Developers and property owners are at risk of having unfinished homes and projects, despite honouring the “pay now, argue later” principles underpinning the Construction Contracts Act 2002 (CCA).

Under the CCA regime, contractors are entitled to prompt payment for work done, and any disputes over payment are dealt with separately from the main construction process. This means that funds cannot be withheld from the contractor unless a valid payment schedule is issued.

While this framework aims to ensure fairness and liquidity within the construction industry, it can pose challenges for developers, particularly regarding the potential insolvency of a contractor in the midst of a project.

To safeguard against exposure to the risk of contractor insolvency, developers can implement several strategies:
 

1. Thorough Pre-qualification: Developers should conduct comprehensive due diligence to assess their financial stability, track record and reputation before engaging a contractor. This can involve reviewing past projects, requesting financial statements, and obtaining references from previous clients.
   
   If you are a residential homeowner looking to engage a contractor, several bodies, such as the Registered Master Builder Association, already do pre-checks for builders affiliated with the association. These include criteria for builders to have suitable qualifications, workmanship, experience, and good financial health.
    
2. Robust Contractual Agreements:  Clear and detailed contracts are essential for mitigating payment disputes and managing expectations. Contracts should outline payment terms, milestones, and mechanisms for resolving disputes, including provisions for retention funds or performance bonds that can provide an additional layer of protection in case of a contractor default.
   
   If you are a residential homeowner looking to engage a contractor, the Building Act 2004 provides a number of standard warranties, such as that works will be completed properly and competently, in accordance with the plans and Building Consent, and that the builder will carry out the works with reasonable skill and care.
   
   However, many builders will also offer a third-party guarantee, which you can pay to include through organisations such as Master Builders or Certified Builders. These guarantees act as an insurance policy against losses in certain circumstances where no protection is under the Building Act and/or standard warranties. This is, for example, if your builder becomes insolvent and is unable to complete the build. In some cases, it can extend to structural and weather tightness warranties.
    
3. Timely Payment:  Adhering to the CCA’s prompt payment requirement can also help maintain positive cash flow and foster good relationships with the contractors. Developers should ensure that payment claims are reviewed promptly and accurately, minimising delays in processing invoices. Nowadays, there are a multitude of online tools that streamline payment claims and schedule processing to eliminate errors.
    
4. Retention Funds:  Implementing a retention fund mechanism allows developers and homeowners to withhold a portion of payment until satisfactory completion of the project. This incentivises contractors to fulfil their obligations or promptly address any defects or deficiencies.
    
5. Diversify Contractors:  Rather than relying solely on one contractor for a project, developers can consider diversifying by engaging multiple contractors for different aspects of the construction work. This approach spreads the risks of contractor insolvency and reduces dependency on any single entity.
    
6. Insurance Coverage:  Obtaining appropriate insurance coverage, such as construction risk insurance, can protect against losses resulting from contractor insolvency or project delays. Developers should review their insurance policies carefully to ensure they provide adequate coverage for potential risks.
    
7. Performance Monitoring of Contractors: Continuous evaluation of the contractor’s performance throughout the project enables developers to identify early warning signs of financial distress, red flags or deviations from the agreed-upon scope of work. This proactive approach allows for timely intervention and risk mitigation strategies, such as replacing contractors/subcontractors where required. Subcontractor insolvency can disrupt the construction timeline and lead to the additional costs of hiring replacements. Developers should look at pragmatic ways to work with their contractors during these trying times and identify the various construction project risks that might raise speed bumps in their planned construction trajectory. These include, for example, budget overruns, inadequate financing, worker shortages, low productivity and/or supplier shortages, environmental risks (flooding) and changing regulations (COVID-19).
    
8. Legal Counsel: Finally, engaging legal counsel with expertise in construction law can provide developers with valuable guidance on contractual matters, dispute resolution mechanisms, and compliance with regulatory requirements. Legal advisors can also offer strategic advice in the event of contractor insolvency or default. This is key to ensuring that developers complete successful projects within budget and scheduled time constraints.

If you would like to speak to our team, who can help you implement proactive measures to minimise exposure to payment complications under the CCA and mitigate risks associated with contractor insolvency, please get in touch with:

Jesvin Boparoy | Senior Associate | Jesvin.Boparoy@shieffangland.co.nz

Kalev Crossland | Partner |  Kalev.Crossland@shieffangland.co.nz