Baker & McKenzie Hotels, Resorts & Tourism Newsletter: Upgrades in a Downturn - By Tina Wyhoon and Alex Hartmann, Baker & McKenzie

This alert sets out a number of simple tips to minimise the potential impact of builder insolvency on hotel refurbishment projects.

Avoiding builder insolvency at the outset

Whilst there is no guaranteed strategy to avoid contractor insolvency on a refurbishment project, there are a number of strategies which can minimise this risk.

As a practical measure, a hotel owner should perform financial due diligence on its builder to gauge the builder's current financial status. Examples of basic information gathering are reviewing the builder's annual reports, undertaking searches of relevant public records to identify company registration status, checking for adverse records on any relevant builder's licence and using commercial and litigation information provided by entities such as Dun & Bradstreet.

Another strategy to minimise the risk of being materially affected by a builder's insolvency is to allocate risks under the construction contract appropriately. Whilst there will be some variation depending on the relevant jurisdiction and marketplace, hotel owners should seek to include clauses such as the following.

• Immediate termination. Providing that builder insolvency is an event of default allowing immediate contract termination by the hotel owner or allowing the work to be taken out of the hands of the builder on the builder's insolvency. The discretion to terminate or take the work out of the builder's hands lies solely with the hotel owner.

• Certification and statements. A clause requiring the builder to provide the hotel owner with a certificate or statutory declaration statement (depending on jurisdiction), declaring that it has paid all outstanding amounts to subcontractors and employees as a pre-condition to payment under the construction contract.

• Unconditional performance security. Allowing the hotel owner to call on the builder's security immediately on the insolvency of the builder, for use against any loss or damage that the hotel owner has or will suffer on the builder's insolvency.

• Parent company guarantees. The builder should provide a parent company guarantee if it is a subsidiary of another company.

• Suspending payment. Allowing the hotel owner to suspend any payment due to the builder if the hotel owner elects to take the work out of the hands of the builder on its insolvency. The hotel owner can retain the unpaid amount until the hotel owner's costs to complete are certified or assessed so that such funds remain available for set off.

• Set off clause. Allowing the hotel owner to set off its loss and damage caused by the builder's insolvency from any amounts owing to the builder and, if those amounts are insufficient, allowing set off against any security being held by the hotel owner provided by the builder.

• Assignment and novation of subcontracts. Providing for the assignment or novation of subcontracts and supply agreements from the builder to the hotel owner or its nominee on the builder's insolvency. Re-starting a stalled project following the builder's insolvency will be far quicker and cheaper if existing subcontracts and supply agreements are assigned or novated to the hotel owner, which must otherwise engage new parties likely to charge a premium in order to assume the risks of the previous builder to complete the project.

• Direct payment of subcontractors. Allowing the hotel owner to pay subcontractors and suppliers directly if they remain unpaid by the builder (both before and after termination of the relevant construction contract). These amounts then become debts due from the builder to the hotel owner which can be set off against either amounts owing to the builder or the builder's security.

• Removal and sale of builder's equipment. Entitling the hotel owner to remove or sell the property of the builder which is on site to make good any money owing from the builder to the hotel owner, including making good any loss or damage suffered by the hotel owner as a result of the builder's insolvency.

• Payment held on trust for subcontractors. A clause which requires the builder to hold certain portions of the contract sum on trust for the benefit of subcontractors or suppliers who have performed works or supplied materials. This measure may protect such funds from the administrator or liquidator and make it easier for subcontractors and suppliers to be paid the funds owed by the builder on the builder's insolvency.

• Licences and permits assignable to hotel owner. Requiring all documentation, licences and permits needed for the works to be in the name of, or assignable to, the hotel owner. This measure would make it easier for the hotel owner to complete the project itself without the need to liaise with the builder's administrator or liquidator to use such documentation, licences and permits.

• Builder's and consultant's IP to vest in hotel owner. Requiring all intellectual property created or provided by the builder for the project to vest in the hotel owner. This measure allows the hotel owner to complete the project in accordance with design documentation on the builder's insolvency without first having to pay outstanding design fees as a pre-condition for use of the design documents.

• Progress reports. Requiring periodic progress reports in an agreed format from the builder on construction progress. This would allow the hotel owner to review project status, costs to complete against budget and hopefully the builder's financial position. The hotel owner may consider having payments assessed and certified by a quantity surveyor or project manager.

Tips to follow upon a builder's insolvency

If the builder does become insolvent, we suggest hotel owners adopt the following strategies:

• Identify the status and conditions of the builder's bank guarantees or other security, including parent company guarantees. Check the existence of any sunset dates or notification pre-requisites affecting enforcement of the security.

• Identify completion status and whether practical completion has been reached. This will affect the best strategy to use. In the absence of the builder on the site, the hotel owner should ensure that the site is safe and secure.

• Defects and Cost to Complete estimate. Prepare a defects list, a cost to complete estimate and review the defect rectification process in the contract (the hotel owner may need to engage an independent technical expert to do this). Is the builder unable or unwilling to rectify defects? Has the builder been given the required notices under the construction contract in respect of the rectification of these defects?

• Subcontract position. Identify each of the builder's subcontractors and suppliers, their relevant scope of work and completion status, warranty obligations, whether their relevant subcontracts can be novated to the hotel owner (or its nominated replacement contractor) and current payment status. Are there direct warranties from subcontractors and suppliers which the hotel owner can enforce?

• Obtain any outstanding statements or declarations from the builder which are required under legislation. For example, the builder may be required to provide a statement of compliance regarding payroll tax, workers compensation and industrial relations legislation. If such statement is not provided, the hotel owner may become jointly and severally liable for certain payments for the relevant period during which those statements are missing.

• Insurance. Locate all insurances and ensure that they are current and paid, as these may be an alternative means of having defects rectified where the builder is insolvent.

• Beware of builder's Security of Payment claims. Act quickly (and within the time periods specified in the relevant security of payment legislation) to deal with security of payment claims once received, as the builder may be trying a final attempt to maximise its cash flow.

• Finally, prepare a strategy on how to deal with the insolvency of the builder, having regard to the hotel owner's rights and obligations under the contract (including in relation to subcontractors), the status of the works including reviewing the contract powers in relation to termination or taking works out of the builder's hands and ensure that the hotel owner complies strictly with this procedure.

We have provided some examples of legal and practical steps that can be taken to help reduce risk for hotel owners. For additional guidance, please contact yyyGraeme Dickson, the Global Head of our Hotels, Resorts & Tourism practice, who can also put you in touch with appropriately skilled lawyers in your jurisdiction.

This alert was written by Tina Wyhoon, Senior Associate, and Alex Hartmann, Partner, in Baker & McKenzie's Sydney office.


About Baker & McKenzie

Founded in 1949, Baker & McKenzie provides sophisticated advice and legal services to many of the world's most dynamic and successful organizations through more than 3,900 locally qualified lawyers and more than 5,800 professional staff in 67 offices and 39 countries. Baker & McKenzie is known for having a deep understanding of the language and culture of business, an uncompromising commitment to excellence, and world-class fluency in the way we think, work and behave. (www.bakernet.com)

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