms.
CLLS hopes that this form of escrow agreement will become an accepted and widely used industry form, however, as with any standard form document, always approach with caution. The form will not necessarily be suited to all projects, and amendments will likely be required to deal with project specific issues.