Contractor and employer insolvency raises a number of specific practical and contractual challenges which parties to a building contract should be mindful of.

When either an employer or contractor becomes insolvent, the immediate priority is understanding what the building contract allows each party to do. Payment, ownership of materials, retentions, bonds and the appointment of a replacement contractor can all become important, and acting quickly can make a significant difference to the options available.

Employers and contractors alike should consider the following when such a situation arises.

Payment

When insolvency occurs, parties should immediately consider the payment terms under the building contract.

If the employer becomes insolvent during the construction period, a contractor may seek to submit an interim payment application for all work and materials supplied to date, following the requirements of the building contract. An application for interim payment should be lodged with the insolvency practitioner as soon as they are appointed to give the contractor the best opportunity to recover any sums due.

In the event of the contractor becoming insolvent, it is common for the payment regime to change. For example, the SBCC standard form contains separate insolvency and termination provisions which suspend the Employer’s obligation to make further payment altogether from the point of insolvency. Similarly, under the NEC4 ECC contract, the Client (employer) can forecast the additional cost to the Client of completion of the whole of the works and deduct this figure from the amount due to the Contractor on termination for Contractor insolvency.

In either case, it is paramount that any industry standard form building contract payment clauses are read in conjunction with any bespoke amendments that may have amended the industry form standard mechanisms.

Sub-contractors can also be affected by insolvency. Pay-when-paid clauses in sub-contracts – which are clauses that allow the contractor to delay paying sub-contractors and suppliers until the contractor has received funds from the employer - are generally unenforceable by virtue of the Housing Grants, Construction and Regeneration Act 1996 as amended.

However, there is an exception if the employer becomes insolvent. If the sub-contract expressly contains a ‘pay when paid’ clause which is compliant with section 113(1) of the 1996 Act the contractor can withhold payment to the sub-contractor where the employer is insolvent and has not paid. This protects a contractor from having to pay sub-contractors from their own funds when there is no opportunity to recover from the insolvent employer.

Ownership of Materials

Another important consideration is ownership of the materials, plant or equipment being used for the works. Following insolvency, it may be prudent to take an inventory of materials, plant and equipment on the site, and prevent their removal until ownership is established.

Ordinarily, in Scotland, the transfer of ownership of unfixed materials to the employer requires taking delivery of the materials and payment for them, although it is important to check the terms of the building contract and other agreements between the parties to establish if this is the position.

On employer insolvency, a contractor may wish to assert their right over any unpaid materials to avoid them being treated as part of the employer’s assets by an insolvency practitioner. Conversely, following contractor insolvency, the employer will want to ensure that the contractor does not remove from the site materials, plant or equipment to which the employer has title.

The position can become more complicated for materials stored off-site.Under Scots law, if the employer has entered into a separate contract for purchase with the contractor, then title in such off-site materials may have passed to the employer regardless of the fact that delivery is yet to occur. In such scenarios, the employer would be able to seek delivery of such items for use in completion of the works.

If a separate contract for purchase has not been entered into, then title to such off-site materials may still sit with the contractor, regardless of whether payment was made by the employer. Establishing the contractual arrangements and ownership position quickly can therefore be particularly important where valuable materials are stored away from the project site.

Retentions

It is common practice for building contracts to contain a retention mechanism allowing the employer to deduct and retain a set percentage of payment otherwise due to the contractor.

Where the contractor becomes insolvent before completion of the works or before making good defects, and provided the contract mechanisms have been correctly followed, the employer is unlikely to release the retention monies to the contractor or insolvency practitioner.

The retained retention funds potentially could be used by the employer to cover additional costs incurred as a result of the contractor’s insolvency, before accounting to the insolvency practitioner for any remaining balance.

The position on retentions is set to change. Under the Commercial Payments Bill draft, the Government has proposed a phased regime that will ban retention clauses in building contracts. If enacted, there will be a two-year transition period, which will see the phasing out of any existing agreed retention clauses, and on completion of this transition period retention clauses will be void.

In practical terms for an employer, this means that retention mechanisms in building contracts will need to be reviewed and ultimately phased out, with employers needing to plan ahead for risk currently managed through retention.

Bonds and guarantees

If there are any bond or guarantees granted pursuant to the building contract that protect the employer in the event of a contractor’s insolvency, the employer may wish to make a claim under the bond or guarantee. It is important to ensure that the specific provisions of the bond or guarantee are complied with.

In the recent case of Renaissance Club at Archerfield LLP v BVB Sureties Ltd [2026] CSOH 67, the surety tried to resist payment under the bond on the basis that the beneficiary’s demand letter did not specify every alleged breach and therefore was not a valid demand.

While in this case the court ultimately held that the failure was not material enough to invalidate the demand, the case highlights the importance of checking the precise requirements of any bond and carefully drafting a compliant demand letter to avoid disputes about the validity of the demand.

Appointing a Replacement Contractor

In the event of contractor insolvency, the employer may wish to continue with the development by appointing a replacement contractor. Following termination of the contractor’s employment for insolvency, many standard form building contracts expressly entitle the employer to engage a replacement contractor to complete the outstanding works.

In practice, procuring a replacement contractor takes time. It can require a new tender or negotiation process and a new programme, likely adding both cost and delay to the project.

The cost of completing the works following insolvency are typically higher than the costs agreed with the original contractor, since a replacement contractor, if prepared to take on liability for the partially completed works of the insolvent contractor, will factor in this risk into its prices as well as general increased costs such as fuel and materials.

The employer may wish to keep key sub-contractors on board and so should consider any available step-in rights in collateral warranties it has.

Conclusion

The risk of insolvency remains an existential one in the Scottish construction sector. Parties should understand their contractual position in the event of insolvency and ensure the building contract terms are followed correctly. Particular care should be taken over termination, payment and retention provisions, as well as arrangements for materials, plant and equipment. Other agreements, such as bonds or guarantees, should also be considered as they may provide some monetary recompense in the event of insolvency.