When a contractor becomes insolvent, it introduces a complex set of risks not only for the contractor’s directors and officers but also for other parties involved in the project, such as employers (clients) and subcontractors. Both directors’ and officers’ (D&O) and professional indemnity (PI) insurance risks are relevant and can lead to serious issues for employers and subcontractors.

D&O insurance risks

D&O insurance protects the personal assets of company directors and officers from claims against them for actions taken in their roles. In the event of contractor insolvency, several significant risks can arise for the stakeholders.

1. Wrongful trading and insolvency mismanagement

• Directors can be accused of allowing the contractor to continue trading while insolvent. This can lead to personal liability for company debts if they are found to have worsened the financial situation by failing to stop trading at the appropriate time
• Allegations of improper handling of finances, such as misallocating funds or failing to set aside enough capital for ongoing projects, can result in lawsuits from creditors, including subcontractors or suppliers, who suffer financial losses
• There may be accusations that the directors knowingly engaged in fraudulent trading, such as intentionally taking on more debt when the company was insolvent

2. Claims from employers (clients)

• If the employer believes the contractor’s board of directors mismanaged the company or took on projects knowing they could not complete them, they may sue the directors for breach of fiduciary duty
• Employers may claim that directors failed to manage risks adequately, leading to the contractor's inability to complete the project, resulting in project delays, additional costs, or the need to engage other contractors

3. Creditor actions

• Creditors, including subcontractors and suppliers, may file claims against directors for personal liability if they believe that they were misled about the contractor’s financial stability or solvency
• During insolvency proceedings, liquidators may investigate directors’ conduct and pursue legal actions for mismanagement or negligence, especially if the company continued trading while insolvent

4. Investigations by the regulators

• The insolvency service may investigate the conduct of directors and bring proceedings against them if it finds evidence of unfit conduct

Whilst the director and officer may not have committed any wrongdoing, they could incur sizeable costs in defending themselves in court against frivolous claims. It's therefore imperative to have a suitable D&O insurance programme in place. 

PI insurance risks

PI insurance protects contractors against claims arising from professional negligence or failure to perform professional duties. Contractor insolvencies heighten these risks in several ways. 

Negligence claims by employers

• If the contractor becomes insolvent before completing a project, the employer may file claims for professional negligence, arguing that poor project management, design flaws, or faulty construction led to financial losses
• The insolvency may cause project delays or non-completion, which can result in claims from the employer for damages, including additional costs for hiring new contractors
• Employers can claim that the contractor’s insolvency constitutes a breach of contract, particularly if the insolvency disrupts the agreed-upon project timeline or quality standards

Claims by subcontractors

• Subcontractors are often some of the hardest hit by contractor insolvencies. If the contractor cannot pay for work already performed, subcontractors may file claims against the contractor’s PI policy, particularly if they believe the insolvency was due to professional negligence or mismanagement
• Subcontractors may also experience work disruption, which could lead to claims for damages if they are forced to stop or abandon work due to the contractor’s insolvency

It is key to point out that in the event of a contractor’s insolvency, there is a high likelihood that any PI insurance policy they hold will likely be left to lapse, with no run-off cover purchased. This means that due to the claims made nature of PI insurance, a policy may not be in place to cover any claims made against them. It is therefore key you take note of the expiry date of any policy to ensure that claims are made and accepted before the insurance lapses.

Mitigating risks

To mitigate D&O and PI risks associated with contractor insolvencies, as well as the potential fallout for employers and subcontractors, stakeholders should consider the following:

• directors should ensure proper financial management, obtain legal advice at early signs of distress and communicate openly with all parties involved with the project
• employers should secure performance bonds, use collateral warranties and perform due diligence on contractors’ financial health
• subcontractors should negotiate favourable payment terms, seek upfront payments or payment bonds and ensure contracts have strong legal protections in the event of insolvency.

Miller is here to help

We understand the significant risks that employers and subcontractors experience when faced with contractor insolvency. Our experts know the importance of taking proactive steps to manage said risks and help your project get back on track. Get in touch with us today and find out more about how Miller can help you.