What does insolvency mean?

The building sector is under pressure and some firms are starting to crack. Duncan Cotterill Partner Alysha Hinton discusses what it means if a firm you work for goes under

According to figures from the Ministry of Business, Innovation and Employment, during the 12-month period ending 23 May 2022, 92 companies in the building sector went into liquidation.

It is no secret that building companies are under immense pressure because of Covid-19, which has created supply chain issues, shortages in labour and materials, and high costs. All of these factors are increasing the financial risks that building companies are taking on and exacerbating the pressures at all stages of the construction supply chain. This raises some important questions, particularly around what it means for sub-contractors or workers if their head contractor goes insolvent. 

What does insolvency mean? 

If a company is ‘insolvent’ this means one of two things:

1. Their debts cannot be paid when they are due. 
2. Or their total debt is more than the value of all their assets.

Liquidation vs receivership

Though the outcome is often the same, there are a few important differences between a company going into liquidation or receivership.

Receivership

A receiver is nominated by a secured creditor (eg, a bank) and acts for the benefit of that creditor alone. A receiver decides the best way to recover the debt – they may decide to keep the company trading or simply take possession and sell the secured assets. After this process, the company resumes possession of the remaining assets and theoretically could continue trading, but will most commonly go into liquidation. 

Liquidation

If a company is unable to pay its debts, meaning the company owes more than it has available, it may be put into liquidation. A company can be put into liquidation by its shareholders, its board of directors or a creditor(s). A liquidator is then appointed to take possession of all the assets of the company and distribute these to the creditors in order of priority. All creditors may record their debt against the company during a meeting of the creditors. Liquidators have the power to investigate the company and hold the directors personally accountable if they have breached their duties. 

Secured vs unsecured creditor

There are two kinds of creditors: secured and unsecured.

1. Secured creditors have the right to repossess and sell a debtor’s assets that they have a security interest over if the debtor falls behind in payments. They are in a stronger position when a company faces financial difficulties.
2. Unsecured creditors do not have the right to repossess or sell any of the debtor’s assets if they default on payments. They are reliant on recovering their money through the liquidation process.

What are the next steps if a company becomes insolvent?

If a contractor/sub-contractor/supplier becomes insolvent and a receiver or liquidator is appointed, then the next
steps are: 

• Secure the site/assets – once a liquidator or receiver is appointed, the control of the site passes to them. An assessment of the assets will then take place. 
• To have your claim recognised, act fast. File a claim with the liquidator for any money you are owed as soon you are notified of the insolvency.
• Review your contract(s) – are there insolvency mitigation clauses in there (step-in rights, etc.), has the contract automatically been terminated?
• Establish if direct contracting between the solvent parties is still possible. 

The effect on sub-contractors 

If a head contractor goes under, moneys owed to sub-contractors becomes general unsecured debt. Unfortunately, once secured creditors are paid, there are often insufficient funds to repay the unsecured creditors everything they are owed.

An additional risk to sub-contractors is site access. If your property is on-site, it may be some time before it is identified, distinguished from the head contractor’s or other third party’s property, and returned to you. You might even lose title to your property and it could be sold as an asset of the head contractor unless your interest has already been registered on the Personal Property Securities Register (PPSR).  

If you find yourself locked out of a site because a head contractor has gone under, contact the liquidator or receiver directly. Do not force entry onto the site – accessing the site without the approval of a liquidator or receiver could result in a trespass notice being issued and police involvement. 

What about retention money?

The Construction Contracts Act 2002 (CCA) sets out the retention money scheme. Retention money is an amount held back from a payment made under a construction contract. It is generally held to ensure that a contractor performs all of its obligations under the contract and is then released either on practical completion, or after the end of a defects’ notification period.

The CCA currently requires any party to a construction contract (party A) who is withholding retention money from the other party to the construction construct (party B), to hold that retention money on trust for the benefit of party B. The retention money may be held in cash, “other liquid assets that are readily converted into cash”, or a financial instrument such as insurance or a payment bond.

If party A is placed into either receivership or liquidation, the receiver or liquidator will hold the retention money on trust and must deal with it in the same way as party A was required to. Court orders are required to administer retention moneys. However, proposed reform of the CCA will make the retention position clearer and remove the need to apply for Court orders. 

What about employees? 

Employees have preferential claims against unsecured creditors for any of the following:

• Unpaid wages or salary earned in the four months before the company’s liquidation. 
• Payroll deductions and donations deducted from an employee’s pay but not transferred by the employer. 
• Any holiday pay that had not been paid to an employee before the company’s liquidation. 
• KiwiSaver contributions, child support payments and/or student loan payments deducted from the employee’s salary or wages but not transferred by the employer. 
• Redundancy compensation if there is an entitlement in the employment agreement.

On the day that a company goes into liquidation, all employment agreements may be terminated. However, where the liquidator needs employees to continue working to generate funds for repayments, the liquidator may make arrangements with employees to enter into a new employment contract with the liquidator.  

 

If you have any questions about insolvency, please contact Alysha Hinton on (04) 471 9452 or at alysha.hinton@duncancotterill.com, or your local Duncan Cotterill advisor (duncancotterill.com). Duncan Cotterill is a full-service law firm with offices in Auckland, Wellington, Nelson, Queenstown and Christchurch.

Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.