This is part 5 of a series of articles comparing the main contract standard conditions of the SIA form published in 2016 and the PSSCOC published in 2020. In an earlier article entitled ‘Construction Insolvency Examined From Commercial Perspective’ that was published immediately before this article, there were several key observations that are pertinent to the issue of contractor’s insolvency. These observations include amongst others, the difficulties in defining insolvency, the challenges in relying on financial statements to assess solvency of any contracting firm etc. What is also clear from the previous article is that to effectively navigate the subject of construction insolvency, it requires application of a blend of different domains of knowledge such as construction law, insolvency law, accounting principles, asset valuation etc. 

This article examines a related issue but from procedural perspective, namely how both the SIA form and the PSSCOC deal with termination of the contractor’s employment arising from its insolvency. Whilst the earlier article focuses on the difficulty of identifying insolvency in a timely manner, this article deals with the effects of termination. Admittedly, the subject of termination procedures rarely drives the decision on which contract form to be used for any given project. However a cross comparison facilitates a qualitative assessment of various standard conditions. Even if one primarily uses the PSSCOC, an understanding of any provisions unique to SIA form triggers an intellectual enquiry of the best practices of post termination procedural measures. This is especially useful since there are various follow up actions expected on the part of the Employer and its consultant once its contractor is found insolvent. However these provisions are rarely invoked as compared to other more common provisions such as extensions of time, variations etc resulting in the lack of critical skills required to navigate the relevant procedures.

Notice of Termination vs Certificate of Termination

Understanding the difference between notice of termination and certificate of termination (also known as ‘termination certificate’) is important in navigating construction insolvency. In this regard, both the SIA form and the PSSCOC has a fairly similar approach. Certificate of termination is issued as part of the certification regime administered by an independent certifier namely the Architect under the SIA form and the Superintending Officer (SO) under the PSSCOC. On the other hand, notice of termination is issued by the Employer to terminate the contractor’s employment under the contract. Given this distinction, they should not be confused with one another and cannot be used interchangeably. 

It should be noted that where the contractor becomes insolvent in a manner defined under the contract, the Employer is required to issue a notice of termination. This is expressly provided for under Clause 32(7)(a) of the SIA form and Clause 31.1(2)(a) of the PSSCOC. Upon issuance of such notice, the contractor’s employment will be terminated immediately. What is also clear from this procedure is that the Architect or the SO is not expected to issue any certificate, which by implication means they are not expected to make an independent determination as to the solvency of the contractor. In reality, the Architect or the SO wears two hats where on one hand they are expected to be an independent certifier but on the other hand, they act as an agent to the Employer. This dual function appears to give rise to conflict of interest, therefore the Architect and SO ought to be aware of this distinction and should discharge their functions appropriately depending on circumstances. In this regard, the Architect and SO are likely to be involved, as an agent in all efforts leading to the issuance of notice of termination by the Employer.

However, in other grounds for termination by default such as acts of non compliance or breach by the contractor, the independent certifier is typically required to first issue a certificate of termination before the Employer issues its notice of termination. In these non insolvency related grounds for termination, the independent certifier is thus expected to make a fair and impartial determination on whether the contractor is in breach or non compliance that would justify termination by default. The Employer will then rely on such determination by way of certificate of termination to follow up with its own notice of termination. As an example, Clause 31.1(c) of the PSSCOC and Clause 32(3)(d)(i) of the SIA form provide for ground of termination by default if the contractor fails to proceed with the construction works with diligence and due expedition. If the independent certifier is of the opinion that such default occurs, a certificate of termination will be issued and the Employer may duly rely on the judgment of the certifier to issue a notice of termination. Therefore, such termination can be characterised as a two-step process. The insolvency related termination by contrast is a one-step process.

The likely explanation on why insolvency related termination is treated differently from other termination by default is perhaps the nature of insolvency. Insolvency is viewed traditionally as a financing or business accounting matter and is not typically within the scope of expertise of a construction practitioner. Whilst the effects of insolvency such as departure of key personnel, slow in progress of works, non payment to subcontractors etc are self evident, most insolvency termination provision are more pre-emptive. This could possibly explain why insolvency related terminations are carved out from other types of termination by default. 

SIA vs PSSCOC – Immediate Priorities Post Contractor’s Insolvency

Once the contractor’s employment under the contract is terminated upon the issuance of notice of termination, there are several key decisions and priority measures expected from the Employer and its team. Interestingly, the SIA form differs from the PSSCOC as regards some of such follow up courses of actions. Under Clause 32(8)(a) of the SIA form, the Employer shall have the option to either complete the remaining works or abandon the project entirely. There is no equivalent provision under the PSSCOC that expressly provide the Employer with such optionality. By contrast, under Clause 31.2(1) of the PSSCOC, the Employer is allowed to use any equipment, plant, structure, tools, unfixed materials etc left by the insolvent contractor for the completion of the construction works. Further, Clause 31.2(3) of the PSSCOC states that the Employer shall not be liable to pay any sum to the insolvent contractor until the expiry of defects liability period. These provisions collectively suggest that the Employer is expected to complete the project by default. 

Unlike the publicly funded project under the PSSCOC, the SIA form is primarily used by the private sector projects which are more vulnerable to market forces. Where the real estate market is suffering from a downturn coupled with project with very narrow profit margin, it is possible that an increase in cost may exceed its modest profit margin rendering the project commercially infeasible to be completed. It is almost certain that the cost of completing the very same project will be higher with the insolvency of the original contractor due to a few reasons. Firstly, there will inevitably be additional time required to procure a replacement contractor. This additional time frame would translate into higher financing cost due to interest charges accrued over an extended period of time. Secondly, the replacement contractor is likely to “inherit” the partially completed construction works and be responsible for any latent defects. This additional risk will increase the construction cost. This could explain the reason for contractually providing the option for the Employer to abandon the project.

On the other hand, there may be instances where the Employer may seek to continue the project in which case there are several consequential contractual provisions under both the SIA and PSSCOC to facilitate this course of action. Should the Employer decides to proceed with the project, its subsequent priority should be to determine whether it prefers to maintain the original team of subcontractors and suppliers or to leave that decision to the replacement main contractor. There is perhaps a stronger argument to maintain the original crew given their familiarity with the project scope of works including any building materials with long lead time for manufacturing and delivery. Maintaining the same crew could save time thereby mitigating any cost overrun. There are also alternative argument for allowing the replacement main contractor to decide whether to engage its own team of subcontractors. If the replacement main contractor is under pressure to complete the project with a compressed duration and also inheriting partially completed construction works, having its own team of subcontractors may alleviate some of the areas of concerns.

Assuming the decision is to maintain the original crew left behind by the insolvent contractor, there are provisions under both the SIA form and the PSSCOC that allow direct payment by the Employer. Under Clause 32(8)(d) of the SIA form, the Employer may directly pay any nominated subcontractor or suppliers as well as domestic subcontractors namely those privately engaged by the insolvent main contractor. This is provided that such payment does not violate any insolvency laws. The amount of such direct payment will then be used to offset against any amount that may be due and payable to the insolvent contractor. Whilst the PSSCOC include a similar provision for direct payment, there is a slight distinction in its application. Under Option Module C of the PSSCOC which deals with the subject of nominated subcontractor, Clause C5.0 therein allows direct payment by the Employer to the nominated subcontractor and thereafter offset such amount from payment due to the main contractor. It should be noted that this direct payment provision does not specifically refer to the context of termination arising from insolvency. Instead it refers to certification of interim progress payment where there are reasons to believe that the main contractor fail to pay its nominated subcontractor despite payment being certified under the main contract for the scope of subcontract works in issue. Arguably the Employer may still utilise this provision in the case of insolvency because where the main contractor fails to pay its subcontractor in a timely manner, it may be an indication of insolvency. It should also be noted that the PSSCOC in this regard confines any direct payment by the Employer only to the nominated subcontractor, to the exclusion of domestic subcontractor. In reality, if payment is confined to only nominated subcontractor, its effectiveness in mitigating delay and disruption in case of main contractor insolvency is muted significantly. The Employer should also be aware of scope of works that are self performed by the insolvent main contractor, without any element of outsourcing. The absence of any party keeping such works in progress could in effect disrupt the progress of works until such time the replacement main contractor is on board. 

Liquidated Damages After Termination

Does the insolvent contractor continue to be liable for liquidated damages even after its employment is terminated under the contract? The short answer is yes, and the insolvent contractor is deemed to be responsible for general delays that occur even after it is no longer responsible for carrying out the subsequent works post termination. Under Clause 32(8)(i) of the SIA form and Clause 31.3 of the PSSCOC, there are provisions for the Employer to recover liquidated damages after termination. The original rate of liquidated damages agreed by the insolvent contractor continue to apply. This explains why only the employment of the insolvent contractor that is terminated as opposed to the contract being terminated. This ensures that the conditions to be relied upon by the Employer for the purposes of liquidated damages survive the termination of employment. 

Once the contractor is insolvent, it is fair to assume that it is no longer capable of paying any financial compensation to the Employer. So is the exercise to compute the recovery of liquidated damages purely academic? There are actually some practical reasons for such computation despite the limited prospect of actual recovery. Firstly, such amount of liquidated damages can be used to offset against any sum that the Employer may be payable to the insolvent contractor for works done until the point of termination. Secondly, assuming a liquidator is appointed by the court to deal with the winding up process of the contractor in issue, such computation provides documentation clarity of the total scope of liability of either party. If there are any outstanding sum that the Employer is liable for, the liquidator has a duty of pursuing such sum according to its terms of reference. Whilst the rationale behind such computation is rather compelling, in reality the process can be arbitrary and somewhat theoretical. This is because the insolvent contractor is no longer involved in the project and therefore not able to make its case or claim as to why it should not be responsible post termination delaying event. Therefore, the independent certifier to a large extent is making its determination based on a fairly one sided narrative with limited check and balance. 

As alluded to earlier, both the SIA form and PSSCOC have its own provision to deal with liquidated damages post termination. There are certain differences between their procedural approaches although their general framework is largely similar. Under both contract forms, although the insolvent contractor remains liable for post termination delays, the certifier shall reduce the period of culpable delay to the extent that there are any failure by the Employer or its replacement contractor that would have entitled the insolvent contractor to extensions of time.

Under Clause 32(8)(i) of the SIA form, the Architect shall issue a Termination Delay Certificate upon completion of the project. Such certificate shall include the date upon which the contractor should have completed the project, the consequential full period of delay and total damages due to the Employer. This certificate is given on the same principles as a Delay Certificate under Clause 24 which is a unique feature of the SIA form. The Delay Certificate in general signifies that the contractor is in culpable delay which in turn triggers the Employer’s entitlement to liquidated damages upon its receipt of such certificate. Whilst it is stated that both Delay Certificate and Termination Delay Certificate shall be issued on the same principles, there is a fundamental difference between these certificates. The latter is issued only when the works are practically completed whereas the former is issued when the project is in delay, usually prior to the practical completion of the works.

On the other hand, the PSSCOC does not have an equivalent provision for delay certificate. Therefore, it follows that the Employer’s entitlement to liquidated damages under PSSCOC is not contingent upon the receipt of such delay certificate. By contrast, the SO is only required to issue a certificate of practical completion upon completion of the project pursuant to Clause 31.3(b). Such certificate shall state the full period of delay that the insolvent contractor is responsible for, the date of actual completion as well as the total damages due to the Employer. The other significance of the completion certificate in this regard is that the amount of damages certified shall be immediately recoverable by the Employer pursuant to Clause 31.3(c). Therefore by implication it suggest that in the absence of such completion certificate, say in the case where the Employer decide to abandon the project at the point of insolvency of its contractor, the liquidated damages are likely to cease to apply post termination. It follows that for the Employer to recover any liquidated damages from its insolvent contractor, it would be required to complete the project so as to crystallise the actual date of completion.

Calculating Costs of Termination

Calculating costs of termination is one important aspect of navigating the relevant termination procedures. After all one of the important objectives of termination procedures is to determine an amount that represents a fair and equitable financial closure post insolvency. The general principle of calculating the costs of termination is to identify any incremental cost (or even decrease thereof) that arises as a result of the contractor’s insolvency. 

The following is a simple mathematical illustration of such calculation. Let’s assume a project with an original contract sum of $1million to be constructed over a period of 12 months. The contractor becomes insolvent by the end of the 6th month, i.e. mid way of the construction duration. If the same project ultimately took 16 months to be completed at a final cost of $1.5million, the additional $0.5million is the incremental cost that would not have been incurred if not for the insolvency. Therefore the $0.5million is the first part of the termination costs which represents the engagement of replacement contractor. The other part of the termination cost is the liquidated damages due to the additional period of 4 months i.e. the schedule overrun. Assuming the liquidated damages for the period of schedule overrun amounts to $0.1million, the total cost of termination is $0.6million (taking into consideration the earlier $0.5million derived). Whether there is any amount due and payable by the Employer to the insolvent contractor or vice versa is dependent on the value of work done by the insolvent contractor prior to termination and the amount that had already been paid by the Employer against such value. Assuming the contractor had completed $0.5million worth of construction works but had only been paid $0.3million, there is an outstanding sum of $0.2million that the contractor should be entitled to. Therefore the net amount due and payable to the Employer is the difference between $0.2million and $0.6million, i.e. $0.4million. 

Under the SIA form, in particular Clause 32(8)(f), the Architect and Quantity Surveyor shall jointly issue a ‘Cost of Termination Certificate’ which takes into consideration (1) all possible cost components that makes up the $0.5million which represents the incremental cost and (2) any outstanding amount that the contractor is entitled to i.e. the $0.2million based on the example above. It should be noted that this Cost of Termination Certificate excludes the $0.1million of liquidated damages amount derived based on the schedule overrun as this is provided for under a separate clause namely Clause 32(8)(i). Since there is an outstanding sum of $0.4million that the Employer is entitled to based on the example above, there are several options available to the Employer to facilitate its recovery. Under Clause 38(2)(e) of the SIA form, the Employer could sell the equipment, plant and machineries left on site by the insolvent contractor for the balance amount that is due. Further, the Employer could, amongst others utilise the unconditional bond  or security deposit, if any that is usually prescribed at 5% of the original contract sum to make good the outstanding balance. 

The PSSCOC has a relatively simplified cost of termination provision which is set out under Clause 31.2(3). There is no specific certificate prescribed and there is also no requirement for joint certification with the consultant quantity surveyor. The SO is required to ascertain the ‘Employer’s Cost’ upon the expiry of the defects liability period which represents the incremental cost incurred as well as liquidated damages for the period of schedule overrun. In other words, the SO will be calculating such cost based on actual cost incurred which is unlike Clause 32(8)(f)(vii)(a) of the SIA form, where there is option for such cost to be estimated in advance once the insolvent contractor’s employment is terminated. The Employer under the PSSCOC can also utilise the security deposit and sale of insolvent contractor’s plant, equipment and machinery to make good any sum that it is entitled to arising from such termination.

Conclusion

The insolvency related termination procedures described above can be protracted, financially painful and complex despite elaborate mechanism stipulated. One would imagine that due to such unpleasant ramifications, this would encourage any Employer to be vigilant and cautious in scrutinising the financial wherewithal of tenderers during procurement stage. Unfortunately, most contract forms have more elaborate mechanism to deal with insolvency related termination than avoidance of insolvency to begin with.




Koon Tak Hong Consulting Private Limited