The effect of contractor insolvency on subcontractor warranties

Although subcontractor warranties provide principals with direct recourse to a subcontractor, some warranties can be undermined by acts or omissions of an insolvent contractor.

How can subcontractor warranties be affected by contractor insolvency?

If a head contractor becomes insolvent, direct subcontractor warranties are intended to provide a principal with remedies from the subcontractor for defects in its subcontracted works. However, a contractor’s failure to pay its subcontractor can undermine the value of such warranties.

In Asphalt Supply Company Limited v Cole John Limited, ASCL’s asphalting of a car park and driveway was defective, which cost CJL $130,129.65 to remedy. CJL sought to recover that cost from ASCL under a subcontractor warranty.

However, the intermediary contractor (Complete Limited) had gone into insolvent liquidation and had not paid $80,040 of the subcontract price to ASCL. While ASCL had no contractual basis to recover its unpaid sum from CJL, the Court held that ASCL was able to raise the same defences against CJL that it would have been able to raise against Complete Limited. ASCL was able to set-off its unpaid portion of the contract price, which reduced ASCL’s defects recovery by over 60%.

Key takeaways

• Principals should:
• keep their ears open and ensure that payments are flowing down to the subcontractors;
• consider, as part of the regular payment claim process, requiring contractors to certify that they have paid their subcontractors; and
• consider having clauses that let the principal pay undisputed amounts to subcontractors directly during the project if the contractor is unable to do so. Subcontractors are understandably less inclined to finish projects and honour warranties if they have not been paid for their work.
• When preparing subcontractor warranties, you should consider and record the extent to which the principal’s rights are intended to be independent of any issues between a contractor and a subcontractor.

Want to know more?

If you have any questions about subcontractor warranties and managing contractor insolvency risks, please contact Lauren Whitehead, Anton Trixl or Steve O’Dea from our specialist Construction Team.

Other articles in the construction essentials series

• The risks of attaching too many documents to a construction contract

Large construction contracts are a common source of complaint from principals and contractors alike, and with good reason: unintended risk allocations may lurk in that pile of paper.

• Payment schedules: why they need to be Spotless

Technical requirements for payment schedules can be a trap for the unwary, and errors by the paying party can cause it to have no choice but to pay even if it has a genuine reason to dispute the amount. 

• Letters of intent: the risks of contracting without a contract

Letters of intent (LOIs) are commonly used to get construction projects underway while the formal contracts are being negotiated. However, starting works without an actual contract can lead to complications.

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